Short Selling

China Evergrande: How Short Sellers Predicted the Crisis

China Evergrande
(3333:HK)
12 months:
-84.7
Activity:
Bearish
Pattern:
High short interest
News:
Disappointing H1 Results
China Evergrande
(3333:HK)
12 months:
-84.7
Activity:
Bearish
Pattern:
High short interest
News:
Disappointing H1 Results

Shares in China’s second-largest property developer China Evergrande Group (3333:HK) have taken a massive hit recently on the back of concerns over the group’s liquidity. Over the last month, the stock has fallen 38%. Meanwhile, over the last three months, it has lost approximately 75% of its value. The group’s problems have sent shockwaves through global markets.

Could investors have seen the liquidity crisis and share price fall coming? Absolutely. Looking at the short selling data on China Evergrande, there have been red flags here for months.

China Evergrande: 3 Red Flags

Here at 2iQ Research, we actually covered China Evergrande Group in a Short Selling Report on 11 August. In that report, we analyzed the short selling data on the Chinese company and highlighted three major red flags.

The first was that short interest was very high at 20.9% of the free float. The second was that utilization (a measure of demand from short sellers) was high at 87.6%. And the third was that the cost to borrow stock was elevated at 28.8%.

Source: 2iQ Alpha Terminal. Data: 10 August.

Source: 2iQ Alpha Terminal. Data: 10 August.

These three red flags, in conjunction with concerning news around the company’s liquidity situation, led us to conclude that China Evergrande was a very risky stock. “The short selling activity here suggests that short sellers expect to see further share price weakness. Given the high level of short interest, we think caution is warranted towards the stock at present,” we wrote at the time.

Short Sellers Saw This Coming Months Ago

Looking back now, that call was spot on. Since our report on 11 August, China Evergrande’s share price has fallen 58% (it was down 67% at one stage).

However, in hindsight, we were actually quite late to the party. What’s interesting is that the short selling activity here actually started ramping up in early June. This can be seen in the chart below.



The chart clearly shows that tickets (short selling transactions), utilization, and borrowing costs rose significantly from early June. In other words, short sellers saw the China Evergrande crisis coming nearly four months ago.

As is often the case, the short sellers got it right. And the short selling data was able to provide invaluable insights for market participants.

What Does the Short Selling Data Say Now?

So, what are short sellers doing now? Are they ramping up their short bets, or closing their positions?

Well, looking at the latest short selling data, we can see that short interest is 16.002% of the free float. Meanwhile, utilization and cost to borrow are 62.60% and 92.508% respectively.

Source: 2iQ Alpha Terminal. Data: 27 September.
These figures suggest that activity on the short side has eased a little recently. However, it is still very high, meaning that short sellers expect further share price weakness.

This week, China Evergrande said it reached a private deal to pay one of its debt payments. This is a positive development.

However, given that short interest remains high, we continue to think that caution is warranted towards China Evergrande shares. The short sellers clearly expect the stock to fall further.

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