Rally in China Internet Stocks Begins to Stall; Much of Gains ‘Built on Hope’

Rally in China Internet Stocks Begins to Stall

Much of Gains ‘Built on Hope’

MIA LAMAR

Updated Oct. 30, 2013 5:45 p.m. ET

HONG KONG—A blistering four-month rally in Chinese Internet stocks is starting to stall as investors question whether expectations are running ahead of reality. After months of big gains, shares in Chinese Internet stocks have roughly doubled so far this year and are now valued at around 30 times expected 2013 earnings, BarclaysBARC.LN +0.90% said in a report. That compares with a gain of around 30% this year for the Nasdaq NDAQ -0.79% Composite Index, home to U.S. technology bellwethers GoogleInc. GOOG -0.56% and Apple Inc., AAPL +1.59% Barclays said.“A correction is well expected in the market—it’s just a question of when,” said Elinor Leung, a technology analyst at CLSA Asia-Pacific Markets in Hong Kong.

Investors jumped into shares of Chinese companies such as Tencent Holdings Ltd.TCEHY +1.09% —operator of the popular WeChat messaging service—and search provider Baidu Inc., BIDU +3.47% counting on their ability to cash in on the country’s fast-growing population of smartphone users.

China overtook the U.S. as the world’s largest smartphone market last year, but the majority of its 1.3 billion people still uses basic phones. Smartphones accounted for just 18% of China’s mobile phone subscriptions last year, and the percentage is expected to nearly double this year to 33%, according to Credit Suisse. CSGN.VX -0.46%

“The story is there but the prices have run a little bit ahead of fundamentals,” said Jan de Bruijn, head of Asian equities at Lion Global Investors in Singapore, which managed US$23.7 billion as of Sept. 30.

Much of the gains were “built on hope,” Mr. de Bruijn said, and with the end of the year looming he has been gradually reducing exposure to the sector since last month. “We need to see more evidence of monetization going ahead.”

Meanwhile, allegations last week by short-seller Muddy Waters LLC that small Chinese mobile-software firm NQ Mobile Inc. NQ +11.26% is a “massive fraud” that “cannot monetize users that it does not have” sent a chill through the sector, investors said.

NQ Mobile called the report, the latest in a string of fraud allegations leveled at Chinese companies in recent years, “false and inaccurate.”

Michael Reynal, head of emerging markets at RS Investments in San Francisco, said he has been trimming exposure to the sector over the past six weeks, primarily in small caps. “We worry at some of the speculative and fast money activity [in the] smaller players,” he said.

Now analysts are warning of further profit-taking after the earnings season got off to a rocky start. Sohu.com Inc., SOHU -2.24% owner of one of China’s biggest Web portals, this week reported a loss for the third quarter and warned of a bigger one in the fourth due to heavy investment spending. The report sent its shares tumbling by 16% Tuesday, dragging down stocks across the sector.

“Certainly the sentiment is erring toward locking in gains rather than risk losing them,” said Andrew Sullivan, director of sales trading at Kim Eng Securities in Hong Kong.