In one of the most salient developments in emerging markets over the past several years, the information technology sector has emerged to represent the largest slice of the benchmark MSCI Emerging Markets Index.
The sector, which accounted for just one-tenth of the index's market capitalization in 2008, now has a 27% weighting. The weighting of commodity-related stocks has meanwhile fallen to 14% from just over one-third.
Asia, which makes up two-thirds of the MSCI index, dominates the emerging markets technology sector. The four biggest developing market stocks are Asian tech companies, known collectively as "STAT": South Korea's Samsung Electronics, Chinese internet duo Tencent Holdings and Alibaba Group Holding, and Taiwan Semiconductor Manufacturing.
Asia's tech sector has consistently outperformed the region's benchmark for the last six years, surging nearly 17% last year compared with a 5.4% rise for emerging Asian equities as a whole and an 11.1% increase for the broader emerging markets index. In the first half of this year, Asian tech stocks skyrocketed 35.4%, fuelling both a 23% gain in the region's benchmark and a 18.4% rise for emerging market shares.
This rally has underpinned the nearly $50 billion of inflows into emerging markets equity funds this year, a marked change from the heavy outflows seen over the past four years. Equity markets in developing economies have fared better than bond markets, which suffered a spate of outflows in early July due to hawkish comments from some of the world's leading central banks.
However, the Asia tech-led rally comes amid concerns about the high valuations of U.S. tech stocks. On July 19, the S&P 500 technology index surged past the peak set in March 2000 amid the dotcom bubble. On July 27, global tech stocks came under strain as shares in Amazon.com fell after weaker-than-expected second quarter earnings.
According to Bank of America Merrill Lynch's latest global fund manager survey, exposure to the tech-heavy Nasdaq Stock Market was cited as the most "crowded," or riskiest, trade in markets for the third month in a row.
Emerging Asia's tech companies, however, are quite distinct from their U.S. peers.
Unlike the so-called "FANGs" -- the quartet of Facebook, Amazon, Netflix and Google-parent Alphabet -- which has driven Nasdaq to new highs and whose business models are internet-based, Asian tech companies have more diversified businesses. According to MSCI, internet software and services has a 38.5% weighting in the MSCI Asia ex-Japan technology index compared with a 56% weighting for hardware, semiconductor and electronic manufacturing and component stocks.
On July 27, Samsung, which overtook Intel as the world's largest chipmaker earlier this year, announced a record profit of $9.9 billion for the April-June quarter, higher than Apple's $8.7 billion profit for the same period. The company, whose semiconductor unit accounts for half its operating profit, is benefiting from a memory chip supercycle stemming from rising global demand to power a range of devices.
Even China's biggest internet companies are more diversified than their U.S. peers, having invested heavily in online games, cloud platforms and digital media. Tencent is the world's largest video game publisher while Alibaba handles more online sales transactions each year than do Amazon and eBay combined. The scope for further growth in China, where the internet penetration rate is still only slightly above 50% compared with nearly 90% in the U.S., is huge.
Just as importantly, emerging Asia's tech stocks are cheaper than their western peers. According to MSCI, Asian tech companies are currently trading on a forward price-to-earnings ratio of less than 15, compared with nearly 18 for their U.S. counterparts. Valuations are underpinned by robust earnings growth. Credit Suisse has noted that the region's tech sector is expected to enjoy the second-strongest growth in earnings per share this year, trailing only the energy sector.
Still, a much sharper deterioration in sentiment toward U.S. tech stocks would put their Asian peers under strain. These risks were laid bare during the "tech tantrum" in early June when negative U.S. market sentiment spilled over into Asia, hitting Chinese internet and South Korean hardware stocks alike. JPMorgan Chase noted that "any misstep by the FANGs could drive a sharp sell-off" in Asia.
It is unlikely that the dramatic gains in the region's tech stocks in the first-half of this year will be sustained, particularly in view of mounting concerns about the sustainability of the rally in U.S. equities. Yet given the much sounder fundamentals of today's tech sector -- profit growth remains strong while valuations are not nearly as stretched as they were at the peak of the dotcom bubble -- a disorderly sell-off seems unlikely.
Global asset manager Pimco once warned that the outlook for the global economy, particularly emerging markets, hinged on three 'C's: China, commodities and central banks.
While all three factors remain important determinants of investor sentiment, the influence in equity markets of the commodity sector -- a key driver of growth and still perceived as a bellwether of sentiment -- has diminished significantly. As oil prices struggle to recover, Asia's tech sector is adding a new layer of resilience to emerging markets.
Nicholas Spiro is a partner at Lauressa Advisory, a specialist macroeconomic and property consultancy in London.