The Ingham Analytics Weekly Letter on Sunday - 14 February 2021

Sunday, 14 February 2021

Welcome to our Ingham Analytics Weekly Letter on Sunday where we take a step back to see wood for trees - not too seriously, and with a touch of humour.

A Happy New Year to our Chinese readers. The year of the Ox takes over from the year of the Rat. We wish all of you a much less challenging year than that just past.

The New Year was on Friday, but celebrations will last for a fortnight. In mainland China the public holiday began this Thursday and will continue through Wednesday this coming week.

For those trading stock exchanges the Hong Kong exchange will be closed on Monday, but the Singapore exchange will be open whilst Shanghai will open again next Thursday.

The celebrations this year will be tempered by pandemic caution on mixing and travel, but people can still have a welcome break. In Singapore, the government has implored folk not to utter auspicious sayings but, as the Prime Minister was quoted, "say them in your hearts instead." One enterprising fellow created a mobile website that lets you play voice recordings of traditional sayings. Anyway, one can still enjoy abundance throughout the year, even if quietly, and, with gold this week still a relatively firm $1,800/oz, may your floor be covered with gold.

The order of Chinese zodiacs seemingly came about through a mythical race to a finish line at the Jade Emperor's party, with the Rat getting pole position and the Ox runner up having carried Rat along, who then cunningly jumped off at the finish to claim first place. The Ox though takes first prize for honesty, reliability and humility.

Let's hope that with vaccines and behavioural shifts we can all get back to a low-key normality and away from the hypertension of the pandemic world.

With China enjoying a rapid economic recovery from the pandemic-induced downturn it is a locomotive for the world. Iron ore is a useful barometer of China's industrial bounce back with benchmark 62% Fe fines imported into Northern China $160/t this week, double the level of a year ago.

This iron ore buoyancy has had benefits for Australia which counts iron ore as its most valuable export, and with it a strengthening Australian dollar which has recovered from an all-time low of AUD1.80/USD last March, the height of the pandemic market selloffs, to AUD1.29/USD. BHP shares are also up sharply, from a 52-week low of AUD24 to AUD45 on the ASX.

As you will have read last week, we regularly assess developments in the Asia-Pacific region given its rising clout in the world. Investment opportunities are gathering apace. The region is also increasingly at the forefront of academic peer-reviewed research articles.

This week we issued a note entitled "Kuaishou bounce" which analysed the listing of Kuaishou Technology (stock code HKG:1024) and what we can expect from Tencent, which is the largest single corporate shareholder in the video-sharing mobile app.

Kuaishou apparently means "fast hand" in Chinese. The company competes with ByteDance, a rival Chinese company behind TikTok and sister app Douyin. The service offers a broad range of videos with 40% of videos getting over 100 views which means it is targeting a mass market.

Tencent will end the financial year strongly and is scheduled to report on 24 March. We have earnings per share of RMB12.91 for the twelve months ending December 2020, a rise of 29.5% from the RMB9.96 of 2019. Our three-year compound EPS growth estimate is 24%.

We estimate a dividend of HK$1.50 for 2020. Seeing as Prosus has a 31.2% shareholding in Tencent the annual dividend income for 2020 is $577m in USD, the largest single source of cash for Prosus as the rump loses money.

The share price of Tencent, last quoted at HK$757 for a market cap equivalent to $938 billion, has had a strong run and we struggle now to see value as the metrics we assess are well above historic averages. Earnings are growing in double digits, but you are now paying a hefty price for those earnings, the highest in a long time. It is like the price earnings ratio inflation we've referred to previously in so-called tech shares in the US.

Prosus and Naspers have not joined the party and have lagged way behind with the discount to the see-through value of the shareholding in Tencent at a record level this week.

For useful background research on markets, we'd recommend checking out the Investment Analysts Journal, owned by the Investment Analysts Society of South Africa and published by top academic publisher Taylor & Francis in Oxford. The IAJ is a widely accredited and cited peer reviewed journal with international reach. The bar to getting an article published is tough and getting tougher.

The IAJ has just published "Stock price prediction using multiple valuation methods based on artificial neural networks for KOSDAQ IPO companies." With the Kuaishou Technology IPO last week this will be of particular interest.

