Despite near-term headwinds, the long-term prospects for both Chinese internet platforms and Asian consumer electronics remain intact, and stand to benefit once the Chinese and developed market economies improve.
Tai Hui
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In brief
- Chinese internet companies are starting to adapt to the new regulatory environment
- Demand for consumer electronics and semiconductors looks set to soften, but this is already partly reflected in the equity valuations
- Despite near-term headwinds, the long-term prospects for both Chinese internet platforms and Asian consumer electronics remain intact, and stand to benefit once the Chinese and developed market economies improve
Chinese internet platforms are learning to live with new regulations
Technology is an important part of the Asian market. China’s internet platforms have taken a hit in the past 18 months on the back of regulatory reforms. These companies are making adjustments to their business models and cost base and should return to better earnings prospects by 2023. In contrast, consumer electronics and semiconductor manufacturers have shown great resilience during the COVID-19 pandemic. However, with the prospects of weaker corporate spending in the developed economies, and as developed market consumers switch spending from goods to services, the outlook could be more challenging for hardware.
The Chinese technology sector reform focused on a number of themes, including tackling monopolistic behavior and squeezing out the competition, adequate pay and social security coverage for delivery riders, limiting minors’ time spent on video games, and customer data protection. While some of these policy objectives are not unique in China, the timing of announcements surprised the market. This raised questions about the long-term profitability of these companies, and whether these rules would discourage innovation.
Since 2Q 2022, the Chinese government’s tone on the sector has shifted and focused on promoting its healthy development. This was regarded as supporting the need for the internet and platform economy to continue developing. Companies have adjusted their business models to comply with regulations and cut costs to improve profitability. Hence, the regulation headwinds have become less challenging. Improvement in the macroeconomic environment, especially in domestic consumption, could provide a much-needed lift to these companies’ earnings outlook.
Exhibit 1: South Korea and Taiwan manufacturing Purchasing Managers’ Index (PMI) softened recently
Markit Manufacturing PMI, seasonally adjusted
Source: FactSet, Markit Economics, J.P. Morgan Asset Management.
Data reflect most recently available as of August 8, 2022.
Semiconductor and consumer electronics could face some cyclical headwinds
Contrasting against Chinese internet companies, consumer electronics and semiconductor sector were boosted by strong global consumer demand during the pandemic. Consumers under lockdown demanded more gadgets for work and entertainment. As more economies reopen, this consumption pattern is flipping back to greater demand for services, and less for goods. Moreover, the prospects of weaker economic growth are undermining corporate demand.
Taiwan’s July manufacturing PMI fell to 44.6, and this was the steepest month-over-month decline since 2012. The new order sub-index fell to 36.6, the lowest since May 2020. South Korea’s manufacturing PMI also fell below 50 for the first time since September 2021, consistent with a contraction in overall manufacturing activities. Its new order component also dipped below 50.
This softer demand and more conservative inventory controls could continue in the months ahead. Taiwan could be in a slightly stronger position given its top semiconductor producers are foundries and therefore in a better position to seek customers from a broader range of business.
Investment implications
Taiwan and South Korea have underperformed year-to-date relative to more domestically driven markets, such as Southeast Asia and India. Both markets’ valuations (12-month forward price-to-earnings ratio) are already trading at the bottom of a multi-year range. Hence, we believe a large part of the challenging outlook for consumer electronics and semiconductor is captured in the current valuations. A catalyst could come once the U.S. and European economic cycle improve once again.
For Chinese internet platforms, the regulatory environment should start to stabilize and allow for a more predictable environment for companies to plan for the future. A cyclical rebound in the Chinese economy should also help to improve their revenue outlook.
Despite some short-term headwinds in both cases, these challenges are already largely factored in, and we believe that the long-term structural factors for these areas remain constructive.
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