Six months ago, I postulated that a mean reversion-type opportunity might exist for companies caught in the geopolitical crossfire between trade-warring nations.
To test this hypothesis, I bought Alibaba and Baidu and later compared their performance to the S&P 500 while the US/China trade war was raging before subsiding.
Against the standard caveat for cause and effect, Alibaba outran alpha and Baidu lagged behind while both taken together still beat that bellwether index.
When it comes to almost anything but a daily movement in the price of a stock, nailing causation is tricky. Why the exception for a daily move? Because, without the help of analysts, we can see for ourselves what happens when a company beats or misses on revenues and/or earnings, experiences a major product problem, takes a legal hit or wins a victory in court, or receives a key regulatory approval or comes under investigation. Such news can/will move a stock's price, instantly, for all to see; it's causal. As but one example, let's remember what happened to the price of Qualcomm (QCOM) the morning after they announced the settlement of their suit with Apple (AAPL) on April 16th. (That was a good day for us:))
The problem with investing ahead of cause and effect is that it usually requires access to insider information; no, no, no. Ergo, one is left to make educated guesses that become troublesome when betting on such things as shifting consumer preferences, legislative / executive action, climate change, or geopolitical dynamics.
Applying Cause & Effect
A little history. Trump is the first President since Herbert Hoover to launch a multi-pronged commercial attack on the US's major trading partners. The roots of this conflict date back to his 2016 campaign grounded on the nationalist slogan, "Make America Great Again". But things didn't begin to heat up until early 2018 when Trump levied duties on Mexican steel and later, a year ago July, provoked China by imposing tariffs on various goods. Chairman Xi responded in-kind fueling a cycle of one-upmanship that extended to blacklisting, the US of Huawei and China of US soybeans.
Eventually, farmers, manufacturers, technologists, and investors caught up with policymakers in understanding, if disagreeing, when in March of 2018 Trump declared, "Trade wars are good and easy to win." As politicians started to pull back from all this, to contain the economic damage the Fed reversed course on QT and began lowering interest rates. In addition, central banks, still concerned about currency debasement, continued to hoard gold. Most everyone began to dial back inflammatory rhetoric while talking about trade deals; 'take a deep breath already'.
It was during this shift that it occurred to me, as I wrote for SA on June 3rd, that, "there may be reversion-type investment opportunities in companies temporarily caught in the crossfire between trade-warring nations." I went on to say that, "I'm testing this hypothesis with investments in Alibaba (BABA) and Baidu (BIDU) whose ADR's have taken hits by bullets flying between the US and China."
We can see with the advantage of hindsight that my foresight was on the mark. BABA and BIDU got whacked as the trade war escalated up to the date of my first article back mid-year. Then, as emotions subsided, these two stocks began to rise, BABA handsomely, BIDU less so, taken together ahead of the S&P 500; alpha.
12/3/18 - 6/3/19
6/3/19 - 11/22/19
There are many authors on SA who do a more thorough job than I in decomposing financials. Such is the case of this fine analysis of BABA presented by Oleh Kombaiev last week. Although I once produced such analyses for a living, as I've said consistently in my writings, my bias is to focus on broader / strategic happenings (such as trade wars). Indeed, it was this approach that returned an 'extra 19%' to me on BABA from the time when I first wrote about it, 06/03/2019, to the date stamp on Oleh's article, 11/21/2019. Let that soak in, an extra 19%.
Two Morals Here
There are two morals to this story. First, alpha may result from non-traditional mean reversion opportunities. Classic examples of this form of investment arise from bounce-backs from commodity supply/demand disruptions brought about by crop failures, livestock disease, and attacks on refineries or tankers. The trade war between the US and China has expanded how I will think about this paradigm.
Secondly and finally, analysis paralysis often/usually manifests itself as decision paralysis. For me, if a strategic hypothesis makes sense and there are no obvious financial showstoppers, I quickly put money on the table comforted that I am more likely to be right than wrong but will not obsess about it either way.
Disclosure: I am/we are long BABA, QCOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Always do your own due diligence in consultation with a licensed and competent financial adviser who understands your unique needs and puts your interests ahead of their own. Remember, there are added considerations in owning foreign securities including those associated with ADR sponsorship, buying and selling the pinks, foreign withholding taxes on dividends, and fees. (All my proceeds from contributing to SA go to charity.)