The paper was authored by two academics from Seoul Business School. We believe this to be a timely addition to the body of knowledge given that we are seeing a stock-listings boom in Asia. In less than one week the market cap of Kuaishou Technology exceeds $200bn, that is 3.5x what the pre-IPO valuation of $60 billion indicated. In their abstract, the authors say "It is difficult to predict future payoffs for initial public offerings" - too right, gentlemen.

There were stories this week in the press about Amsterdam exchanges having traded slightly more shares in European companies during January than traded than London. The increase since December is fourfold. This shouldn't be news as firms long since arranged to serve EU based clients within the EU rather than London.

The EU has steadfastly refused to accept the City of London's credentials, centuries in the making and regarded as gold standard everywhere else, even though the UK has given reciprocity. The EU holds other jurisdictions, even Brazil, to lower standards so this smacks of protectionism and vindictiveness around Brexit but misguided and likely to damage the interests of EU based firms and customers. The Governor of the Bank of England this week made it quite clear that the City will not be an EU rule-taker and if the EU refuses to take a sensible position on a common framework of global standards with flexibility to adapt as circumstances warrant, then so be it.

As we said last week, the City won't be losing any sleep as it sees its main competition and opportunity in New York, Singapore, Hong Kong and even Shanghai. China and its capital markets are booming, with lots of companies going public and raising money from stock and bond sales domestically and abroad.

What the EU also myopically misses is that share trading on formal exchanges has been not only falling but close to becoming marginalised. The overwhelming majority of trading is carried out on systematic internalisers within firms based in London. Financial firms match up trades internally between clients. Also popular with institutions are block trades and dark pools.

If you want to get a big order done quietly and without upsetting pricing that's where you go - and the only centre within the European area that can handle all this is, you guessed it, London.

And whilst trades can be booked in Amsterdam or Paris or Frankfurt activities such as settlement, clearing and risk management, where the value lies, are carried out in London. If clearing for example were to be forced into separate EU centres it would result in fragmentation, higher bid-ask spreads, higher capital requirements and lower lending.

To put equities in context, trading volumes in derivatives and foreign exchange in London are 75x larger and 5x larger than all EU centres combined.

Back to dark pools. This week data showed that a record 47% of US equity trading volume in January was executed outside public stock exchanges, up from 40% a year before. On some days it is half. Brokers route trades through market makers that execute privately. So, when you see daily volumes out of say the NYSE or Nasdaq you are likely seeing half the picture.

Whilst there are arguable downsides to internalisers and dark pools it is hard to see how all trades can be forced onto an exchange. It hasn't worked in the EU despite a directive in 2018. Canada has a rule that trades must be executed on an exchange, but those markets are small relative to the US, several companies have a New York listing anyway, there are far fewer listed counters and investors simply bypass Canadian exchanges for the US and its vast pool of liquidity and choice.

This week we also issued "Stop the Game - I want to get off", observing that when a veteran short seller says he's never seen anything like it the saga of GameStop takes on a whole new meaning of spectacular. We unpack how this chain of events unfolded to the extent intra-day volatility was being traded on occasion at 2,700%. There are fascinating background charts and tables. The institutional framework wobbled but held firm, with margin escalating, but we don't believe there will be systemic risk unless this behaviour lets rip widely across many more shares.

On a cryptic topic, news that Tesla has bought bitcoin has raised interest in the cryptocurrency. Mr Musk's company bought $1.5 billion in bitcoin. Tesla also said it expects to start accepting bitcoin as payment for its products soon. The bitcoin disclosure came in their annual report. Apparently gold bullion and gold exchange-traded funds are on the list.

Whether this is a gimmick we can't say, Mr Musk has a history of being controversial. There are accounting risks to bitcoin as digital assets are considered indefinite-lived intangible assets and not currencies so a decrease in value below what is paid, even if temporary, means you must write down the value by taking an impairment charge. Tesla has acknowledged this, saying "if we hold digital assets and their values decrease relative to our purchase prices, our financial condition may be harmed."

The other thing is that Tesla makes no profit on the EV's it sells, other than green credits. If bitcoin was received for a $100,000 car and the price of bitcoin fell on the day the losses get bigger. If a US dollar is received, whether the dollar goes up or down against other currencies is irrelevant.

Digital assets consulting firm Paradigma has said that sharp changes in a digital currency's valuation means you shouldn't bet the farm. Cryptocurrency is known to swing wildly. Hardly any companies now accept bitcoin directly as payment and the few that experimented with bitcoin payments quietly dropped it for lack of use.

Chinese New Year is our big deal of the week - lots of luck and profits!



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