Ingham Analytics Weekly Letter on Sunday - 4 April 2021

Sunday, 4 April 2021

Welcome to our Ingham Analytics Weekly Letter on Sunday where we take a step back to see wood for trees, taking stock of things that grabbed our attention during the week that was. Scarcely believable, it is the beginning of April but not too much foolishness about other than a large US based family firm blowing up spectacularly on highly leveraged trades.
 
Well done to the Aspen Pharmacare team on their tie-up with Johnson & Johnson, the first successful manufacture of a biological vaccine by Aspen. Sterile capacity is tiny in South Africa and Aspen has invested time and effort in record time to ensure effective production out of Port Elizabeth through technology transfer from J&J. Equitable access in Africa is assured as is affordability. Once again, private sector initiative scores a win - and an African diplomatic coup.     

Vaccine squabbles elsewhere are a sad reality, with the EU ignominiously leading the charge of the righteous brigade.
 
It is not as though pharmaceutical companies are rolling in the folding stuff either on developing vaccines for the pandemic. The profiteering narrative is often thrown at Big Pharma but the risk of a pipeline not bearing fruit is high, one in ten may make it and then you've got a two-decade window off a patent to try and get your invested money back let alone something above that.
 
AstraZeneca quickly identified that the experimental vaccine invented at Oxford University had traction and worked with the UK Vaccine Task Force to test, manufacture and distribute at low cost. The vaccine is user friendly in storage and transport, ideal for poor and richer countries alike.
 
Unfortunately, aggressive, ill-informed and vindictive politics got in the way. Yet investors can only praise AstraZeneca, in collaboration with academia and government, to live good governance as a corporate citizen whose goal is to do good. That is about as Hippocratic as it gets.   

The iShares Global Healthcare ETF is a reasonable proxy for exposure to a clutch of pharmaceutical, biotechnology, and medical device companies. In total 126 holdings so about as comprehensive as you'll get. Johnson & Johnson is the largest constituent followed by a host of household names including Pfizer and AstraZeneca. Your return year-to-date is 2% and for 2020 it was 12%. Over five years your total return averages 10% which mirrors the Dow Jones Pharmaceutical & Biotechnology Index. A king's ransom? We think not.   
 
Scientific marvels these drug companies are but we have typically been cautious about investment in the sector, where one size doesn't fit all. If you are an AstraZeneca shareholder you've had to make do with flat dividends for four years. Pfizer's share price is effectively flat over four years.   
 
The EU's shoot-in-both-feet vaccine fiasco, not our fault everyone else is to blame, continued this week. They've driven a protectionist coach and horses through binding legal contracts with little thought to the supply chain implications either. Such is the mess and misinformation that the leaders of Germany and France resorted to (sharp intake of breath) a conference call with the Kremlin earlier in the week - one topic on the agenda was the Russian Sputnik V vaccine, of all things.
 
If they begged for yet more humiliation, then the Chinese were there to oblige this week. Harrumphing over Chinese treatment of the minority Uyghurs, the EU declared persona non grata four Chinese officials and one institution. The Chinese retaliated with ten Europeans and four institutions. Europe protested, summoning Ambassadors. The Chinese ignored them, unprecedented in diplomatic circles. A Communist Party rag made the comment that the EU "doesn't have the financial and military power that Washington has". Ouch.
 
In matters diplomatic and military, history teaches us to speak softly but do so knowing you've got a big stick to wield too. Already in a catatonic state, European Union GDP has shrunk by a fifth because of the loss of the world's fifth biggest economy that just so happens to have sizeable defence and diplomatic clout. The EU is a military dwarf with a limp diplomatic voice, drowned out by America's staunch roar.
 
Back to governance. ESG is the hot investment topic of the times. Although making money out of it is not so hot. However, seeing as this is Easter, we were intrigued to see that the famed English grocer Fortnum & Mason have a green "Sailboat Easter Egg" on sale. They partnered to produce a truly sustainable egg that is fairly farmed, vegan, with cocoa beans transported from Grenada to the UK via wind-powered sailboat. It is contained within a hexiflex sleeving, 100% plastic free. Yummy, for GBP30.
 
If you think GameStop is plain daft the Archegos family office episode is the latest in a long history of financial catastrophes that show that while Wall Street banks have all this information, they haven't a clue what is going on at their competitor next door.
 
In the Archegos liquidation it seems clear that the banks didn't realize until too late that they were holding similar positions, with serious implications for the price of those shares, already super inflated.

Archegos had a network of lenders or prime brokers using the services of six different banks. The use of leverage and willingness to pay chunky fees made Archegos a remunerative client. No questions asked.
 
The typical collateral we learn was $15 to borrow $85. The trades in 2020 catapulted stocks like ViacomCBS and Discovery Communications to new heights and the fund added to that by using derivative trades called swaps agreements. Archegos became the largest single shareholder in many of these stocks - without the cash to back it up. Each bank had no clue that their rivals were adding fuel to the fire.
 
