The Ingham Analytics Weekly Letter on Sunday - 20 December 2020
Welcome to another Ingham Analytics Weekly Letter on Sunday in which we aim, inter alia, to take a step back to see wood for trees, in South Africa and around the world - and with a mix of irony and humour.
This is the last Weekly Letter on Sunday for 2020 and we'll be resuming on 10 January. We wish you all a safe break from the daily grind.
A limp end to the week on Wall Street. Tesla stock ended at a record. Friday marked what's known as quadruple-witching, the simultaneous expiration of stock-index futures and individual-stock futures together with stock-index options and individual stock options.
We're close to the end of 2020, a decade since the global financial crisis precipitated by sub-prime in America, excessive risk taking and a debt implosion in the EU. The more things change the more they stay the same.
Financial and economic weaknesses in the developed world pre-pandemic have been accentuated this year. Interest rates are at rock bottom; even ten years ago the US ten-year yield was over 3% compared to less than 1% now. The German ten-year yield is negative. In Switzerland you pay the bank to keep your money on deposit.
America has run perpetual federal fiscal deficits ever since, 5% in 2019 alone, and perpetual current account deficits. All funded by the kindness of strangers. If a country can't run a surplus after a decade of a cyclical upturn it is hardly like to and certainly not now. At some point the exorbitant privilege enjoyed by the US and thus the dollar will end but for now it's the only gig going in FX.
If you're exposed to the JSE All-Share Index it's flatlined in rand in ten years and lost over 40% of its value in USD, even at R14.50/$ on Friday. And that's including Naspers/Prosus, which has sunk from a premium to the holding in Tencent to a large discount. Sasol has lost 80% of its value in USD in a decade - that's one dry oil well.
We're on record as saying the JSE is largely uninvestable other than for a few dual-listed stocks such as a BHP or Richemont with Bidcorp being an industrial outlier thanks to the fact most of its earnings are generated outside of South Africa and well-diversified. We won't touch the main local banks, in part due to their exposure to sovereign risk. Capitec is the exception but a bit too pricey now having shot above our fair value in the past couple of months.
This week Charlie Munger, renowned as Warren Buffett's business partner, was interviewed by a professor from the California Institute of Technology. Mr Munger turns 97 on 1 January so he knows a thing or two. He remains active as vice-Chairman of Berkshire Hathaway, with Mr Buffett, who turned 90 in August, as Chairman. These two gentlemen are good examples of why an arbitrary retirement age of say 65 is pointless in this day and age, in fact several of their notable achievements were over the past 25 years.
In the interview, the down-to-earth Mr Munger was at a loss to explain the "frenzy" in the US stock market. "Frenzy is so great, and the systems of management, the reward systems, are so foolish" he said. "Nobody has gotten by with the kind of money printing now for a very extended period without some kind of trouble". And on froth he said, "nobody knows when bubbles are gonna blow up." His conclusion is that investors should not expect the kind of returns enjoyed over the past 10 years, at least in the US.
This year has been dominated by COVID-19 and the economic hit caused by government responses globally to try and combat the pandemic. There is no standard textbook entitled "The definitive guide to combatting COVID-19" so it is hardly surprising that the battle seems to have been rather hit-and-miss. Numerous armchair epidemiologists with their bachelors' degrees from the University of Google have spouted forth their solutions on social media; if only authorities had listened all our troubles would be over.
Come 1 January, COVID-19 will be still with us. We'll only really get to know how deep the damage goes in the coming months. The degree to which there is worldwide economic recovery, be that V, K, L or whatever letter of the alphabet you think best, will be a function of vaccine effectiveness and human behaviour. Practical, common-sense conduct can do much to keep the pandemic in check. Government largesse in many countries, a necessary stopgap to ease things along, will have to be reined in next year as it is not sustainable.
There are stirrings in the real economy, as we've mentioned in recent notes such as "Dr Copper gives a diagnosis". China and other Asian countries are growing, prices of industrials metals such as copper and iron ore are shooting up, Brent crude oil is above $50/bbl, and shipping freight rates have risen significantly. Residential property has held up well in the US, UK and elsewhere. Mining stocks have been on a run whilst oil stocks are up from year lows.
The pandemic could shift habits and preferences and there may well be positive effects on productivity. Trends already apparent may just be accelerated. Who knows, the ANC may rediscover or be forced to rediscover fiscal responsibility? But we have a sense that the post-pandemic world will still look a lot like the pre-pandemic world, whatever stargazing futurists reckon.
One of the big disconnects this year is the proverbial gap between Wall Street and Main Street. Low interest rates, the Robinhood day-trader effect that has brought millions into casino-like stock market activity, and a slew of initial public offerings in the US that typically have a "tech" moniker attached has sent a relatively small number of US shares skyrocketing, divorced from the valuation fundamentals that old hands have grown up with. Maybe this time it is different, although we've heard that before and it never ends well.
