“The trick of successful investors is to sell when they want to, not when they have to.” – Seth Klarman

I’ve been having that unsettling feeling again in my gut about everything markets related.  You know, that feeling that keeps you up at night when you have to get up to pee and then you come back to bed and have a quick debate in your head of whether you should check your phone or not, which you inevitably lose and then you go one step further and check stock prices and then your head starts spinning and you’re up for a good two hours…yeah that one.

It all kinda started three weeks ago when Facebook decided to shave off US$120 billion in market value after missing earnings expectations on lower revenue and slowing user growth. The company had gone through some pain earlier this year after the Cambridge Analytica scandal but they managed to dutifully shrug that blip off and keep their stock investors happy with a steady rise in share price for the next few months.

And then this happened:

Source: Bloomberg

I started seeing articles pop up on the internet the next day inducting Facebook into the “biggest one-day rout’s in history” Hall of Shame after it essentially wiped out an entire half year’s worth of work, all in a matter of hours. Imagine that. You work your tail off for seven months and at the end of July, piss away all your gains.

I’ve seen a lot of traders fall victim to the same fate from my days sitting in the trenches of Wall Street. Every major product desk at an investment bank used to have a “proprietary” element to it where traders would be given a little bit of rope (firm capital) to try and trade opportunistically around customer orders. Some desks were purely prop and all too often an eager trader who had worked all year would try to be a hero in November, just before bonus season, and inevitably lose everything he or she had worked for all year. The smarter, more senior traders would learn to scale down their risk going into year-end and some of the superstars would even take the last month off and just shut down their book. It was the ultimate badge of honor, basically telling the bank “You know what? I’ve made enough money for you so I’m going to do nothing in December and just wait for my nice fat bonus.”  And the best part was that the banks we okay with that.

Back to Facebook…what frightened me about that selloff was the violent nature of it, almost indiscriminate. It was as if investors were just waiting for a reason to take profit and punish Zuckerberg, who not for nothing, lost US$16.8 billion that day. I still doubt anyone feels bad for him.  But still…it was unsettling.

And then you had the Tesla print.

Source: Bloomberg

Let’s play that little game of “if an alien came down to earth and saw this chart what would they think…?”  Yeah, we all saw it and many of us are still picking the pieces of our blown minds off the kitchen floor. Tesla reported its largest ever loss but shares spiked after Elon Musk guaranteed positive cash flow and profit in the 2nd half of the year.  WTF.

Next up, and over in Asia, was the earnings miss from Sunny Optical 2382 HK this week.  We started the week off on the wrong foot as the turmoil in Turkey and rising tensions with the U.S. over the weekend had investors on their toes from the get-go. Adding fuel to that flame was yet another incredibly busy week of earnings particularly for the Asia tech and internet sectors.

When the company reported that margins declined more than expected, the company single-handedly dragged other peer companies and the entire market lower. The stock initially vomited a whopping 27%, a level not seen for the company since Oct. 2008.  

Source: Bloomberg

The price action was particularly worrisome and telling of how the rest of the week would pan out as the company, being one of the tech bellwether names of Asia, is very widely held by investors.  Without even digging into the details of the earnings miss, the violent knee-jerk sell-off was telling of investor risk appetite and foreshadowed the unforgiving manner in which investors would punish an earnings miss.

This was all building up ahead of almighty Tencent, the leading tech bellwether of China and the 3rd largest constituent of the HSI (9% weighting), which reported Wednesday night…and missed.  The HSI was already wobbly and barely off its knees after the Sunny Optical miss earlier in the week, but surprisingly most investors were not concerned about a potential miss until after the Sunny wake-up call.  I started seeing brokers put out notes trying to call one side or the other but the screaming question in the back of everyone’s minds was “What happens if they miss???”

The market was jittery on Wednesday leading up to the big announcement.  Tencent usually reports after market hours, around 5:00 pm and it there was a nervous excitement in everyone’s voice I spoke to, as people tried to “guess” what the next earnings print would be.  All day long the market and stock itself were under pressure as people took profit ahead of the numbers and short sellers piled on board. Going into the final hour of trading there was a certain calm before the storm as you could almost hear the casino dealer saying “No more bets…” before the market close.

5 o’clock…5:30pm…6:00pm…still nothing. What does this mean? What does this mean!!? Surely it’s a miss! They’ve never NOT reported by 5 pm. All of Hong Kong was in a silent panic. A broker rang me up as we were all waiting.

“So what do you think Jay..beat or miss?”

I didn’t know what to think, nor did I have much to say to him because going into earnings is not really the time to be placing new bets. That’s just not how we do things here and it certainly is not a sustainable investing process when managing institutional capital particularly in a time when valuations are at peak multiples and streetside analysts have extrapolated recent history indefinitely out into the future to come up with their lofty target prices…

….And then…the death knell:

Source: Bloomberg

 

Kaboom. For the first time in 10 years, Tencent, the darling of China missed earnings expectations. Overnight the US-listed ADRs were down 6% and anything remotely related to Asia took a beating. Fears of contagion started spreading overnight and investors woke up Thursday morning hoping the world wouldn’t end that day.

Call it a misprint, a one-off or maybe the luck of the dragon, but after matching at HK$320, Tencent surprisingly held its ground. The buyers (and short coverers) came piling in and by Friday morning the HSI was well over the 27,000 level as global investors gave a collective sigh of relief.

So after the dust has finally settled, will I be able to sleep this weekend? Unlikely.

This earnings season was particularly challenging and now safely on the other side, I strangely feel even less comfortable than I did before. Just like the tremors of an earthquake leading up to “the big one”, I’m finding it increasingly difficult to navigate these markets effectively. The S&P continues its defiant move upward and any discounts to the intrinsic value of assets that once existed have now all but disappeared. I’ve said this before, but I’ll say it again if you haven’t taken some precautionary chips off the table then how is good a time as any to start doing so. I’m not a contrarian for the sake of being a contrarian but let’s not wait until the last minute to answer that question “what happens if they miss?”

P.S. If you want to know what happened with Tencent, here’s the long short of it.  After listening to the earnings call and digging in deeper, the smoking gun for the miss came from the company’s mobile gaming segment which was negatively affected after the Chinese government decided to suspend monetization approvals for all mobile games across the board. Fortunately, Tencent had already gotten 15 games approved before the ruling came down and is the best positioned in the industry if and when the suspension ends. The temporary suspension of approvals was not due to a change in policy but rather a restructuring of the regulatory bodies and smart investors would have adjusted down their assumptions to exclude this monetization deriving a base case valuation for the company of around HK$320 which is the level it held and also the 12 month low of the stock. At the time of this writing (Friday afternoon) the stock is up over 5% from this level, trading at HK$337on heavy volume. Is this a dream come true or a worst nightmare waiting to unfold? Only time will tell.