We can add Chinese stocks to the list of currently toxic stocks. Cannabis was a sector that I loved last year and which has become a difficult season for the winter. I would love to say that I came down from this dock to the Silver Quay, but I waited until the ship started to take on water, jumped on its side and swam to shore. Still, it was luckier and less painful than many.
On the Chinese side, I was a big supporter of names related to eSport and streaming. It worked well with Bilibili (BILI), but Huya (HUYA), apart from certain scalp trades, was a disappointment with several other names.
Luckin Coffee (LK) launched a curveball with Chinese names listed on the stock market by announcing a massive fraud that reached the C-suite. The stock was shut down on Tuesday and has not reopened since. Muddy Waters had this one overlapped with fraud. After Tuesday’s bell, TAL Education Group (TAL), a K-12 after-school tutoring service in China, announced that an employee plotted with external suppliers to boost sales. Unlike Luckin who dropped 80% to the news, TAL is only 8%. The main reason: TAL estimates fraud at 3% to 4% of total turnover, while Luckin’s fraud appeared to represent around 50% of turnover in the last three quarters.
While the fraud ended there, Muddy Waters targeted iQIYI (IQ) yesterday, alleging that the company fraudulently and materially overvalues its users, its income, the consideration for the acquisition and the value of the content of “barter”. In conjunction with Wolfpack Reports, the two conclude that this dates back to the time before the IPO. This would imply Baidu (BIDU) as an accomplice to the fraud. Yesterday, IQ sold hard before rebounding to become flat. The shares were down about 5.6% in the early morning today.
Unfortunately, we have to operate on the principle that there is smoke, there is fire. Anyone who remembers the days of reverse merger of Chinese companies using this strategy to exploit the United States has struggled to trust Chinese finances. There was so much fraud from that time, it made your head spin and became a common joke.
This does not mean that I think all businesses are fraudulent with their accounting. Heck, this can end in LK and TAL, but what we need to be aware of is the risk. If another fraud were to hit, the Chinese names will be sold hard. If Muddy Waters publishes another report, it is likely that the stock of the report will be severely affected. And, as investors and traders, we have no way of knowing which company it may be. It’s not a terribly large area, so it means our chances of missing it are reduced. Chances are it’s higher growth, a smaller name, so maybe we can limit some risks by avoiding them, but it’s always difficult. We already see puts accumulating at Pinduoduo (PDD) this morning. A hit could come from JD.com (JD) and Alibaba (BABA).
The market rebounds, but remains fragile. The brief report of a warm hand can have a great influence. If you don’t believe me, then check out the two-day action in eHealth (EHTH), Muddy Waters’ latest target. Tuesday was the day when those who knew the report was coming in were shorting the stock. Today is the reaction to the report released. Stocks lost 15% on Wednesday and 26% in the past two days.
There are enough names that have been beaten since early March, we have little reason to force a trade or investment in a toxic sector.
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