This week the Securities and Exchange Commission fined Robinhood Financial LLC $65 million for not properly disclosing deals with high-speed trading firms. It is common in the US for retail brokerage firms to earn revenue by sending customer orders to high-speed traders who pay for the right to execute those trades. There is a perverse incentive we believe to favour volume for the firm rather than what is best for the client, and the stay-at-home pandemic has fed this.
Also, this week Massachusetts securities regulators filed a complaint against Robinhood for aggressive marketing to novice investors who know no better, other than maybe being swept up by greed.
There are several stocks that we can name which meet the crazy definition but the one that exhibits this Wall Street/Main Street disconnect best for us is Tesla. The ascent is surreal. A descent could be just as surreal.
For five years Tesla broadly flatlined. A year ago, you paid $80 for a share. Short sellers were all over it. The company made few cars and no profit, other than from sale of 'green' tax credits to other companies. In April, amid pandemic panic, things got weird - the stock started to go parabolic. The reason that Tesla wasn't in the S&P 500 is that it didn't meet profitability criteria - but then a dramatic 180 degrees and from Monday, 21 December Tesla is included.
We mentioned in a previous letter that the S&P 500 seems like a typical emerging market index it is so lopsided - and consequently a benchmark best avoided if you want anything remotely like a representative gauge. Tesla won't really impact the price earnings ratio of the index but from a market cap point of view will make it just that bit more lopsided.
Six stocks, or 1% of the total stocks in the index, collectively valued at $8 trillion or 4x that of the FTSE 100, will account for 35% of the S&P 500.
Around $11 trillion is indexed or benchmarked to the S&P 500 so passive funds have had to buy tens of billions of dollars of Tesla stock. On top of retail investor pandemonium this further boosts Tesla in the lead up to inclusion. Perversely, short seller positions boost a stock as losses mean they need to buy stock to cover their positions.
At a price on Friday of $695 for a market cap of around $660 billion, Tesla is valued as much as Toyota, Volkswagen, Daimler Benz, BMW, General Motors, Ford, Fiat Chrysler and Ferrari combined. S&P Global Ratings rates Tesla credit at BB - which means speculative grade. We make no pretentions to value it accurately, and boy have we tried, with any number of scenarios plugged in reaching as far as Mars.
On this topic, what was interesting this week were comments at a news conference by Toyota President, Akio Toyoda. Toyota of course is famed for the hybrid Prius but has no plans for a battery only electric vehicle for the mass market.
He criticised the hype around electric vehicles and made several cogent points that should give boosters pause for thought.
Mr Toyoda spoke to the law of unintended consequences - indirect carbon emissions through electricity generation would escalate, costs of new infrastructure would be stratospheric, a huge automotive value chain would be destroyed if petrol and diesel cars are hastily banned, millions of jobs could be lost and the cost of EV's is such that only the richest can afford them. Some governments want to outlaw internal combustion engine cars within a decade but Japan, hardly a laggard in automotive technology and innovation, is noticeably shtum.
Whilst the valuations of several stocks in the US have levitational qualities, Tencent is on the pricey side these days but not absurdly so. We've recommended avoiding Prosus and Naspers, unless you really have no option, but Tencent has much to recommend it - it has a diverse and growing range of revenue drivers, it makes money, lots of it, generates cash, lots of it, and has a strong balance sheet - for youngsters out there what old timers used to call the statement of financial position.
We issued a note on Friday entitled "Gaming for change" in which we upped our three-year earnings forecast on Tencent. With nine months of the financial year under the belt Tencent is heading for a strong finish to 2020. A strong Q3 result was pushed along by mobile games revenues which we expect will help to underpin 2021.
We also issued another Tech themed note entitled "Will antitrust action spoil the US tech party?" Both Google and Facebook face federal antitrust lawsuits and Amazon is in the crosshairs. A breakup of these firms isn't out of the question. As per our point above, with a handful of so-called Tech names making up such a hefty proportion of the S&P 500 and Nasdaq, if they sneeze the index takes a bath.
And finally, as we're on about stock market escapism, famed English spy novelist David Cornwell, who wrote under the pseudonym John le Carr, passed on Saturday last week aged 89 in Truro, Cornwall. We'll all remember gripping novels such as "The spy who came in from the cold", "Tinker, tailor, soldier spy" and many other well-crafted stories together with the character George Smiley.
Mr Cornwell served in British intelligence, in both MI5 and MI6, and had first-hand experience of the Cold War goings on in espionage. His final novel entitled "Agent running in the field" was published in October 2019. For holiday reading there is little to beat thrilling John le Carr books, which are just as entertaining as when he first became published in 1961.
The debut of Tesla to the S&P 500 on 21 December is the big, and scary deal for us this week
Thank you all for visiting us.
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