The purpose of this post is to (1) take some accountability/provide a mea culpa on a couple China-based stocks that I pointed out last August, and (2) once again reassess the risk/reward of investing in Chinese ADRs now that they have been decimated even further. When I first started the blog last summer, one of the first posts that I made suggested that there might be select Chinese names worth entertaining after the entire sector started to blow up last year, post Archegos’ implosion.
Notably, I pointed out Tencent (TCEHY) and Tencent Music (TME) as “best in show” stocks and reiterated that I have been notoriously skeptical about US listed China based companies and that there was an extraordinary amount of risk in investing with Chinese securities. I wrote last year:
Keep in mind that Chinese stocks are subject to insane risks and that I am attempting to bottom fish in the most opaque and odious parts of the market.
Those risks have come to full fruition now, as the market is anticipating the same fate for Chinese ADRs as it is seeing for Russian ADRs. Russian ADRs of course, have been halted and are likely going to get torched if, and when, they ever reopen. The same goes for Russian ETFs. The risk of total loss is looming, waiting only for your respective brokers to mark your books. And so as you can see from the chart below, Chinese equities and Chinese tech names have been floored over the last week or two, helped along by the fear of China wanting to retake Taiwan and similar sanctions being placed on the Chinese as we have placed on Russia.
The fear in Chinese names was exemplified in capitulation in shares of Didi (DIDI) last Friday - another name I had pointed out as potentially worth a look last year at $7 or $8 – because of fears that the company won’t be able to list in Hong Kong.
This crash continued Monday, with Tencent facing a reportedly record fine for anti-money laundering violations by Beijing.
Make no doubt about it, major changes have taken place in relations geopolitically that have made Chinese stocks far riskier now than they’ve ever been - and, keep in mind, we are talking about a subsect of stocks that was already rife with fraud to begin with.
The sanctions on Russia have been effective in helping prevent further investment in Russian equities. Russia is working to ally itself with China further, looking to stand down the West over its invasion of Ukraine (and potentially even become long-term economic/monetary allies that challenge the dollar, now that the West has cut Russia off).
Chinese ADRs are now as close to full on liabilities as you can get. There’s a serious chance they are all marked to zero eventually, now that the U.S. understands that it can use sanctions a la Russia on Chinese to fight it economically.
But for now, speculation of such sanctions against China is exactly that: speculation.
And at least on the surface, China is posturing like they want to play nice with the U.S. Bloomberg reported Tuesday morning:
On Tuesday, China’s foreign minister Wang Yi -- in his most explicit statement yet on American penalties -- said he wants the nation to avoid being impacted by U.S. sanctions over Russia’s war.
In re-assesing the risk/reward, both the risk and the reward have grown significantly. There is a far higher risk that China ADRs go to $0 now than there was last summer. As prices collapse, that means potential reward for buying these ADRs, should things normalize (unlikely), is exponentially larger than it once was.
While it seems incredibly likely (they literally buzzed Taiwan with a dozen fighter jets Monday morning), there is no guarantee that China is going to want to retake Taiwan, although, as I noted, there has been an obvious alliance between Russia and China developing over the last couple of weeks economically. China has reportedly been interested in buying strategic assets out of Russia and Russia is probably seeking whatever counterparty it can to keep its economy up and running.
We know that Russian ADRs have already essentially been cancelled and zeroed out.
Keeping all of this in mind, there is still a voice in the back of my head that won’t let me totally ignore how cheap some Chinese names have gotten. Before you read what I’m about to write, keep in mind that if you had invested in these Chinese in August of last year, you would be down materially on that investment.
But I think it’s also important to note that some of these Chinese names are becoming ridiculously cheap - if their ADRs survive. Perhaps getting cheap is with good reason, but if Chinese stocks come out of this somewhat alive, there are going to be significant potential gains.
