Just four Internet stocks account for more than half of the MSCI China Index’s 22-per-cent rally this year. Tencent Holdings Ltd. and Alibaba Group Holding Ltd. have led the charge, surging at least 40 per cent, followed by JD.com Inc. and Baidu IncAFP / Getty Images
China is having its own FANG moment.
Just four Internet stocks account for more than half of the MSCI China Index's 22-per-cent rally this year. Tencent Holdings Ltd. and Alibaba Group Holding Ltd. have led the charge, surging at least 40 per cent, followed by JD.com Inc. and Baidu Inc. That's helped lift the index's valuation to levels last seen in 2010.
While a love for technology shares worldwide is boosting other major benchmarks, such as the S&P 500 index, none are so influenced by so few stocks this year. As evidence of the distortion: An equal-weighted version of the MSCI China, one that strips out market-value biases and gives Tencent the same influence as logistics-provider Sinotrans Ltd., is lagging the actual index by the most in almost four years.
Even after a reversal of fortune crushed a similar trade in the U.S. last year, soaring sales have left China analysts and investors confident for now.
"The momentum here is all about extremely strong earnings," said Hao Hong, Bocom International Holdings Co.'s chief strategist in Hong Kong. "Nobody's going to rush out the door. The leading tech stocks with larger market share, good earnings visibility and good cash flow will continue to do well."
Tech stocks command some of the highest price-to-earnings multiples on the MSCI China, though valuations for both Tencent and Alibaba are far off their 2014 peaks. Hong Kong-listed Tencent last week reported record sales, buoyed by demand for games among its billion-plus users on WeChat and QQ, prompting analysts to raise their target prices on the stock. Alibaba's first-quarter revenue rose at a faster-than-expected pace of 60 per cent.
JD.com, a U.S.-listed e-commerce firm that's up 60 per cent in 2017, just posted its first quarterly profit as a public company. Revenue for Baidu, China's biggest online-search provider that has gained 17 per cent, is forecast to jump 21 per cent this year.
Herd mentality can have its pitfalls. In the United States, the FANG block of Facebook Inc., Amazon.com Inc., Netflix Inc. and Google parent Alphabet Inc. trailed the market last year for the first time since Facebook's initial share sale in 2012.
In Hong Kong, sudden plunges among high-flying technology shares are causing jitters. AAC Technologies Holdings Inc. has tumbled 28 per cent from its April record after a short seller questioned the Apple Inc. supplier's accounting. Tongda Group Holdings Ltd. sank as much as 19 per cent on Tuesday after short interest rose to a record, according to IHS Markit Ltd. data.
"It's risky when the whole market's underpinned by a handful of large caps," said Ben Bei, CIMB Securities Ltd.'s director of Hong Kong and China strategy. "You just need one bad earnings report for sentiment to turn."
For now, there's little sign of the love-in with Chinese technology shares ending. The MSCI China technology gauge is near a record high, while Tencent – projected by analysts to gain another 10 per cent in the next 12 months – is closing in on Exxon Mobil Corp. in terms of market value.
Fund managers say going long technology stocks has become the most-crowded trade globally, according to a Bank of America Corp. survey published May 16. Worldwide, the industry group has rallied 20 per cent this year, topping all other sectors on the MSCI all-country world index. In the United States., the Nasdaq composite index is just points shy of a record.
For analysts at China International Capital Corp., profit growth will continue to provide a bull case for MSCI China technology shares. They say earnings made up more than 40 per cent of the sector's stock gains since March.
"A solid contribution from earnings means that the market has fundamental support rather than just unrealized expectations," CICC analysts including Hanfeng Wang wrote in a May 22 note. "We expect the earnings recovery to continue."