There was tremendous tension between the U.S. and China last year. The issues were finally put to rest after a long war of words that plagued the markets for most of 2019. The result was a trade deal, or at least part of one that quieted the headlines. Politicians are picking at this old scab by ratcheting up the fiery talks. The Senate wants de-list Chinese companies from U.S. stock exchanges if they don’t comply with local accounting standards.
In theory, this sounds reasonable, but given the antagonistic history between the two nations, any rule changes carry a more serous tone. These headlines negatively impact Chinese stocks like Alibaba (NYSE:BABA) as they break. But in the case of Alibaba stock, the effects should be temporary, and therein lies the opportunity.
Investors should buy the dips that come from any rhetoric on this topic for the next few months. First, the rule is not specifically for Chinese, but all foreign companies. Second, Alibaba stock is not the target of this renewed focus from the White House. They are trying to stop another fraud situation like Lukin Coffee (NASDAQ:LK). BABA has had enough history and is large enough so that is above such suspicion.
Fundamentally, this is not an expensive stock among its cohort. It has a 25 price-to-earnings ratio and 7.5 times its sales. This is in line with Facebook (NASDAQ:FB) and Apple (NASDAQ:AAPL). This is not like high-flying stocks like Shop (NYSE:SHOP) or Zoom Video (NASDAQ:ZM) whose stock prices are 45 and 75 times their total sales. Zoom has a P/E above 2,200. None of these are an exact match to Alibaba, but they are all growth stocks in different stages of maturity.
Alibaba Stock Will Need to Rise to Challenges That Lie Ahead
While I am bullish overall on BABA stock, I am not blind to the risks. Those mostly come from extrinsic factors not specific to the company. There is a new concern this year and it is a giant one.
The macro-economic condition has completely changed from last year. The U.S. went from full employment to maximum unemployment. There are at least 25 million people out of work, so there is a huge risk to the downside in general. If the stock market corrects this fall, Alibaba stock will follow. From that sense caution is definitely warranted.
Technically BABA stock is not in an obvious bullish spot. It just suffered a full correction on the earnings headline. Onus is on the bulls to break through this overhead resistance. Usually they fail at it on the first try back so that they can gather better momentum to break through on subsequent attempts. It is also important that they don’t fade too far below. In this case I expect support near $205, $198, and $192 per share.
Buy the Dip, But From Lower Levels
Knowing this I am more certain of the downside support than the short term upside potential. I am not discounting Alibaba’s future prospects, I am merely tempering my enthusiasm for the next few months. Meaning this is not my call to short BABA stock.
In fact, I would suggest creating income while this global malaise abates. To do this I can sell July BABA $190 put and collect $2.50 per contract. If the stock stays above my strike through mid-July then I am a winner already. I don’t need a rally to retain my gains, but if it falls below it then I own shares and break even at $187.50 per share. In essence I would have entered the position with a 12% buffer from the current price.
We have maximum risk and so many uncertainties still loom. Leaders are trying to jump start the economies after shutting everything down for a few months. This is a monumental task and much easier said than done. Yes, the governments are spending trillions to pull this off, but it won’t be enough. I say this for the simple fact that the “normal” that they are aiming for is going to be restricted.
Case in point: Disney (NYSE:DIS) serves a good example of the new world post-Covid-19. This is the prime example of the crowd economy stock. The reopening is restricted to 25% of max capacity. Even if they double that we are still looking at a new normal that could be half of what it was. The new realities are still very unclear. And by the way, we still have 25 million people out of work in the U.S. alone. Probably more.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.