China's Tech Rally Is Missing This Key Ingredient

One of the most hated corners of the market has had a good run lately.

I'm talking about Chinese stocks... and more specifically, Chinese tech stocks.

The Hang Seng Tech Index – a key index that tracks this corner of the market – was up as much as 27% from its April low.

The massive rally outperformed the S&P 500 Index by nearly four times during that period. And it propelled Chinese tech stocks into a new bull market.

But is it a real bull market?

Generally, markets are in a bull phase whenever prices rise at least 20% from their lows. But Chinese tech stocks have had their fair share of false starts...

In the past two years, the Hang Seng Tech Index saw gains from its lows that far exceeded 20% three different times... And it also fell three times, giving up most of those gains.

So despite the repeated sizeable rallies, the index is still down two-thirds from its February 2021 all-time highs. The index has essentially taken one big step forward and two steps back.

That's a disappointing turnaround. The latest rally looks like it's starting to peter out, too... And you might feel like Chinese tech stocks are only bouncing back whenever they become deeply "oversold," as they were in January.

But as I'll explain today, we're seeing a potential light at the end of the tunnel for investors...

The "stop and start" behavior in Chinese tech stocks isn't random. There's good reason for it. And it has little to do with China's growing concern over U.S. government regulations.

It boils down to growth – or the lack thereof.

China has been going through one of its worst economic crises in 50 years. It's due to a steep decline in the country's real estate market... which historically accounted for 25% to 30% of its gross domestic product ("GDP").

Sales in China's property market fell 20% from 2021 to 2023. And new-development volumes are down a stunning 58% over the same period.

When such a major part of the economy slows down this much, it has knock-on effects on other parts of the economy...

For example, less new-home construction leads to lower revenue for construction-related firms... and lower employment in both real estate and construction industries.

That trickles down to suppliers of copper wire, PVC pipes, cement, floor tiles, paint, and windows. It also hits businesses that supply furniture, lighting, fixtures, and appliances.

In other words, a severe slowdown in real estate impacts a wide range of industries... including tech. Lower consumer spending hurts this industry. And we're already seeing the effects in some of China's leading tech companies...

Alibaba (BABA), the "Amazon of China," grew revenues by only 1.3% in the first quarter of 2024. (JD), the country's second-largest e-commerce player, only managed a 1.6% year-over-year increase in revenues in the same quarter.

Digital entertainment giants Tencent (TCEHY) and NetEase (NTES) posted similarly slow growth... 5.1% and 2.7%, respectively.

And search engine and artificial-intelligence leader Baidu (BIDU) did even worse... It hardly grew at all – increasing 1% year over year.

As recently as 2021, these companies were all growing revenue at double-digit rates, some much faster. And the slowdown in growth is something that should have investors worried.

China's economy – particularly its property market – needs to do a lot better for growth to pick up. But it doesn't mean this latest surge in Chinese tech stocks is over...

Beijing is now doing a lot more to help its ailing property market. In mid-May, the People's Bank of China announced that state banks and developers would buy up $41.5 billion in unsold properties all around the country.

Beijing also ordered banks and local governments to reduce interest rates and down-payment ratios, while lifting long-standing purchase restrictions in key cities like Shanghai, Shenzhen, and Guangzhou.

The International Monetary Fund also recently upgraded its 2024 and 2025 growth outlook for China's economy. The country's GDP is expected to grow 5% this year and 4.5% next year. Both numbers beat previous estimates by 0.4 percentage points each.

Overall, things are starting to look better for China. And while it's too early to tell whether these new measures will significantly help the property market, they're the strongest measures Beijing has approved to date.

That signals a shift in policy... and shows that things are likely to go from "bad to less bad" in this corner of the market.

So don't give up on Chinese tech stocks just yet. This is an area of the market you should keep an eye on this year.

Good investing,

Brian Tycangco

Further Reading

Hong Kong stocks rallied for 10 days straight in early May. That kind of winning streak is incredibly rare. But according to history, more gains are likely in the future... Read more here.

Beijing reintroduced its "guardian angels" to China's stock market earlier this year. These state-owned companies have successfully stopped the bleeding in Chinese stocks before. And their latest crusade could help prices finally find a bottom... Learn more here.