Photograph: ChinaFotoPress via Getty Images

China's Great Short Seller Suddenly Turns Bullish

Jon Carnes is about the last person on Earth you’d expect to turn bullish on China’s stock market.

This is a man who built his career on wagers against Chinese companies, bets so successful that one analyst ranks the 41-year-old among the best short sellers worldwide -- more effective than industry giants from Carson Block to David Einhorn. Carnes’s bearish research caused such a stir in 2011 that he fled China and had to fight off fraud allegations. The ordeal landed one of his colleagues in a Henan province prison.

Eos Holdings President Jon Carnes. Source: Jon Carnes via Bloomberg
Eos Holdings President Jon Carnes. Source: Jon Carnes via Bloomberg

So when Carnes says he’s now an advocate of investment in China Inc. -- with a 111 percent rally forecast for the Shanghai Composite Index -- it’s worth paying attention. His optimism is all the more striking given it comes at a time when many international money managers are turning bearish, put off by what they see as bubbly valuations and unjustified government intervention to prop up share prices after a $4 trillion rout.

For Carnes, the bull case is simple. The stock market’s surge to a seven-year high in June caught most Chinese investors by surprise, and they’re determined not to miss the next buying opportunity. In a country where household wealth surged to an estimated $21 trillion last year, less than 10 percent of the population is invested in equities.

“A lot of people missed out on the bull market,” Carnes said by phone from his office in Vancouver. “This violent correction is a huge buying opportunity for them.”

Alfred Little

Carnes, who started his investment career in 1992 with $3,000 of savings from a part-time job at a South Carolina fried chicken joint, has been researching Chinese shares for at least a decade. Around 2009, he started focusing on short-sale opportunities in companies he suspected were inflating their financial statements.

To shield against authorities who frowned on negative publicity for Chinese firms, Carnes created a fake online identity -- Alfred Little -- that he used to broadcast his views.

It was a winning strategy. His record of public bets ranked first among more than 28 short sellers last year tracked by Activist Shorts, a website that analyzes bearish research. At least eight Chinese companies he targeted have since de-listed or been charged with fraud.

Prison Time

Carnes also made enemies along the way. After one Alfred Little report in 2011, targeting a Toronto-listed miner of silver in China, he got threats of violence and decided to leave the country.

Mainland authorities charged his Chinese-born colleague, Kun Huang, with defamation and Huang served two years in prison. Carnes’s use of the fabricated Alfred Little identity led to fraud allegations by Canadian securities regulators, which got dismissed in May.

After all that, Carnes and Huang are back together in Vancouver, managing about $10 million and overseeing a team of seven analysts in China and North America. Their firm, Eos Holdings LLC, runs money for Carnes’s family and a few friends, his charitable foundation and Eos employees. He doesn’t accept funds from outside investors.

“I really have to give him credit for fending off these problems, getting up and dusting himself off,” said Block, the founder of Muddy Waters LLC who rose to fame with a successful bearish wager against Sino-Forest Corp. in 2011. He met Carnes five years ago and the two have worked together on China research.

One Short

While Block remains a skeptic on Chinese markets, Carnes says the Shanghai Composite may surge to a record 8,000 in the next 18 months. His stock picks include U.S.-listed E-Commerce China Dangdang Inc. and Jinpan International Ltd., a maker of power distribution equipment. He’s also looking for buying opportunities in Shanghai.

The only thing Carnes is shorting these days is the Direxion Daily FTSE China Bear 3X Shares exchange-traded fund, better known by its YANG ticker on U.S. exchanges. The wager is a bullish one, paying off when Chinese shares surge. The Shanghai Composite dropped 2.2 percent on Thursday and the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF lost 3.3 percent to $39.70 at 10:06 a.m. in New York.

Carnes’s optimistic stance contrasts with a bearish shift by many of his international peers. Foreign investors sold Shanghai stocks through the city’s cross-border exchange link for the past three weeks, with outflows accelerating after the government banned stake sales by major shareholders and allowed more than 1,400 companies to halt trading.

China Cynic

At 67, the median price-to-earnings ratio for stocks on mainland bourses is on par with its level at the peak of China’s equity bubble in 2007.

“I generally think there are better risk/reward opportunities than going long in China,” Block said. “He’s probably less of a cynic about the world and about China than I am.”

Carnes says Chinese shares have room to rise as more domestic speculators pile into the market. The nation’s household wealth -- estimated at $21 trillion by Credit Suisse Group AG in 2014 -- is primarily tied up in real estate, bank deposits and unlisted businesses. Just 8.8 percent of respondents in the latest China Household Finance Survey had equity holdings in the second quarter of 2015.

“There’s tons and tons of money in China, and that money has to go someplace,” Carnes said. “I don’t think giant bull markets like this end that quickly.”

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