Is China’s STAR market the world’s most predictable market?
Volatile, unpredictable and prone to the whims of individual investors. These are comments that are often associated with China’s stock markets. When the STAR market launched in July this year, aimed at securing investment in China’s homegrown technology companies, commentators rushed to make similar claims. Many raised concerns of a bubble and over inflated, unrealistic prices. However, with third quarter results expected in October, what can the performance of the STAR market tell us about the innovation landscape and impact of the trade war in China?
The STAR market acts as one and is highly responsive to the trade war
Perhaps one of the most remarkable features is the almost identical trend lines for all STAR stocks and their responsiveness to key events in the trade dispute. Significant dates are instantly recognisable from just looking at share values. Those companies with the largest intellectual property portfolios follow the pattern most closely. Although, the rest are still incredibly closely aligned. Comparing the performance of STAR companies to Apple, who are also heavily reliant on China for their supply chain, many of the ups and downs are the same. However, the fluctuations for Apple are less pronounced and the launch of new products in September has created a buffer from the dispute which is not seen for the STAR market.
This close alignment demonstrates the importance of the global markets to Chinese technology and business. It explains why China is keen to avoid decoupling. Although STAR is becoming less reactive to the trade war. Investors are becoming desensitised to the boom and bust cycle of trade talks and tariffs, as hopes of a short term resolution fade.
Investors are taking a long-term view on the value of innovation
Although the first day of trading saw huge increases in share prices, the highest being Anji Microelectronic Tech at a whopping 400%, the market quickly readjusted and started to cool. There was no long-term bubble, just excitement at the launch of a much hyped new market. Whilst this slowing can in part be attributed to the trade war, all shares are trading at a higher price than their IPO listing. Increases range from 38% to a high of 250%. Some share values remain above day one levels, although surges were around 100% on that day, considerably lower than others.
Company valuations are based on substance
Anji Microelectronic demonstrates how the market is functioning rationally. The market has rectified the sky high end of day one valuation, but the company has still held its value 235% above its IPO listings price. The business has a strong IP portfolio with a high number of domestic and overseas patents. Given that on average 75% of a company’s value lies in its intangible assets, which includes intellectual property, the value of shares should reflect these assets.
Indeed, many of the companies on the STAR market have strong domestic, if not overseas IP portfolios. Taking all the companies listed as a whole, over 40% of trade marks and over 20% of patents are filed overseas, indicating developing strengths in global markets. However, this alone is not a recipe for success.
Many of the market leaders also have high R&D spend or significant numbers of R&D staff. Anji Microelectronics spend 20% of their turnover on R&D and 36% of staff are engaged in those activities. Given the importance of innovation in retaining control of markets and capturing new ones, it is right that these indicators are reflected in investors’ decisions.
The Chinese Government has created a culture which rates innovation highly
Acknowledging the importance of R&D reflects the Chinese Government’s whole system approach to drive innovation which is booming. China ranked 14 in this year’s Global Innovation Index. A meteoric rise from 35 in 2013.
Many of the STAR companies have grown-up in national innovation zones such as Zhangjiang High Tech Park in Shanghai. These parks, found across China, create incubation spaces and business taxes for new companies at favourable rates; provide a flow of Government backed Venture Capital; and a focus on sectors where there are existing strengths in the local economy.
The trade war will drive increased investment in innovation. This could be one of the most crucial factors in Anji Microelectronics’ valuation, as they undertake semiconductor R&D, where China is now actively seeking to improve its own capabilities.
China is becoming a world leader in technology
Although China has priorities for technological development, it must not be forgotten that China has already made great progress. In many fields, China is considered to be world leading and not just copiers of technology.
This is reflected in the STAR market companies. As well as STAR companies building their technologies on patents filed in other countries, companies in other countries are basing their innovations on patents filed by STAR market entities. What might be surprising is that Japan is the country most often cited in STAR market patents, ahead of the US and China coming in third. Whereas the US holds the number one spot for citing STAR patents with China second and Japan third.
STAR: A market to watch
The STAR market is not as unpredictable as some had anticipated. Although it is immature and the market size is small, it should not be ignored. With companies representing emerging high-tech fields and building strong intellectual property portfolios, it should become a highly functioning market with meaningful valuations based on intangible assets. The STAR market should be closely monitored by investors and those seeking to understand China’s capabilities to do business there.
Figure 1 - Diagram showing the value of top 10 IP intensive STAR companies and Apple compared to close price on day one of the STAR market (21 July 2019). Data and char courtesy of Financial Times.