The catalyst for the meltdown was when ViacomCBS announced it would sell new shares. This sent the stock down. Because of Archegos's highly concentrated positions, the drop in Viacom hit the fund's portfolio, and Archegos started selling other stocks in its portfolio to cushion the blow. The quantum sent those other stocks tumbling.
 
In the blink of an eye what little collateral Archegos had given the banks wasn't enough to back the loans. Banks hit Archegos with margin calls to back up its trades. But there was no cash.
 
That forced the banks to sell Archegos's collateral stocks even as they were falling, exacerbating the selloff. Whilst Morgan Stanley and Goldman were first out the exit others were not so fleet of foot. Whilst those two heavyweights will likely book losses on the trades, income and profits elsewhere will probably dilute the group impact. But for Credit Suisse and Nomura there will be real bottom-line impacts.
 
If you'd like to get the technicalities on this check out our note "Isn't Tom Cruise the star of Mission Impossible?" and we'll have further to say on risk management next week. GameStop and now ViacomCBS are examples of both market irrationality and the danger of overleveraging.
 
The lesson of Archegos this week? You can fool some of the people some of the time but not all of the time. Will something similar happen again? You bet.
 
2021 is a year in which the US economy may just meet its boom. For investors exposed to US equities, and many in South Africa these days are, we think that the profits outlook for this year and into 2022 has picked up considerably since January when all looked dire. This security blanket of the vaccines also shapes psychological behaviour and confidence, a driver of growth that shouldn't be underestimated.
 
GDP real growth or decline is not the best gauge in isolation to forecast where profits of companies in aggregate will go. The annual percent change in earnings is better understood by the percentage point change in the annual percent change of real GDP. This crunching leads us to think that we're in for a considerable lift in profits, but we think it'll benefit the more traditional out-of-favour companies most. We'll have more detail on this topic in a forthcoming note.
 
Seeing as it is the Easter and Pesach long weekend if you haven't visited yet or subscribed, then our Weekly Letter on Sunday back issues are all archived on www.inghamanalytics.com under the Premium Letter section. They are mostly as relevant today as when first published. You'll also find our research notes online, available on a pay per view basis and of course downloadable for those who subscribe monthly for ZAR105 - and with that comes the Sunday Letter.   

And finally, we've referenced Volkswagen in the past couple of Letter's. This week one of the better April Fool jokes was pulled off by Volkswagen AG's US subsidiary. The company sent out a news release saying it was changing its US name to "Voltswagen."
 
No such thing as bad publicity, it may even catch on. Why not? Dieselgate wasn't the publicity you'd always like but it did galvanise the giant automaker into clearing out the Augean stable. It has quietly invested in electrification and jumped ahead of Tesla in EV volume - without fanfare, no bitcoin or green credits to turn a profit, and no executive titles such as Technoking and Master of Coin.
 
Markets were shut on Friday but as of Thursday the tightly held VW ordinary shares are up 80% year to date and the preferred shares, with the same economic interest, are up 58%. The prefs remain a relative bargain at a 21% discount to the ordinary shares. And VW is still relatively cheap compared to the EV makers that make no money and trade on a promise for the future.

The Volkswagen beetle of the future that isn't an April Fool   


Thank you all for visiting us.

Most read
Sasol - A fifteen-year gulf
South African bond yields - COVID-19 infected?
Now what do they want?
Rate accelerator
Is there a TARGET(2) on my back?
Latest research notes published this week
Isn't Tom Cruise the star of Mission Impossible?
If you want an expert take on why ViacomCBS has fallen like a stone, top international trader Andrew Kinsey gives a succinct analysis in "Isn't Tom Cruise the star of Mission Impossible?" And there are other lessons to derive, so... Read More

Is this true insanity?
Ingham Analytics has issued their second note on GameStop this week, a share trading sensation. The first note was entitled “Is GameStop a bathtub drain? and issued just ahead of the Q4 and full year results whilst “Is this true... Read More

Are more treasuries gonna get shaken loose?
A supplementary leverage ratio is Tier 1 capital for banks over total leverage exposure. In 2020, the US Federal Reserve gave American banks a temporary relief that is due to expire shortly. With government bond yields rising in the US,... Read More

Is GameStop a bathtub drain?
Ingham Analytics has issued an updated analysis of the GameStop saga in the US, a trade that continues to astonish by its volatility and speculative behaviour. If you’d like to get a better understanding of the short-dated options market in... Read More

South African bond yields - COVID-19 infected?
Hot on the heels of "Rate accelerator" which analysed the interconnection between equity and debt markets and how that is playing out, particularly in the US, Ingham Analytics has issued a locally focused note entitled "South African bond yields -... Read More