Emerging Markets: Upcoming Information Technology Sell-Off?

Summary

• Since the beginning of the year, growth in Emerging Markets has been driven by the information technology sector.
• The four largest holdings in the Emerging Markets ETF - SATT have a similar problem as FAAMNG in the S&P 500.
• In the next few weeks, a sell-off of the SATT equity can be expected, following the sell-off of the FAAMNG.
• SATT and the information technology sector have strong forecasts and fundamentals which means that a sell-off may be needed as a correction before the new highs.

Globally, the information technology sector is one of the best performing sectors. The sharp increase in the price may lead to the conclusion that the sector is overvalued, resulting in a sell-off.

I view the possible sell-off as a correction and a potential buying opportunity for either iShares MSCI Emerging Markets ETF (TICKER: EEM) or SATT stocks based on the strong forecasts, fundamentals and analyst recommendations. SATT, which includes: Samsung Electronics (OTCPK:SSNLF), Alibaba (TICKER: BABA), Tencent Holdings (OTCPK:TCEHY), Taiwan Semiconductors (TICKER:TSM).

In this article, I will explain why the upcoming sell-off is a correction and a buying opportunity.

Since the beginning of the year, global equities have had outstanding performance. The MSCI Emerging Markets Index (MXEF) outperformed both the S&P 500 Index (SPX) and MSCI World Index (MXWO).

Source: Bloomberg Terminal

The largest sector in SPDR 500 Index ETF Trust ETF (Ticker: SPY) is information technology which is around 22.22% of the entire portfolio. The largest holdings of SPDR 500 Index ETF are FAAMNG stocks, which includes: Facebook (Ticker: FB), Amazon(Ticker: AMZN), Apple (Ticker: AAPL), Microsoft (Ticker: MSFT), Netflix (Ticker: NFLX), Google (GOOG) (Ticker: GOOGL). FAAMNG stocks drove the performance of S&P 500 Index and the technology sector.

The recent FAAMNG sell-off had a significant impact on the technology sector and the S&P 500 Index. While some investors see the sector as overvalued, others see the sell-off as a correction and as an opportunity to buy.

The Emerging Market ETF, iShares MSCI Emerging Markets ETF, which follows the MSCI Emerging Markets Index, has a similar problem: information technology makes up 26.56% of the portfolio. The largest top 4 holdings of the iShares MSCI Emerging Markets ETF are SATT.

Source: Bloomberg Terminal

Fundamentals of iShares MSCI Emerging Markets ETF and iShares S&P Global Tech ETF (IXN). Source: Bloomberg Terminal

• Based on its fundamentals (P/E and P/B), the technology sector is one of the most expensive sectors in iShares MSCI Emerging Markets ETF.
• While the ROE is one of the highest, the dividend yield is one of the lowest in the sector.
• Since the beginning of the year, Samsung Electronics returned 34%, Tencent Holdings 38.46%, Taiwan Semiconductor 25.58% and Alibaba 64.98%.

Source: Bloomberg Terminal

Source: Bloomberg Terminal

Since the start of the year, SATT equity became more expensive based on the P/E fundamentals:

• Samsung Electronics P/E increased from 8x to 13.709x (71%);
• Taiwan Semiconductors P/E rose from 12x to 15.06x (25.5%);
• Tencent Holdings P/E rose from 35.47x 47.82x (34.81%);
• Alibaba P/E increased from 45x to 60.88x (35.28%).

Source: Bloomberg Terminal

It is only natural for investors to question the valuations and sustainability of the returns.

Thus, it is reasonable to expect a sell-off of the SATT in the coming weeks, much like the recent FAAMNG sell-off. SATT in aggregate makes up 12.57% of the iShares MSCI Emerging Markets ETF portfolio.

While Tencent Holdings and Alibaba are overvalued, Samsung Electronics and Taiwan Semiconductors are undervalued relative to the average 20.43 P/E of the information technology sector of iShares MSCI Emerging Markets ETF.

In the next section, I will compare the revenue and profit margin growth for Q1 2017 and Q1 2016:

Source: Bloomberg Terminal

Authors table. Source: Bloomberg Terminal

Taiwan Semiconductors, Tencent Holdings and Alibaba have significantly higher revenue growth than profitability, which is the problem facing most of the companies operating in emerging markets.

Next, I will compare EPS of 1 year: Samsung Electronics EPS increased by 53.76%; Taiwan Semiconductors EPS rose by 44.04%; Alibaba EPS grew by 53.79%; and Tencent Holdings EPS increased by 49.13%.

Even though P/E has a high growth for the SATT equity, that increase can be justified by the growth in earnings.

The question is whether SATT has reached its peak so investors shouldn't expect an upside potential, or it is a correction before new highs.

To help address this question, I compared the fundamentals of iShares MSCI Emerging Markets ETF and iShares S&P Global Tech ETF information technology sector.

The iShares MSCI Emerging Markets ETF information technology sector seems to be cheaper than the global information technology sector on fundamentals:

• P/E (20.43 vs. 23.06) and P/B (2.80 vs. 4.08).
• The ROE is lower (15.45% vs. 18.19%) due to lower profit margins.

Next, I will analyze forward-looking fundamentals.

Authors table. Source: Bloomberg Terminal

• Revenue and EPS are forecast to increase significantly for all SATT stocks. Thus, Tencent Holdings, Alibaba and Samsung Electronics should become cheaper based on the P/E ratios.
• Taiwan Semiconductors is expected to become slightly more expensive based on the P/E but cheaper based on the P/B ratio.

Finally, it is interesting to note the opinions of some analysts who follow the four companies:

• Samsung Electronics : 36 out of 38 (94.7%) analysts recommend "buy," while the rest suggests "hold."
• Taiwan Semiconductors: 17 out of 30 (56.67%) recommend "buy," while the rest suggests "hold."
• Tencent Holdings: 34 out of 35 (97.14%) analysts recommend "buy," while the rest suggests "hold."
• Alibaba: 39 out of 41 (95.12%) analysts recommend "buy," while the rest suggests "hold."

The bottom line:

Since the beginning of the year, emerging markets, similar to the S&P 500, have been driven by the information technology sector.

The domination of four entities (SATT) among emerging markets creates a situation analogous to the domination of FAAMNG equity which resulted in a sell-off.

Some analysts believe that SATT will be considered overvalued in the same way as FAAMNG was. From this perspective, investors can expect a SATT sell-off.

Still, the information technology sector and SATT stock have strong forecasts, fundamentals, and recommendations. Thus, I view the possible sell-off as a correction and a potential buying opportunity.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long EEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.