(Bloomberg) -- Investors haven't taken into account the market risk inherent in China, said short seller Carson Block.
“I think that investors for the past decade were basically pulling the wool over their own eyes on the capriciousness of the policy environment in China,” Block, chief investment officer of Muddy Waters Capital, said in an interview Monday on Bloomberg TV. “So that's coming home now to bite a number of investors. But it's just one of many risks that you really need to take into account but investors have not.”
These risks are another reason “why, all other things being equal, a China stock should trade at a significant discount relative to a stock of a company that's based in the U.S.,” he said. “But often we've found that they don't, because investors like to tell themselves these fairy tales about it.”
China has sought to rein in private enterprise in industries from technology to education that Beijing blames for exacerbating inequality, increasing financial risk and challenging the government's authority. The moves wiped out about $1 trillion from shares listed on the mainland, in Hong Kong and the U.S. last month. Turmoil triggered by the crackdown had left some market participants wondering whether the nation's stocks had become uninvestable.
U.S. investors don't fully appreciate that Chinese economic data is “not real data,” that there's “inaccuracy and then lying embedded in that,” said Block, who has been short Chinese stocks for years.
In the wake of the recent meme-stock frenzy -- which saw Redditors drive up the stocks of companies many hedge funds were short -- Muddy Waters had made adjustments to how it invests, he said.
“We are no longer ignoring that. We're very attuned to where retail traders are talking these things up,” Block said. The firm quickly covered a short after seeing the investment discussed on Reddit. “Better to be safe than sorry. So that's how we're utilizing it.”
Muddy Waters is also now generally market neutral, meaning it has long positions to balance out the short ones.
“So for every short position we might have 30 to 50 tiny long positions,” he said.
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