Gauging China's tech crackdown Gauging China's tech crackdown http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\beijing-china-skyline-small.jpg August 20 2021 August 2 2021

Gauging China's tech crackdown

After sentiment plummets, China appears keen to reassure investors.

Published August 2 2021
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The market’s response to a series of regulatory actions by China against some of its high-profile tech companies has been swift and severe. Given already extreme tensions between the U.S. and China over trade and data security, it’s not surprising these latest moves are feeding the perception this could be part of a bigger trend that ultimately could mark the end of profitability for China’s Big Tech companies. Putting the emotions and headlines aside, here’s our take:

  1. These events are not part of a coordinated move against private enterprise Understandably, China’s regulatory actions against some of the world’s most valuable companies are considered extreme. Their common threads involve antitrust issues, data security concerns and conglomerate control over enormous stores of consumer information. Meanwhile, the country’s actions to transform private education companies into nonprofits has heightened worries over its use of heavy-handed state control. But given China’s dependence on a growing, flourishing economy, especially in the wake of challenges from the Covid-19 pandemic, we don’t believe these actions represent an overarching decision to restrict opportunity or stifle entrepreneurship.

    Keep in mind that Western economies have a long history of operating within a free enterprise system and have created well-developed regulatory structures along the way. China’s comparatively recent entry into this system started with an almost hands-off approach that gave its tech pioneers a tremendous runway for growth. China is now confronting issues that come when startups become juggernauts and gain outsized influence and control in the marketplace—issues with which the U.S. and Europe are very familiar.

    China’s move against online tutoring and test prep companies comes in response to a growing education arms race that pressures parents financially and students emotionally. The government believes these tutoring services are only helping students become better test takers, without significantly supporting their intellectual advancement. The thinking is that this isn’t the most effective way for students and families to spend their energy and resources, so directing their time and money elsewhere is good for society overall.

  2. China wants to eliminate any perception that it’s moving against free markets While Chinese authorities won’t directly acknowledge any error or overreach related to their regulatory decisions, its state media outlets are taking strong steps to clarify regulators’ intentions. These communications all emphasize China’s desire to strengthen its anti-monopoly stance to foster more business opportunities and competition, welcome foreign investment and deepen capital market reforms to ensure better disclosure, more market-oriented underwriting and improved investor protections.

    Regulators in Beijing held a call last week with executives from global investment firms, Wall Street banks and Chinese investors to reassure them that China remains committed to allowing companies access to capital markets and that its action on its online education businesses was an unrelated, isolated situation.

  3. Disruption presents opportunity Although investors have reason to be cautious when it comes to some of China’s Big Tech firms, their fundamentals remain solid and prospects attractive—even as their valuations have plummeted.

     Meanwhile, here are three trends that are likely to accelerate in China: 

    • Green energy Although cost factors have presented obstacles, China still aims to derive 16.5% of its power consumption from solar and wind by 2025. President Xi Jinping’s stated goal is to have a quarter of energy consumption come from non-fossil fuel sources by 2030. We see strong opportunity in China’s battery and electric vehicle manufacturing industry, including upstream components, equipment and materials suppliers.
    • Localization of the tech supply chain Looking ahead to the proliferation of artificial intelligence and Internet of Things, among other digital developments, China has mandated internal development of smart sensors, semiconductors and chips that support these technologies. These capabilities will play a critical role in smart manufacturing, smart industrial support and autonomous driving networks.
    • National brands Tensions with many Western countries are driving a growing sense of national pride among Chinese consumers who are showing a greater preference for national brands and eschewing previously favored foreign names.

    We don’t underestimate the challenges of navigating this very fluid, unpredictable situation. It’s clearly times like these when our on-the-ground research and first-hand knowledge of China’s companies, their management teams and the markets in which they operate support us in weighing every risk in our search for long-term opportunity.  

    Tags International/Global . Markets/Economy . Equity .
    DISCLOSURES

    Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

    International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

    Federated Global Investment Management Corp.

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