John Paulson – Sino Forest Part II

In my previous article, I talked about how John Paulson was sitting on a $500 million paper loss when his large stake in Sino Forest Corporation depreciated in value following allegations of questionable accounting.

Now, Paulson has disclosed to his investors that he has completely sold out of his stake in the company.

Paulson May Deal Clients a $720 Million Loss

The Bloomberg article states that Paulson cut his stake in the company by 30% prior to the June 2nd stock collapse.  With some quick math he still held 24 million shares going into the June 2nd stock collapse.

This can be interesting to analyze as you can find new order flow generators, scenarios and inefficiencies in the market.  Lets begin the order flow analysis.

On June 15 The CFO of Sino Forest, David Horsley released a statement saying “I’ve spoken to them(Paulson) and they are very supportive, giving us suggestions and issues that we need to address.”

Paulson Tries To Prop Up The Market

Sino-Forest Says Top Shareholder Paulson Offers Advice After Stock Plunges

Now, this assumes Paulson is still holding on to his stake of 24 million shares.  Why would the hedge fund say such things to Sino-Forest?  Because they are not stupid.  The market knows that Paulson is the big player still holding on to his large stock of Sino-Forest.  Paulson knows that if he indicates that he will dump his shares aggressively, the market will drop further.  Bearish order flow will be generated as short sellers start pressuring his positions and attempt to get in sell orders before Paulson can dump his entire stake.  Paulson knows that dumping 25 million shares will drop the stock a few dollars lower.  Thus he is attempting to prop up the market indicating that they are giving suggestions to Sino-Forest to help them through the allegations.  If Paulson wanted to dump his stake, he knew that he needed to dump the stake while keeping it as low key as possible.

Order Flow and Information Flow

Now here is where the inefficiencies of human beings come into play.  Paulson runs a $30 billion + hedge fund.  He should have access to order flow and information flow.  His portfolio managers who were watching the Sino Forest position should of been watching it like a hawk.  It was obviously a huge position within the portfolio.  You would think they would be plugged into the information flow of the stock?

It turns out that the Muddy Waters Research firm was “pre-marketing” the report on Sino-Forest for a few weeks prior to the stock price collapse.  A whopping five weeks to determine a change in sentiment, fundamental value, or send a team to do their own research.  Did Paulson know about this information flow or not?  I am not sure, but if he did, then it seems that he miscalculated the shift in sentiment and fundamental value.

Sentiment and Fundamental Value

After all, the stock was dropping substantially for a few weeks prior to the June 2nd collapse.  A simple look at a chart could show that the market was breaking through key support levels.  That could be cause for concern.  Now a move down through a key chart support level can potentially be a mispricing.  But other times it can signal that the sentiment is deteriorating and fundamental value may be changing.  He was going into the June 2nd collapse being long 24 million shares, when he should of been short 24 million shares of the stock.  That is trading and investing.  A group of market participants are long, while another is short.  Some wins, others lose.  In this case a large transfer of money from Paulson to the short sellers.  The people that have the order flow, liquidity, and volatility on their side win.

A stock doesn’t drop 80% based on moving averages, chart patterns, astrology, stochastics, etc.  Similarly, a currency pair is not going to move 2,000 pips without some sort of global macro reason.

Inefficiencies and Size

Paulson’s Sino-Forest Loss Renews Questions About Size

In the dealbook article, the author states that:”The opportunity to pursue inefficiencies and niche strategies is just harder when there’s [a lot of] money.”

That is absolutely right.  The more money you have, the bigger moves you have to catch in order to produce the same returns.  Smaller funds can take advantage of day trading and swing trading inefficiencies, but large funds can’t.  The large funds need to go for bigger global macro moves.

Now Paulson made the calculation to dump his stake as he performed an order flow and sentiment analysis of the situation.

Paulson Tells Investors Sino-Forest Loss was C$462 Million This Month

The Bloomberg article above states: “Paulson & Co., the biggest shareholder in Sino-Forest before the selloff, said it divested the stake after concluding the stock may be “depressed for an extended period of time,” even if a special committee investigation were to show that the allegations are unfounded.”

Paulson made the decision that even if the allegations proved to be unfounded, there would be short term and medium term damage done to sentiment and outlook for the stock.  Paulson’s pain tolerance point had been reached.

What does that mean in order flow terms?  That means that the bargain hunters and fundamental players that would drive the stock higher, would be non-existant, or severely reduced due to the bad perception of the company and hit on sentiment.

Market Participants

So what are the order flow generators right now, and what are the market participants thinking?

Buy Side

1.  Short sellers looking to take profit can be on the bid side.  They may be looking to take profit on a portion or all of their positions to lock in their huge profits.  They don’t want the stock the snap up to $10 or $15 dollars to wipe out their profits.

2.  Any Day traders or short term traders looking to buy some shares to play a quick move up in the stock.  They might be looking for a quick 25 cent or 50 cent pop higher.

3.  Any speculative swing traders looking to play a bigger snap up higher in the share price.  These traders are looking for a few dollars move higher.  Sort of like what happened on June 6th, where the stock gaped higher by $2-3.

4.  Any bargain hunting fundamental long term players looking to buy the stock on the cheap who believe that the company’s accounting is credible and the allegations unfounded.  These market participants believe that they have identified a fundamental mispricing.  They believe they have the right facts and thus know the companys fundamental value is higher.

Sell Side

1.  Any short sellers that are expecting the stock to go to zero may still want to add to their shorts.

2.  Any short sellers that missed the move can be choosing to get in late now.

3.  Any investors that still hold the stock but haven’t sold yet and are waiting for a small bounce in order to sell can be sitting on the offer.

4.  Any investors or traders that are long the stock and start getting scared of the stock moving to zero, and start to sell.

Order flow thinking can be fun.

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