The bounceback in Chinese stocks from their multi-year lows risks running out of steam unless the nation’s tech giants can deliver on their earnings next week.

Index heavyweights Tencent Holdings Ltd and Alibaba Group Holding Ltd both publish results next Tuesday (May 14), followed by JD.com Inc and Baidu Inc two days later. Those four firms alone represent more than a quarter of the MSCI China gauge.

The earnings scorecards come at a crucial time for the nation’s key stock gauges that recently entered a bull market but are still some 40%-to-60% below their highs set in early 2021. A key question is whether the rebound - driven in part by cheap valuations and a rotation away from Japan - is durable or will once again be punctured by disappointing results. 

“If we do see these earnings coming through, the momentum will carry on,” said Sean Taylor, chief investment officer at Matthews Asia in Hong Kong. “At the moment, we have signs that earnings are being downgraded less.”

Chinese tech companies are something of a bellwether for the nation’s entire stock market as they have tentacles stretching through the economy from their online sales, advertising and mobile games. The rebound in their shares - mainly due to the renewed interest from global funds in China’s biggest and most liquid stocks - faces an earnings test as many are now technically overbought.

Tencent is forecast to report a 6% increase in revenue for the quarter through March, while Alibaba’s sales are predicted to rise by 5.6%, according to average analyst estimate compiled by Bloomberg.

The early earnings data haven’t been entirely favourable. Chinese firms have so far delivered a “sizable miss” in first-quarter (1Q) results, though there’s been a sequential improvement from the previous three months, Morgan Stanley said in a client note last week. 

The US bank warned against chasing the rally in Chinese stocks at the index level due to technical overbought signals and ongoing pressure on corporate earnings. “We expect the rally momentum to abate,” strategists Laura Wang and Jonathan Garner wrote in a note on Tuesday.

MSCI China Index members that have already announced 1Q numbers have recorded an average 3% decline in earnings per share from a year earlier, with real estate, utilities and materials firms the worst performers, JPMorgan Chase & Co also said last week.

There’s still room for optimism though as tech companies were some of the best performers last year in boosting profits. Forward earnings estimates for an MSCI Index of 100 Chinese tech firms climbed about 20% in 2023, even as forecasts declined for other industries, data compiled by Bloomberg show.

The sector is also still relatively cheap even after the Hang Seng Tech Index’s 13% gain since the end of March. While the forward price-to-earnings ratio has risen to 16 times, it’s still below the one-year average of 18, and well short of the five-year mean of 26.5.

Traders have been quick to jump on positive business developments. Tencent’s shares have been boosted by news the company is set to release the long-awaited Chinese version of Nexon Co’s Dungeon & Fighter mobile game this month, a title that will help revamp its ageing portfolio. The stock of Xiaomi Corp climbed to a two-year high after the smartphone maker announced better-than-expected initial orders for a new electric vehicle.

Still, investors say they need to see sales growth to add to their conviction toward tech. Results from both Tencent and Alibaba missed analysts’ estimates for the fourth quarter, and there’s concern about China’s disappointing retail-sales data published last month.

“The overall backdrop of the internet industry hasn’t been consistently strong,” said Vivian Lin Thurston, a fund manager at William Blair Investment Management in Chicago. E-commerce firms, as a proxy for China’s overall retail market, are unlikely to see a robust recovery just yet, she said.

Skeptics also say the profitability gains have been mostly fueled by cost cuts rather than rising sales or greater pricing power.

“Even though there’s always room for cost reduction, it’s not a sustainable source of earnings growth,” said Nicholas Chui, a fund manager at Franklin Templeton Investments in Hong Kong. “Rightfully, investors are on the lookout for more repeatable sources.”
 

  - Bloomberg