Trade view / 20 December 2012 at 7:30 GMT

China Finance: Market may have overbought last week's bounce

Fredrik Oqvist Fredrik Oqvist
Founder / ChinaRAI
China

Executive summary

  • The market bounce-back from the news of a possible mass-delisting of all US-listed Chinese stocks has pushed prices back to the levels seen before the correction for the new risk
  • This happened despite there being no real news from the US authorities to signal that the issue is solved
  • This is a signal to sell off the bounce play as the downside risk has become too large, and possibly look for strategic short positions once again

A week after the potential of a mass-delisting of Chinese shares on US exchanges (as I described in an earlier TradingFloor.com article), started to truly rear its ugly head, we have had a number of interesting market reactions. First we saw stocks take a dive on the initial news, and then we saw a rebound as the market oversold the stocks and news filtered in about a more lenient view taken by the China Securities Regulatory Commission (CSRC).

However, this by no means insures that the risk of a mass delisting is gone and forgotten. But if we look at the scale of the bounce in the market we find that for many stocks, the risk of delisting is no longer priced in, and we are back to the same price level we saw before the Securities and Exchange Commission (SEC) announcement.

The US Public Company Accounting Oversight Board (PCAOB) has still to make its announcement regarding future rules for the Chinese accounting firms, and by extension the US-listed Chinese companies. And it is their decision, in accordance with their rules, that will determine the outcome of this issue.

While the CSRC’s willingness to try to find a compromise is definitely a step in the right direction they are not the ones making the decision in the US, nor are they in complete control of the decision in China. There has been no real show of support for this type of compromise from the Ministry of Finance (MOF), nor from the central government.

Professor Paul Gillis, an authority on the subject and member of the PCAOB standing advisory group, recently said:

The picture that is painted illustrates that U.S. and Chinese regulators are looking at the situation differently. Both appear to be pursuing a situation based on the rule of law, but there are conflicting laws. China wants the U.S. to allow it to conduct and control all investigations in China, which is unacceptable to U.S. regulators. 

So the risk is clearly still present and the prices no longer seem to reflect this reality; have a look at what has happened to the stock prices of Baidu (NASDAQ: BIDU), and Youku (NASDAQ: YOKU) in the last two weeks. This situation seems like a set-up for an even harder fall should there be a negative statement from the PCAOB in the near future.

Aggressive bounce increases down-side risks

Bounce took stocks higher than before correction

Source: Saxo Bank

Sell signal
To me this is a sell-signal, as I believe we still have a good chance of seeing a negative statement from the PCAOB regarding the solution to this mess. While I believe the will to see a solution is there, all parties appear locked into their positions, and as such there is a lot of downside risk for these stocks at present. I would even go so far as to say there is once again a potential short case across the board as the bounce itself may have become overbought.

Furthermore, as the time-line indicates the PCAOB has to make a decision on the matter by the end of the year, so it seems likely that we will receive notification this week. This means we have a potentially very negative impacting market event with a pretty good idea of the timing of it.

Why the market has chosen to ignore this is a bit of a mystery to me, although recent encouraging economic data from China probably helped. All the same, I think market optimism in this case might be overblown, unless people in the know are operating with better information than I have been able to find.

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Fredrik Oqvist writes regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the signup process. You can also bookmark the China Finance blog page.

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