By DUNCAN MAVIN And TOM ORLIK
Short sellers are apparently running the market for China stocks. But it ain't what they say so much as the fact they say it that has investors hitting the 'sell' button. With a market this vulnerable, investors must question the rationale for holding any but the bluest-chip overseas-listed Chinese companies.
The latest stock to fall under the short sellers' sword belongs to Nasdaq-listed advertising display firm Focus Media Holding Ltd. After short seller Muddy Waters alleged accounting shenanigans, the Shanghai-based company's shares fell 60% in an hour—barely enough time for most investors to digest the short's dense, 80-page report—before eventually closing down 39% on the day.
Carson Block, the man behind Muddy Waters, is no Meredith Whitney—the U.S. bank analyst whose word was enough to send financial stocks spiraling downward during the dark days of 2007 and 2008. But his reports seem to have the same kiss of death impact on valuations for the companies he targets.
There is now a mini-industry trying to find out which Chinese company will be the next focus of short-seller attacks. Hedge funds that discover what shorts are researching can get their positions in place, knowing that once the report is published, the stock is almost bound to fall. In the days before Muddy Waters published on Focus Media, a rapid build-up of short positions was an indication that word of the report's existence had leaked out.
There's an argument that the shorting trend is injecting a welcome dose of skepticism and analytic rigor into the market's view on the China story. In time, that should improve governance at Chinese companies and encourage investors to spend time distinguishing true value from fraud. For now though, with the herd mentality as strong on the way down as it was on the way up, value investors will have little luck. Against that backdrop, the only safe option may be to stay out of the market altogether.
Write to Tom Orlik at Thomas.orlik@wsj.com
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