Meinung

Liquid Markets and the RoaringKitty Affair

The speculative mania in stocks like GameStop is reminiscent of similar excesses in the Chinese stock markets. The fact that share prices are becoming increasingly disconnected from fundamentals ultimately threatens the stability of the financial markets.

Anne Stevenson-Yang
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Shortly after shares of GameStop reached $483 – up close to 2500% since the beginning of the year – every major publication and pundit has commented on the retail mania in the stock market.

Those of us who lived in China in 2009 and in 2015 remember that the exact same kind of bubble inflated there and, when it started deflating, was given new air by regulators who feared a retail revolution, just as some in the Congress and administrative agencies are trying to do now in the U.S.

The result of this effort at prudence in China has been to send the bubble from one asset class to another. There have been comic inflations in green tea, mung beans, garlic, and steel, not to mention gold, property, and equities. Over the last year, excess Chinese money has been pouring into international stock markets. It turns out that regulators in both countries, in trying to steady their own markets, have simply internationalized the stock bubble.

Welcome to late-stage market financialization. This is why anxiety about a crash now extends well beyond stock markets and across borders, all the way to the ultimate source, the U.S. dollar.

Robber's Stories

The U.S. stock mania has been going on for a couple of years now, and a chunk of the capital to fuel it is coming from China. The two biggest retail-trading channels right now are two companies called Futu Holdings (FUTU) and Up Fintech (TIGR). Both cite Robinhood as a role model and both offer digitized trading platforms to individual investors, with tools that make it easy to buy securities like futures, options, and margin trades that used to be the sole domain of professionals.

Unlike Robinhood, the Chinese platforms need most of their customers to commit fraud in order to start trading. Since the Chinese government does not allow its citizens to buy hard currency with their Renminbi in order to invest in the stock market, traders must tell their banks that they need dollars for overseas travel, to pay a child’s tuition, or to execute an import – current-account exchanges are allowed, but not capital account exchanges, and stocks belong to the capital account. Given these controls, companies like Futu and Up Fintech provide channels for capital flight for both individuals and institutions.

Futu and Up Fintech are fairly small compared with their U.S. counterparts, but they are growing fast. Both companies more than doubled in revenue and number of customers last year. Together they are responsible for about $190 billion in trading per quarter on Hong Kong and U.S. exchanges and have about 750,000 paying clients. Futu’s Daily Average Revenue Trades (DARTs, a common industry metric) number is around 400,000 now, less than one-tenth the DARTs on Robinhood. Up does not report its DARTs. But China, like the U.S., has message boards with «thought leaders» and bots that drive retail investors into particular stocks.

One such promote was GSX Techedu, widely viewed by careful short sellers such as Muddy Waters, Grizzly Research, and Citron as a complete fraud and yet able to increase its market value ten times since it listed in June 2019 on the New York Stock Exchange.

«Learn from me and don’t go short!» wrote «Little Do» in September. Up Fintech itself published commentary supposedly debunking the short reports after Citron published on GSX in April 2020.

Foul Play

China’s money supply has been growing faster than its economy for decades now. That is because credit becomes less efficient, and it takes more money to create the same level of (targeted) growth. As the supply of money swells, so do asset values. That’s why real estate owners all over China can believe that they are millionaires even as the apartments they bought sit empty and are quietly deteriorating.

The reason the money supply can swell like this without busting the exchange rate is that the Renminbi is not freely convertible. Individuals are not supposed to be able to take their overflowing RMB accounts and buy dollars to invest in the stock market. But sometimes, the pressure is just too strong, and China’s great wall of capital controls springs a small leak. The Chinese economy is like an over-inflated bicycle tire. Every now and then, a pinprick will send money hissing out. Enter Futu and Up Fintech.

China’s property market is just like the retail market in stocks. Every time a property owner tries to call the general bluff and sell a unit, inevitably for less than it was bought for, the other owners in the complex cry unfair and hold a public protest, after which the local government hurriedly persuades the rogue seller to take the unit off the market.

That is what happened in the U.S. when Robinhood and Webull, briefly, barred new purchases of «certain stocks». If inflated asset prices are not supported by fair market tests, both regulators and transaction agents can suspend transactions to avoid shattering the illusion of wealth created by bloated valuations. This action got framed with the narrative «Wall Street wins over the Little Guy,» and lawmakers stepped in and demanded that the Robinhood founder testify in Washington.

Precarious Trends

In China, the day traders who took out second mortgages to buy into the stock market bubbles that formed in 2009-10 and 2014-15 were supported by regulators who instructed state companies under their control to buy and hold. None of those efforts ultimately help, when the real problem is the tsunami of cash coming out of the U.S. Fed and China’s central bank.

Once the stock market crashes, and retail investors lose their savings, lawmakers will no longer be asking retail brokers like Robinhood why they cooled the mania but regulators like the SEC why they let it happen in the first place. While markets are going up, investors clamor to regulators to help them make money. When markets reverse, they criticize regulators for letting it happen.

There is a lot of focus now on the role of social media in creating fevered buying groups led by promoters like RoaringKitty. The SEC is reportedly investigating «Flash Crash» instigator Navinder Sarao, who helped instigate a brief market crash from his parents' basement in the suburbs of London in 2010. In the U.S., as in China, the problem is not individuals with big followings who talk trash about stocks. The message boards on WeChat, Stocktwits, Reddit, SeekingAlpha, and many more sites are rife with touts, some of whom are quietly paid by the companies seeking to inflate their share values.

The regulatory focus on saving the Little Guy is misplaced: The Little Guy is always going to lose out, in both economies. The remedy for the crazy run-ups in random stocks like GameStop, AMC, GSX, and so many others is to curtail the obvious manipulations in markets that are now completely determined by technical factors and have long ago departed from pricing related to underlying business performance.

As long as equity markets remain detached from their original purpose, i.e., to provide capital to support growth of viable, ongoing enterprises, and straightforward value investment is overlaid with second-, third-, and fourth-order derivatives that do not contribute to this purpose but enable massive leverage for speculation, the delusional instability we have increasingly experienced will not only remain but grow. Regulators and other market participants dedicated to maintaining some semblance of order will face an endless game of whack-a-mole, and the moles will prevail.

Anne Stevenson-Yang

Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The firm publishes highly diligenced research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Anne was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Anne has also worked as an industry analyst and trade advocate. She authored the 2013 published Book «China Alone: China's Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat.
Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The firm publishes highly diligenced research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Anne was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Anne has also worked as an industry analyst and trade advocate. She authored the 2013 published Book «China Alone: China's Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat.