COVID-19 has created clear winners and losers. Now one of the areas that stands out as a key beneficiary, is technology.
And that’s been reflected in some pretty impressive stock market returns in the area. Now this has raised some concerns about whether we’re in another tech bubble. In our view, this isn’t the case in most areas of technology in emerging markets. I’ll now hand over to Portfolio Manager, Guido Giammattei, who will provide some more insights into his research on the topic.
Thank you, Dijana, for the introduction.
Global equity markets, including EM equities, have seen a strong recovery since the bottom in March. But the breadth of the market has been incredibly narrow and technology stocks have accounted for the lion’s share of this recovery. For example, it could surprise most to know that two of the largest technology companies in the U.S. have now a combined market capitalization larger than all of the companies in the STOXX 50 European Equity Index. Yes, that is a market cap larger than the top 50 listed companies in Europe. The stock performance of technology stocks globally has prompted many investors to speculate tech stocks may be in or on the verge of another asset bubble, similar to that of 2001. So in this webinar, we’re going to look at some charts in the attempt to answer that question. So whether there is or not a tech bubble. But we’re also going to look at our crystal ball and provide a view on the outlook for tech stocks and their role in emerging markets from an equity standpoint. A good place to start to determine if we are in a bubble, is to find the definition for it. A commonly accepted one is a dramatic rise in price over a short period of time that is not supported by the value of the product. Which suggests to us we should try to look at two factors, price performance and valuations, to see if we are in a tech bubble. So in answering that question, we see three key reasons supporting the view EM tech is not in a bubble. First, if we look at tech stocks performance, and we will look at some valuation charts on the next slide, EM tech performance has been strong, but not that strong. DM tech stocks have appreciated by 145% and EM tech stocks have gained 52% over the last five years. When we look at some of the most well-known asset bubbles that have occurred over the last 50 years, like gold in the ‘70s, the Nikkei in the ‘80s, the dot-com bubble in 2001, or the U.S. housing market at the beginning of the millennium, prices were up in the range of 600% to 800% in a very short period amount of time. So, for example, during the last tech bubble in 2001, the Morgan Stanley composite index information technology increased by 700% in only 18 months preceding the burst of the bubble in 2001. So we can see from these charts that this is not the case now. Performance has been strong, but far from extreme. Secondly, not all tech is equal, as can be seen on the chart on the left-hand side. We have broken down the global tech industry into its four main areas, information technology, IT services, internet and e-commerce, and finally software. By doing this it appears even more evident that performance is far from extreme. In fact, some tech areas, like IT services, and perhaps to a lesser extent also internet and e-commerce, have actually been kind of weak in the last couple of years. EM software, the strongest of the segments, is a very small area comprised only of literally a handful of Chinese A shares. And thirdly, EM tech has not done as well as the developed market tech. Performance has been normal. Now moving to valuations, the second area that based on our definition of a bubble will help us form a view on whether there is a bubble, we have looked at the broad range of valuation metrics. In this slide, we can see on the left-hand side the historical price-to-earnings ratio for emerging market tech stocks. Likewise performance, EM tech valuations are far from extreme and they’re actually in line with their long-term averages. Except, once again, for the EM software segment which, as mentioned earlier, is a very small area within emerging markets technology. Also worth noting the chart on the right-hand side that EM tech stocks still trade at a decent discount to developed market stocks. In terms of the outlook for the tech sectors, every data point that we look at suggests to us that the trend is still favourable. Data has become the new must- country’s strategic resource for competitiveness. It has replaced what the oil and mining products represented in the ‘90s and in the best part of the 2000s. Potentially meaning an emerging tech war is a new geopolitical battleground. This is likely to lead to localized IT infrastructure. This seems particularly true in the case of China. And as a consequence, a possible duplication of IT supply chain and a very steep acceleration in technology investments, which is very supportive for a demand for tech products and services. The chart on the right-hand side shows that China is the largest consumer of semiconductors globally, and imported over $300 billion of semiconductor products, while only producing $24 billion. This is an 85% deficit and it poses significant risk to China. And as such, the country set the policy target of reaching at least 40% but up to 70% self-sufficiency ratio in semiconductors by 2025. China is very determined to become self-sufficient in sales. In fact we can see on the chart on the left-hand side that they went from 5% to nearly 20% in five years. And now over the next five years, they want to reach up to 70%. They also want to become self-sufficient in many other tech areas, which means that there will be plenty of demand for IT hardware and services for EM companies. Also the growth and sheer size reached by Asia in emerging markets in terms of internet users, supports a positive outlook for emerging market stocks. On this slide we see about half of the world internet users are in Asia and two-thirds of them are in emerging markets. So EM clearly represents a very large and attractive captive market for local tech companies. And this is clearly also supported for the outlook in terms of growth. Now finally, emerging market equities offer a good way to participate to this trend. The tech industry has become the largest industry in the context of emerging markets’ capitalization. And I think this represents an improvement in the sectoral composition of emerging markets’ equities. The higher-quality consumer in the IT sectors have become much more significant at the expense of the commodity sectors, as we can see on the chart on the left-hand side. This sector stand to have higher return on equities and more stable earnings roof. So the tech industry in particular, which as I mentioned has become the largest industry in the context of EM, has OEM market cap, has and is expected to drive the majority of the earnings growth. And, for example, all-in 2020, the industry will drive over 50% of the earnings growth for emerging markets equities. So to conclude, price performance and valuations don’t support the view that there is a tech bubble, at least not for emerging market stocks. Clearly not all tech stocks are equal. But on an equity basis, the need to be of a strong digital infrastructure has become key for any country and any business from a competitive standpoint. And this, in our view, supports a favourable outlook for emerging market tech stocks.
Thank you, Guido, for your insights. And thank you for joining another episode in our future of emerging markets series. For further information, please contact your local RBC representative.