(Bloomberg) — China tech stocks are benefiting from signs of an economic recovery and will rise again if profits rise, according to an analyst who previously questioned the sector's investibility.
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Alex Yao, co-head of TMT research in Asia at JPMorgan Chase & Co., said shares have taken a breather after a rally earlier this year but still have room to rise another 20% to 25% as fundamentals such as costs and competition improve. Yao wrote in an April report that the sector has bottomed out.
“If this industry can grow profits at 10 percent or 20 percent over the long term, I think people should reward that profit sustainability,” Yao said in an interview last week.
Technology bellwethers such as Tencent Holdings Ltd. have led a rebound in Chinese stocks as the Chinese government has shifted its focus from broader restrictions to supporting the economy. That has prompted global funds to raise their holdings, but stocks have given up some of their gains over the past month as investors wait to see improving earnings and stronger policy support before investing more.
The Hang Seng Tech Index, which tracks China's major technology stocks, rose 38% from a low in January to a high in May. It has since fallen about 8%.
“From a top-down perspective, once the macro economy recovers, e-commerce stocks will benefit from a cyclical recovery in consumption,” Yao said. “The theme here is China's macroeconomic stabilization.”
Macro Indicators
Investors are closely monitoring data coming out of China, including consumption growth, inflation and property market trends, for clues about the strength of the country's economic recovery. “Macro indicators showing early signs of stabilization” have been the main driver of the sector's rally so far this year and will be a key factor in how stocks move going forward, he said.
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China's growth remains very uneven — the country's housing slump deepened in May and industrial production fell more than expected — but improving consumption and strong exports are offering some encouragement to traders.
Two years ago, Mr. Yao surprised markets by downgrading 28 companies, including Tencent Holdings Ltd. and Alibaba Group Holding Ltd., citing geopolitical and regulatory risks. He raised some of the stocks' ratings just two months later, but “uninvestable” has become a catchphrase that has remained closely associated ever since.
The analyst currently rates stocks including Tencent, Alibaba and Meituan at overweight.
To be sure, the rally in tech stocks could be choppy given that sentiment for Chinese stocks remains weak. Investors are also concerned about geopolitical risks and the potential impact of a sharp price war in China's emerging artificial intelligence market.
“What's most important is that the sector will demonstrate consistent and healthy earnings growth,” Yao said. “And if it can deliver that from a fundamental perspective, the sector remains very attractive.”
(Adds Hang Seng Tech Index performance in fifth paragraph)
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