Given the recent revelations that Deloitte auditors were duped by Longtop Financial Technologies (LFT: NYSE)who paid off their own bankers to mis-state accounts, a broad selloff of Chinese ADRs is underway. Our data shows that headline-grabbing revelations of fraud create tremendous opportunities when the proverbial baby is thrown out with the bathwater.
The MarketPsych Report is driven by linguistic analysis software that analyzes specific sentiments (such as fear and excitement), topics (such as management changes and layoffs), and tones (such as uncertainty and urgency) in investors' online comments, the financial news, and executive interviews. This language data powered our outperforming MarketPsy Long-Short Fund LP.
Revelations of Fraud in Chinese ADRs
A contagious selloff of shares of the largest Chinese ADRs listed in the United States has hit even stable Chinese stocks such as Huaneng Power (HNP) and Harbin Electric (HRBN). As expected, Chinese growth stocks have been hit the hardest including Renren (RENN: off 35%), Baidu (BIDU: off 10%), Shanda (SNDA: off 15%), and Sohu.com (SOHU: off 20%).
And some of the most speculative names are appearing on our "Fraud Rumors" list this week. Most of these are verifiable frauds; certainly the rumors are flying: 1. CSKI --- CHINA SKY ONE MEDICAL, INC. 2. CHBT --- CHINA-BIOTICS, INC. 3. CMED --- CHINA MEDICAL TECHNOLOGIES, INC. 4. CBEH --- CHINA INTEGRATED ENERGY, INC 5. ABAT --- ADVANCED BATTERY TECHNOLOGIES, INC (based in China)
Below you can see that online investors have been discussing fraud in some of these companies for years. To the right of the charts is a list of "fraud" related discussions among online investors about CBEH (first chart, since 2010) and ABAT (second chart, since 2009). Let me be clear - there is real fraud in many Chinese ADRs. And that is why a real opportunity has opened up in this sector. Our social media data for the past 8 years confirms that many stocks are sold off as "guilty by association." Using daily aggregations of Fraud Rumor frequency, the stocks over the past 8 years that scored in the top 1% of our Fraud Rumor measure rallied an average of 15bps (0.15% per day) over the next week. Now, the real frauds did not rally for long or at all. But ON AVERAGE, it paid to buy a basket of perceived "frauds" and hold on. Good companies in the same sector as the Frauds were sold off by trigger-happy traders. In the current environment, we've seen across-the-board selloffs in Chinese ADRs, despite the fact that many are well-run multinational companies and several have market caps over $10 billion.
* June 16, 2011. London. Moderating the panel "Texts, Tweets, Twits: How is Market Sentiment of Value in Quantitative Trading" at the Battle of the Quants in London at the May Fair Hotel * June 21, 2011. Los Angeles. Presenting "Predicting Market Prices with Sentiment Analysis of Social Media" at the CFA Society of Los Angeles, Omni Hotel. * July 21st, 2011. New York. NasdaqOMX Presents: "Sentiment Research and Social Media Analysis: A New Source of Investment Data" at Nasdaq MarketSite.
Derived from a German proverb, das Kind mit dem Bade ausschütten, and first appearing in 1512, "throwing the baby out with the bathwater" refers to the psychological bias of "misattribution." In our hurry to solve a problem, we mistakenly classify everything as "the bathwater," discarding the good along with the bad. Psychologically speaking, the mind attributes the "dirty" quality of the bathwater to all things in the bathtub. Misattribution is a short-cut in our thinking - a heuristic - that allows for faster processing but often leads to mistakes in judgment. In the case of Chinese ADRs, many good babies have been thrown out in the past week.
How Do We Avoid Misattribution? The time when we are most likely to abandon our investing common-sense is during stress. As China-focused investors watch the bad news pile up and their shares plummet in value, they begin to wonder, "can I ever really know which of my stocks are frauds?" This fundamental uncertainty leads to across-the-board selling and retrenchment. Ultimately all panicky sell-offs are the same. Emotion takes over and fundamentals are thrown out like the "baby." In the uncertainty and fear of spring 2009, an incredible opportunity arose to buy shares in the best companies worldwide at deep values. Fraud rumors hit the same emotional trigger - panic - as "insolvency" and "subprime" did in early 2009. Fundamentally we cannot AVOID misattribution, but we can become AWARE of it. Through awareness of the markets' "black-and-white" thinking, experience with challening extreme assumptions, and a healthy dose of skepticism, we learn to see the panic for what it is and pick up the bargains that are left behind by the stampeding herd.
Books Both books named "Top Financial Books of the Year" by Kiplingers.
Linguistic analysis paired with behavioral economics opens a new dimension for enhanced client services.
MarketPsych Data provides granular quantitative sentiment data (400 sentiments) from social media (stock message boards and Twitter) and earnings conference calls.
MarketPsych Data includes market participants’ and executives’ perceptions, beliefs, tones, and topics of concern about 6,000 U.S. stocks and equity ETFs in an hourly data stream.
Optimized to identify value over two+ years of real-time trading.
Or text sentiment analysis software was developed over 7 years.
We use customized dictionaries and grammatical rules domain-specific to financial and business news, executive interviews, and stock-related conversations.
Disclaimer This material is not intended as and does not constitute an offer to sell any securities or a solicitation of any offer to purchase any securities. Past performance is no guarantee of future returns.
