Carson Block Sees Fraud ‘Top to Bottom’ in China Stocks

Carson Block Sees Fraud ‘Top to Bottom’ in China Stocks

i want to start with your era of looking at companies on the mainland in china as perspective shorting opportunities for fraud to analyze their balance sheets are there still those opportunities or has that era ended well it’s interesting because i just want to point out before i was short on anything in china i went there being very long so i didn’t go there thinking that this is all a fraud um the answer to your question is yes and no okay in that there was never any real disincentive um that got baked in for companies to stop defrauding us investors and fraud is because china is an emerging market fraud is just very prevalent in the environment and we always forgot that as western investors we saw these tall gleaming skyscrapers and we eat at western restaurants and really we were lulled into the sense of complacency that china functions like the west in many ways and not like an emerging market so the fraud fraud is endemic like many ems but we’ve never in my view gotten it out of the capital markets now the companies that came to market in the prior decade and that really were the first ones to get washed out in 2010 to 2012. okay that was the low-hanging fruit those were the empty boxes that had no real business and you could just surveil the factory gates and see that there was nothing there what then happened was the businesses became largely almost exclusively online businesses and those are harder um in order to prove fraud and we can look at a lot of these companies do a tax rate analysis and determine almost every single time we do it that yeah there’s fraud to some level in the financial statements but it’s harder for us to prove that to the satisfaction of u.s investors and since the u.s still has literally no way to enforce or to investigate or enforce against the managements in china for defrauding us investors it’s this asymmetry that was similar to the lead up to the financial crisis which is well you know if i lie to you you being u.s investors um nothing bad will happen to me and the possibility is i mean i used to say i could make tens of millions of dollars that’s chunk change in you know today’s valuations hundreds of millions maybe even billions of dollars on the back of my lies why wouldn’t i do that so that has never been addressed in a substantive way so when i do look at the universe of especially us-listed china companies and we do these tax analyses we just come up with fraud pretty much top to bottom all right so do you have any current targets that you’re looking at or certain uh companies that stand out well the other dynamic that has occurred so the short answer is no not and we’re always looking at some stuff in china but we after gsx last year so we were short gsx it’s like a bunch of other people were short gsx publicly it’s empty box near total fraud i mean that stock just got jammed up on us twice now obviously some portion of that was arch egos bill huang but that really did hit home or bring something home to me that about what had changed in the at that point 10 years i’ve been shorting china frauds back when i started doing this the people on the other side were not market savvy at all and they didn’t know how they didn’t understand how stocks traded today i think there’s a lot of manipulation of these stocks and not just the china stocks and i think that using hft type techniques which are so far beyond the capability of regulators to understand and suss out when there’s manipulation i think there are a number of stocks that you could call manipulated at least at times but especially in the china space so we you know we could be convinced it’s a fraud but the question becomes does it matter and to be fair we ask this question about non-china-based companies all the time now just um you know this many years into this monetary policy fueled bull market but that’s the thing with china you might have a fraud but i mean we were actually having serious conversations last year about whether we should be long some of these especially the ones that were in the the the esg type indices yeah um i mean that’s it’s just a strange time sorry to cut you off but i before we continue with china you seem to be vaguely referencing perhaps the meme trading phenomenon in the united states the reddit traders the idea of the robin hood and what that’s opened up the sort of irrational trading seemingly based on the fundamentals in specific names how challenging does it make your job to seek out the fundamentals to seek out you know balance sheet mismatches that seem not to matter if somebody just has a right hashtag on a chain well so i think that that to me the bigger issue but it does dovetail with what you’re talking about is the prevalence of passive investing in the market because what ends up happening and i didn’t appreciate this until really late last year early this year when you have passive buyers of more and more of the float it doesn’t create a linear upward effect on stock prices it creates a convex upward impact on stock prices so then you layer on top of that retail buying of out of the money calls to create this these gamma squeezes and yeah and and so you just get this crazy uh disconnect in a number of stocks between the actual economic fundamentals and what the stock prices are doing now the saving grace for people such as myself that when it comes to meme stocks um they advertise it openly that they’re going to squeeze it so we are no longer ignoring that or we’re very attuned to where retail traders are talking these things up so we don’t have so much capital that we can’t get out of the way knock wood so i’m not so much worried about that but it’s the it’s the distortion of passive buying on really just a lot of crap companies and sometimes abject frauds especially from china that to me that’s the more disturbing issue well but how do you then engage with this how do you make money do you stay away all together or when you said that you know basically they’re advertising what they’re going to do and then you can play with that how well so we’re not yet playing we’re not playing long squeezes um on meme stocks but what you know good a good example of how we utilized this was xl fleet that’s a company that we shorted earlier this year it’s a spac you know close to an empty box basically in our view and the stock had gone down and we made money on it now we’re very quick to pull the trigger on getting out of something if we have to so we saw all of a sudden retail traders talking it up there was a bunch of buying about a money uh call options and we just covered our short entirely turns out the stock did not squeeze so you know but better safe than sorry so that’s how we’re utilizing it um on top of that we run our book generally market neutral so for every dollar short a name we’re going long to hedge it and we’re going along rather than just indices we’re going along what are called factors or factor baskets so for every short position we might have 30 to 50 uh tiny long positions that we think will explain most of the beta there so that’s how we’ve changed our business to keep up with the times in the meantime there’s also this concern you could have meme traders in the united states and over in china you could have massive policy shifts that suddenly start to change entire industries we saw that with the semiconductors today as people were concerned about potential accusations of price manipulation from regulators in china you’ve also seen this with milk formula and other areas how do you get a sense of what the next area they might be targeting could be do you try to play in any of that or does that make it nearly uninvestible for you because it’s not about fundamental research it’s based on something that cannot be predicted well that’s the point it can’t be predicted and i think that investors for the past decade were basically pulling the wool over their own eyes on the capriciousness of the policy environment in china so those that’s coming home now to bite a number of investors but i mean it’s just one of many risks that you really need to take into account but investors have not um and it’s another reason why all other things being equal a china stock should trade at a significant discount relative to a stock that’s from a company that’s based in the us but often we’ve we’ve found that they don’t because investors like to tell themselves these fairy tales about there’s this tremendous cognitive dissonance always has been with china they’ll investors will say well you know it’s growing really quickly we think that the real gdp growth print will be seven percent this year and i’d say but you know that that’s not real data i mean you know that that’s you know that there’s inaccuracy and then lying embedded in that and nobody actually takes that seriously yes but we have to be long because it’s gonna grow seven percent a year so it’s cognitive dissonance we live in this world where in where investors are forced to allocate more and more money to the equity markets by low interest rates financial repression and they take on more risk and in my view are not adequately compensated for it and you see that at moments like these
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Carson Block Sees Fraud \'Top to Bottom\' in China Stocks

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