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Don’t seek logic in stock price moves

Alibaba_adobe_575px_12Apr21
By Matthew Thomas
15 Apr 2021

Imagine trying to explain stock markets to an alien or an intelligent caveman, someone who has grown up in a world without the flicker of red and green numbers, the theatre of shareholder meetings, the strange spectacle of Jim Cramer’s pre-scheduled rage.

It would perhaps not be too difficult to explain to them the market mechanism. It may be that some form of money is universal — the popular notion that less developed societies relied on barter as a means of exchange has long been debunked by anthropologists. Once money has been understood, moving from the simple act of using it to buy a good to the more abstract notion of using it to buy a stake is also unlikely to befuddle these visitors from foreign lands.

But how could we explain why stocks move the way they do? Could we explain it at all — since we are seldom sure ourselves? Asian investors got a good example of one factor driving stock prices on Monday, when Alibaba Group Holding’s stock jumped by around 6.5%, while its Chinese technology peers stumbled.

Alibaba is, of course, the company that has just been hit with a Rmb18.23bn ($2.78bn) fine, the company whose founder disappeared for three months after offending the Chinese Communist Party, the company recently forced to cancel the $34bn IPO of its subsidiary Ant Financial, which announced a wide-scale restructuring this week.

JD.Com, Tencent and others, which all fell in Hong Kong trading, have so far not suffered a similar fate. Why?

The answer will be obvious to experienced market practitioners, and can be approximated by the old stock market dictum ‘buy the rumour, sell the fact’. In this case of bad news, of course, the maxim should be reversed: ‘sell the rumour, buy the fact’.

Equity investors are increasingly becoming worried about a clampdown on tech companies by Chinese regulators, the best example of that being the recent punishment of Alibaba. But since Alibaba has already been punished, while the others have so far not provoked the ire of the Party, the obvious move is to avoid the rest and flock to Alibaba like it’s just discovered a vaccine for Covidiocy.

This is elementary logic for stock traders and bankers, but does it really make sense? Would our visitors be able to comprehend the idea of having faith in a company that has been punished simply because it has been punished?

The intuitive logic is that Alibaba will face no further punishment from the Chinese government, or at least that the worst of it is out of the way. There is some reason to believe this idea. Chinese regulators can fine a company 10% of their last year’s revenues for anti-trust issues; Alibaba was fined 4%. That leaves wiggle room for further punishment but it also implies regulators did not feel they needed to use the full weight of their powers against the company.

The problem with ‘buy the fact’ logic in this case is that Chinese regulators are unpredictable, and the regulatory backlash is not static. The specific actions against individual companies are less important than the wider point that regulatory freedom for Chinese technology companies is tightening.

Should Alibaba have fallen in line with its peers? Or should those peers have performed better? These are probably the wrong questions. The movement of stock prices is the end result of a great mass of decisions, impulses and interactions. The price is nothing more than the end result of this hazy process of buying and selling. Asking whether stock prices are ‘correct’ implies some objective metric by which we can judge them — and ignores the fact that if we had this metric, stock price volatility would be almost non-existent. The best we can do is make comparisons, ask questions, quietly scratch our heads.

This might perhaps be the moment when we would lose our interlocutors, who would decide to go back to Mars or to their cave — or find more comfort in the confident pronouncements of analysts or traders with discounted cash flow models that spit out an exact fair value for each stock.

But those of us in the real world shouldn’t get too excited. China’s clampdown on tech companies is not an existential threat to the industry, but it is certainly a long-term problem. Once the regulatory noose tightens, it becomes very hard to loosen. Just ask bankers.

By Matthew Thomas
15 Apr 2021