Forget GameStop and scrutinise Chinese listed companies

The GameStop bubble is a good reason for the US to start de-listing China Inc now. Otherwise, the explosive use of social media to create viral stock picks may render the US market unsafe for all retail investors

With all the bubbling frenzy around GameStop Corp., it's time to step back and look at how the broader market is doing. It turns out, there's froth elsewhere, too. Look no further than the Chinese companies listed in the US.

Of the 100 largest China-based firms by market cap, the mid-tier has already rallied a whopping 43 per cent this year, far outpacing the top and bottom third, data compiled by Smartkarma's Douglas Kim shows. The biggest winners tend to be thematic. For instance, Futu Holdings Ltd., an e-brokerage that enables Chinese citizens to trade US stocks, soared over 150 per cent to a $15.8 billion market cap, as investors bet the notorious day traders in the People's Republic would join the retail rebellion too. Daqo New Energy Corp., a solar panel maker, more than doubled in price to an $8 billion market value.

One reason for this outperformance could be the rise of the 'Reddit army,' noted Kim. Retail investors are not powerful enough to move the needle on mega-caps such as Alibaba Group Holding Ltd., but they may just be the price setters in a smaller arena.

Last week, Carson Block said his Muddy Waters Capital 'massively reduced' its positions when he recognised a squeeze may be building for one of his shorts, GSX Techedu Inc., a Chinese online education platform that is now being probed by the Securities and Exchange Commission. Just like GameStop, GSX made the perfect target for a short squeeze. As of Jan. 15, short sellers had built 65 million shares of positions, or about 45 per cent of shares outstanding, in GSX, exchange data shows. It is now worth more than $20 billion after a 130 per cent rally in the last year including a spike of 36 per cent on January 27 during the GameStop surge, despite Muddy Waters' allegation last May that up to 80 per cent of its users were fake. GSX did not respond to an email request for comment.

Unsurprisingly, Block has described the meme militia movement with words like 'mob' and 'mania.' But he has darker suspicions. Talking to Bloomberg News, he said what appeared to be a history-making retail uprising was more of a smokescreen for hedge funds targeting other hedge funds. The SEC is now combing social media and message board posts for signs whether fraud played a role in GameStop's dizzying rally.

For the moment, that's an unproven theory. But Block may be on to something: The conditions appear ripe in the mid-sized China ADR space for some institutional manipulation.

Unlike the amateur hordes, hedge funds need liquidity to trade. By now, this corner of the market has a lot of that, allowing the institutions to move in and out of their positions deftly. The mid-sized Chinese names are not small: They range from $1 billion to $8 billion in market cap. Daily trading has been brisk, too. For instance, EHang Holdings Ltd., a self-flying car maker that went public in a tiny $41 million IPO just over a year ago, now boasts of over $200 million 20-day average daily trading turnover. The stock is up 285 per cent this year.

But there's not much research on these stocks. On average, they are tracked by only seven research firms, compared to 21 for S&P 500 companies. (EHang is tracked only by two.) And don't forget: they operate in China, half-a-world away from New York, with lots of room for error with people who don't do their homework. The recent allegations of bot activity on Reddit also raise fears that misinformation is being targeted at retail investors.

I have been an advocate of delisting Chinese companies from the US - not because of China Inc.'s suspect accounting standards, but because investing in an emerging market company shouldn't be this easy. Delisting is even more relevant right now, as Americans rush to try their luck with individual stocks. In January, retail investors accounted for at least 30 per cent of US cash equity trading volume, estimates Goldman Sachs Group. A decade ago, it was a mere 10 per cent.

The US Congress has passed a bill that could ultimately lead to kicking Chinese companies off American exchanges, but it has a generous phase-in period. That may be too long.

The Biden administration is busy right now, and banning Americans from investing in Chinese companies is likely to be put on the back burner. But if the White House is concerned about the GameStop saga - which it is - it has to pay attention to the froth around mid-sized Chinese companies. The GameStop bubble is a good reason for the US to start de-listing China Inc. now. Otherwise, the explosive use of social media to create viral stock picks may render the US market unsafe for all retail investors. (Bloomberg)