While Chinese President Xi Jinping's vision of an economy dominated by high-tech and consumer-oriented companies may be years away, they're already standing out from their old-growth counterparts when it comes to earnings.
About two-thirds of the 54 companies in Bloomberg's index of U.S.-traded Chinese equities that have reported quarterly earnings since July exceeded analysts' projections. Approximately three-quarters of the gauge's members are technology and consumer-discretionary stocks. At the same time, more than half of 73 members of the MSCI China Index, which is heavily weighted with industrial and financial shares, missed earnings estimates.
That divergence comes as China's gross domestic product expansion is slowing to the weakest pace in 25 years. The government has ended its decades-long one-child policy to boost consumer spending and signaled that consumption and services will be at the center of its growth strategy. It has taken unprecedented steps — from subsidies to venture capital financing — to promote Internet, technology and innovation as growth engines.
The pattern in earnings can be a helpful guide for U.S. investors, many of whom have reduced the total amount of money they have in Chinese assets and are considering areas that show greater potential for growth, according to Ella Ji, an analyst at China Renaissance Securities Inc. "The pie is definitely getting smaller," she said by phone last week. "But if they are investing in China, they'll certainly pick leading companies with solid earnings related to the new rather than old industries to offset the economic uncertainties."
Back in August, a rout in the mainland market wiped out more than $5 trillion of equity value and also triggered a selloff of Chinese shares traded in the U.S. Technology companies have driven a 36 percent rebound in the Bloomberg gauge of Chinese ADRs from this year's low in September. That compares with a 9.6 percent gain on the MSCI China Index from its bottom.
The MSCI Inc. last month added 14 U.S.-traded Chinese technology companies to some of its largest indexes, allowing a broader pool of investors to buy stakes in companies such as online retailer Alibaba Group Holding Ltd. or search engine Baidu Inc.
Their share prices are moving up in step with improved earnings. Chinese online travel retailer Ctrip.com International Ltd., education service providers New Oriental Education & Technology Group Inc. and TAL Education Group, and online game operator Netease Inc. were among the five best-performing ADRs since July 1, each rallying more than 20 percent. All have reported better-than-expected revenue for the last quarter.
"It's not that everything is great in the world or in China, but these are companies that are well positioned in the right sectors," said Gabriel Wallach, founder and portfolio manager at North Grove Capital LLC in Boston, whose largest holdings of Chinese companies is Ctrip. "We're not betting on the old economy, or you want to call it industrial, to recover any time soon."
China's manufacturing conditions in November slipped to the weakest level in more than three years. Car service companies Bitauto Holdings Ltd. and Autohome Inc. were two of the ten worst-performing stocks on Bloomberg's China ADR index, plunging more than 35 percent since July 1. Both announced their fourth-quarter sales guidance lower than analysts' projections for the first time in a year, with gross margins dropping to the lowest level since 2015.
Some investors worry that China's Internet sector is still at the stage of inception. Fierce competition is also squeezing profit margins as companies burn cash to gain market share. Hedge funds, for example, reduced their holdings of China's biggest e-commerce companies during the third quarter.
"Although investors are no longer taking China with an one-size-fits-all approach, it will take a bit of time for the technology sector to grow," said Chiheng Tan, an analyst at Granite Point Capital Inc. by phone from Boston. "Only when the scale of the industry becomes big enough, profitability and margins might catch up with pace of the revenue."