China’s Tech Clampdown Herds Investors Into Hardware Stocks

(Bloomberg) -- Asia’s hardware technology stocks, led by chipmakers, are getting back in the spotlight as China’s regulatory onslaught casts a shadow over some of the region’s biggest and hottest software names.

The MSCI Asia Pacific Information Technology Index that includes the likes of Taiwan Semiconductor Manufacturing Co. and Samsung Electronics Co. jumped 3.2% this week, the most since January. In contrast, the MSCI Asia Pacific Communication Services Index dominated by consumer Internet giants such as Tencent Holdings Ltd. fell for a third week. The gauge tumbled almost 12% in July, its worst monthly performance since 2008.

The widening divergence between the two sectors is predominantly the outcome of Beijing’s effort to reshape its technology industry by reining in Internet behemoths deemed to pose a threat to financial and social stability. Also part of its broader industrial policy, China’s ambition to achieve semiconductor independence and use advanced manufacturing to power its economy is a big long-term positive for some of the region’s leading hardware firms.

“Part of the attraction of hardware tech has been that there is visibility and outperformance in the latest round of earnings that we have seen,” said Zhikai Chen, head of Asian equities at BNP Paribas Asset Management, adding that the firm has been overweight hardware manufacturers since the start of the year.

“Until the regulatory uncertainties clear up, there is probably little likelihood of consumer tech outperforming.”

Favorable market dynamics induced by the pandemic -- including work-from-home needs, supply chain disruptions and growing automation -- also bode well for prices of memory chips and other key products. The contrasting performance of the two sectors helped TSMC briefly dethrone Tencent as Asia’s most valuable company earlier in the week.

The rout in Tencent shares extended this week -- taking their year-to-date loss to 20% -- driven by fears that Beijing’s escalating regulatory assault may see it next target the world’s largest gaming arena. That inflicted pain on the firm’s Japanese peers as well.

Chinese social media company Kuaishou Technology also joined the selloff as an influential state-backed newspaper urged tighter regulation of Internet video content, underscoring the extent of investors’ fears about a widening Chinese online crackdown.

In contrast, Semiconductor Manufacturing International Corp. has surged almost 30% in Hong Kong over the past two weeks, with China’s biggest chip foundry also raising its annual sales outlook. TSMC and Samsung -- which have predicted robust demand growth for their key products -- are also up this year.

“Amid the Chinese regulatory tightening on Internet companies and government support for the semiconductors industry, chipmakers are a safer bet than Internet giants,” said Jian Shi Cortesi, a portfolio manager at GAM Investment Management in Zurich. Some money has fled consumer tech in recent weeks to seek shelter in its hardware counterpart, she added.

Still, Cortesi sees opportunities re-emerging for the battered Internet firms over the long term, partly because some of the recent selling was driven by panic. While the trend could continue in the short run, investors are ignoring the high valuations of some Chinese semiconductor names and the cheapness of their large Internet peers, she said.

Meanwhile, Alibaba Group Holding Ltd. this week released quarterly sales that missed estimates for the first time in more than two years, further underscoring the impact of the crackdown on consumer tech companies.

BNP’s Chen said his firm pared some exposure to software tech. Hardware tech is more resilient than other sectors given the favorable supply and demand dynamics, he added.

“Regulatory uncertainties are causing investors to recalibrate their exposure to a certain extent,” Chen said. “As long as the chatter or fear over which sector is next on the software IT side is not resolved, I think this is probably likely to be the case for a while.”

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