US Technology stocks have had a volatile start to the year due to ongoing trade war threats, rising user privacy concerns on social media and tech bubble fears.
But Citi analysts believe that comparisons to 1999’s tech bubble burst are wide off the mark.
Unlike 1999/2000, the Technology sector’s current valuation of 22.6x price-to-earnings (PE) is lower than the 65.7x PE in 1999 – a far milder valuation risk.
The changing face of EM
Emerging Market (EM) equities have historically underperformed compared with developed markets (DM) during market corrections.
In the last eight DM corrections, MSCI EM equities, on average, underperformed global equities by 4% in US dollars.
However, EM equities held up relatively well in the Q1 2018 equity sell-off, outperforming global equities by 1%.
Citi analysts believe that EM’s current resilience is largely attributed to the changing composition of EM equity indices, moving away from old economy sectors including Energy and Materials towards new economy sectors such as Technology (see Chart 1).
In 2008, Energy and Materials made up 34% of the EM index. In 2018, these two sectors represent less than 15% of the index.
Technology has become the largest sector, representing 28% of the EM index, up from 10% in 2008.
Chinese technology in focus
The largest EM Asia technology companies are from China, Korea and Taiwan. Asian technology companies operate in a supportive regulatory environment.
In China, for example, domestic firms have imposed self-censorship adhering to government requirements. In exchange, the firms are allowed significantly less regulatory controls than tech firms in other markets to operate in areas including financial transactions, foreign acquisitions and intellectual property.
China has also shown potential leadership in the Fourth Industrial Revolution (FIR), which is the fourth major industrial era combining mobile connectivity and artificial intelligence to change the way people live and work.
China’s position as a frontrunner in the FIR is supported by an abundant supply of talent, a supportive government and ample financing.
Chinese tech giants such as Tencent and Alibaba are also highly innovative and diverse by global standards as they have moved on from merely being apps or marketplaces to developing vast ecosystems differing from platforms in Western markets.
EM Asia Technology performance
EM Technology represents about 18% of the global Technology sector (on which Citi maintains an overweight call as it recorded the best performance in 2017) and is the cheapest among regions.
Supported by favorable regulations and innovative players, EM Asian tech valuations are at a 32% discount to DM.
While EM Technology returned an impressive 65% since 2017, valuation multiples have only increased from 17.5x earnings in January 2017 to current levels of 18.1x.
Developed market technology share prices, by contrast, have outpaced their earnings by almost 17% over the same time period.
Among the largest technology names, EM Asian companies are growing faster while trading at lower valuations than their US counterparts.
The largest DM Technology companies trade at an average valuation of 36x 2017’s earnings compared with 30x for EM Asia’s largest firms.
The largest Asian technology companies’ earnings grew 3.3x more on an average percentage basis than US tech earnings-per-share growth.
Citi advocates investing in technology’s lasting industry disruptors as the longer-term prospects for EM Asian technology appear even stronger than in other regions.