As Zerohedge noted yesterday, JP Morgan has all but capitulated on the Chinese internet sector after the NASDAQ Golden Dragon China index crashed the most since 2008 yesterday. Not to be totally useless, but this capitulation means either (1) the bank is right and is telling clients to sell at huge losses or (2) the bank is wrong and is providing buyers with more of an offer to buy into, pressuring stocks lower. Well it is true that the lower the price of a stock goes, the more its risk reward profile changes, it is also important remember that sometimes stocks just go to zero – as we just saw in the case of Russian ADRs. You have to remember this when potentially considering an investment in these Chinese names. Having said that, as I put on some exposure to Chinese names I will be doing so defining my risk with options. Long dated call options allow me massive optionality to the upside over the course of a year or two (if these names normalize) and an exact defined risk (whatever the calls cost) up front, that I know I can be comfortable losing 100% of. This isn’t Warren Buffett style investing folks, it’s super risky speculation with the potential for large gains and/or losses.
But I think it’s worth at least looking at now. Until the geopolitical landscape changes to directly confirm that fears of sanctions and delistings may be imminent, I’m going to try my hand at a couple names this week, via call options. I’ll likely start with the diversified KWEB ETF.
And hey - while investing in Russia is definitely a faux pas at this point, investing in China isn’t really yet. And the same asset managers that would never call for access to investing in Russian names given the circumstances may be able to scratch their “deep value overseas investing-in-the-enemy” type itch by pulling the trigger on some Chinese names.
We’ll have to see if the circumstances lure in any other idiots beside myself…
Disclaimer: This is not a recommendation to buy or sell any stocks or securities. I own KWEB, TME, TCEHY, SEED and other Chinese ADRs. I often lose money on positions I trade/invest in. I may add any name mentioned in this article and sell any name mentioned in this piece at any time, without further warning. None of this is a solicitation to buy or sell securities. These positions can change immediately as soon as I publish this, with or without notice. You are on your own. Do not make decisions based on my blog. I exist on the fringe. The publisher does not guarantee the accuracy or completeness of the information provided in this page. These are not the opinions of any of my employers, partners, or associates. I get shit wrong a lot.
Trust across the western world is fading fast; your blog is excellent, you emphasize the caveats to readers, and you should neither feel any guilt nor be blamed at all for writing a blog post about Chinese stocks in the past. Swim at your own risk, fellow readers! All that said, since Chinese companies are essentially unaudited (ignore bullshit CCP audit), best not to touch them at all.
If China / Russia are cut off from the West - who is fucked more? They make a large percentage of our goods - but we also buy a large % of their goods.
I'm more worried about the lack of fertilizer and commodities that the West will lose out on. China / Russia are going to pump more CO2 into the air than ever before - while hoarding all the minerals we need to build electric cars. Mayor Pete and Joe bubbles are going to burst when electric cars cost $250K.
My biggest fear is that Xi is playing chess while Biden and Putin are playing marbles. Joey is more worried about putting transgender ppl into office versus thinking of the future of the economy. But he put job security in when #2 Is Harris and #3 is Pelosi. As bad as he has been - it could be worse.
This headline says it all: "Emerging markets - (always) emerging for a reason"
The U.S. has the best companies and best economy. Looking for international diversification just costs money without corresponding benefits to a portfolio. IMO
Knowing nothing and having lost a shit ton of money ove the years, well for normies, I ain't no senator's son, I doubt trade with the PRC will cease, It can't. Until they are the agressor, and that time may come, this might be a generational chance to take some long dated out of the money calls. I only wish I had bought some puts...
Picking bottoms is nasty business
Taking off a lot of exposure I added using calls this morning.
Wow, congrats on your timing today, well done! Holding any or cashing out?
I see China having massive leverage in the current geopolitical scenario and I don't believe US has the balls to sanction China, given that they control most of the world's supply. Having said that, in my opinion, Beijing is more of a concern to Chinese ADRs than the geopolitical tensions that may ensue in the future. But, history teaches us that Beijing and the Chinese economy has been very very resilient in all atmospheres - they are planning and preparing for the long-term. I find Chinese equities (direct exposure, not via ADRs) are currently at an unbelievable bargain.
My Gasprom shares are zero ( I thought the risk of that was small). What does America gain by harming western investors like me? Sorry but USA actions don’t appear rational. Therefore Investing in china? Not a chance!