Benchmarks tracking the Chinese market reached peaks in Q1 2021 — followed by a steady decline up to the present date.
High hopes for a strong post-COVID surge were dashed by underwhelming recovery, geopolitical tensions, weak stimulus measures, and troubles in critical sectors like real estate.
As a result, the CSI 300 Index dropped by as much as 45.33% compared to its February 2021 peak
Picks for you
Understandably, this led to a marked increase in short interest for Chinese stocks — particularly U.S. listed Chinese stocks.
However, an unprecedented stimulus package by the People’s Bank of China, which included interest rate cuts and a $141 billion measure aimed at the equity market has led to a sharp reversal.
In fact, China’s stock market has seen an almost parabolic rally — with a record-breaking 22% surge in a single day. The fate of short sellers has shifted rapidly — and they are now facing a problem.
Short sellers scramble to cover losses on Chinese stocks
An October 1 report by Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners revealed both the extent of the losses and a more granular look into the specifics.
Over the course of 2024, total short interest in U.S. listed Chinese stocks increased by $5.6 billion or 30% overall, with JD.com (NASDAQ: JD) and Alibaba (NYSE: BABA) leading the charge.
However, since the rally, new short selling slowed to just $132 million — while the value of the shorted shares rose by $5.8 billion. Prior to September 13, when the rally started, short sellers were up some $3.7 billion in year-to-date (YTD) mark-to-market profits — now, after the surge, they’ve incurred losses totaling $6.9 billion — in other words, they’re down $3.2 billion.
In a rather dramatic turn of events, barring NIO (NYSE: NIO), Li Auto (NASDAQ: LI), Xpeng (NYSE: XPEV), and PDD Holdings (NASDAQ: PDD), all other short trades on U.S listed Chinese stocks are now unprofitable on a YTD level.
Potential catalyst for Chinese bull run
Although the stimulus package did cause a rally, there is still widespread institutional skepticism on whether this upswing can be maintained in the face of a still flagging economy.
However, at least as far as equity markets are concerned, the increasing squeezability of Chinese stocks, as well as the losses incurred by short sellers thus far, could easily lead to short positions being terminated or widespread short covering — further weakening selling pressure and driving further price increases.
The bull case for China isn’t some fringe opinion — of particular note are the decisions made by Michael Burry of ‘The Big Short’ fame, whose portfolio allocated 45% of its holdings to just three Chinese stocks — in fact, some of the most shorted Chinese stocks such as JD, Baidu, and Alibaba.
A proactive turn from Chinese financial state institutions is likely to keep short-term and medium-term price action positive — but the ultimate fate of these stocks, particularly with their focus on tech, e-commerce, and EVs hinges on real, broad Chinese economic recovery — not singular events like stimulus packages.
