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Market Thinking - Does the Upcoming Xiaomi IPO in HK herald a busy summer?

Does the Upcoming Xiaomi IPO in HK herald a busy summer?

Market thinking

Upcoming Xiaomi IPO in HK will take advantage of recent financial liberalisation measures and could herald a  busy summer

  • We remain hopeful and cautiously optimistic about Korean talks and also encouraged by increasing evidence of a shift in investor attitudes to be hopeful and cautiously optimistic about China
  • Trade talks and tensions
  • The Royal Commission into Australian Banks is causing shockwaves and a necessary tightening of mortgage standards might cause problems in residential property markets where yields are below government bonds, supply is increasing sharply and other classic speculative behaviour has been much in evidence
  • Geo-politics continues to dominate noise markets

Golden week here in much of Asia, however it was announced that  Xiaomi, the handset maker is going to have an IPO in Hong Kong in early July, taking advantage of two of the recently announced market reforms here in Hong Kong, the first  allowing for dual listing and thus enabling founders to retain control and the second (according to a banker on the IPO quoted in the Financial Times) to take advantage of the new China Depository Receipt system (CDR) that was announced last month. Xiaomi is first and foremost a handset maker, but like many tech companies in China has also seeded a  wide variety of what we would refer to as Fourth Industrial Revolution companies in the whole Internet of Things (IoT) space and while the recent market developments have doubtless encouraged the move to listing – a $100bn valuation is targeted – the escalation of US China Trade tensions has introduced a note of caution. As we have discussed, the reality behind the current trade disputes is less about steel and aluminium and much more about the IoT, access to the Chinese Consumer and competition in third markets  - Xiamoi is the top phone in India for example.

The other aspect of the trade tensions of course has been geo-politics and as previously discussed, the role that US pressure on China had, resulting in  Chinese pressure on North Korea ending in the (historic?) photoshoot this week between the leaders of North and South Korea. But as President Trump himself acknowledges, there is an awful long way to go.  Naturally there is much scepticism in the media – and particularly in the below the line comments sections about the prospects of peace, but  there appears to be  a shift away from some of the dogmatic certainty of recent years towards a more balanced and nuanced acceptance of alternative opinion, particularly with respect to China.  An example of this was this week’s column by Martin Wolf in the FT, titled How the Beijing Elite sees the world. The points he makes are that Chinese policy makers basically have a belief that 1) China needs strong central rule i.e. that Xi’s ‘job for life’ is seen as necessary and not a threat 2) Western models are discredited – they believe in the fundamental role of the market but not the current western approach. If anything this validates the key point of the previous paragraph, there is no point expecting China to follow ‘our’ model.  3) China does not want to run the world. China has plenty to be going on with at home and wants co-operation not conflict 4) China is under attack by the US. They view the US as regarding them as an economic threat and see US policy as trying to contain them. 5) US goals in the trade talks are incomprehensible – they question whether this is economics or politics and  importantly stress that the notion that China’s technological upgrade is ‘non-negotiable’ and finally that 6) China will survive these attacks

While world attention on this part of the world has lately tended to focus on China, trade wars and North Korea, in Australia, there have been some significant political/economic developments that may have passed people by, although certainly not in the local market. A banking Royal Commission has unearthed a number of scandals over the last few months and in the words of Peter Costello, (the former Treasurer and now Chairman of the giant Future Fund) the big four Australian Banks, who control around 75% of the market, are now “on the mat’ . It’s as if all the scandals that have hit everywhere else in the last decade have all come at once to Australia. Interest rate fixing, mis-selling, poor advice, and money laundering. Senior managers everywhere have resigned or moved aside and taken pay and bonus cuts as the Commission and other regulators have focussed on a variety of failures including as one  QC put it about AMP (who along with the big 4 is a key player in the financial planning industry)  the scandal of  “fee for no service conduct”. CBA has also been hit with a ‘damming’ report from the regulator on issues such as anti-money laundering and counter terrorism law failures,  leading the Australian Treasurer Scott Morrison to demand more senior heads to roll, while some shareholders at AMP, where the Chairman and CEO have already gone, have called for the whole board to resign.

The finance sector is hugely important for savers as well as borrowers, comprising as it does around a third of the main index and thanks to the dividend tax imputation credit likely an even bigger percentage of private investor portfolios. The banks in particular have high yields and thus are widely held in personal pension funds. All of them have seemingly abandoned attempts to incorporate wealth management into their businesses. NAB this week announced it is to sell its MLC asset management business, CBA is looking into floating its Colonial First State business, while ANZ have already largely exited from most of its wealth advisory and insurance businesses.

Perhaps more pertinently for the economy as a whole, and particularly the housing market, is that one of the key criticisms appears to be lax lending practices, particularly in mortgage lending, suggesting a forthcoming tightening. At the risk of analysis by anecdote, it is worth repeating something passed on to me a few months back (and which I wrote up at the time). While every time I go to Australia to speak at a conference one of the key ‘audience vote’ questions is about property prices in Melbourne or Sydney, I am interested in the Gold Coast near Brisbane. This is currently in the middle of a 2007 Miami moment according to some locals. Small mortgage lenders will lend you the deposit on, say, a high end AUD$1m apartment at a relatively high mortgage rate, but the big lender will lend you the other 90% at a very competitive rate. The trick is then to further borrow another, say, AUD$200,000 as a ‘home improvement loan’ and use a portion of it to pay back the original deposit loan, while spending the rest on refitting etc. You then sell the improved property (theoretically) for AUD$1.4m, pays back the home improvement loan and walks away having made AUD$200,000 out of apparently thin air. Everybody wins in theory. The big bank then lends 90% to the new buyer of the (now) AUD$1.4m property and it all carries on. Except the problem now is that, increasingly, the valuations underpinning the Loan To Value (LTV) of 90% are coming under question.. The AUD$100,000 spent on improvements has pumped plenty of money into the local economy – fuelling demand for more credit (for luxury goods .) -  but hasn’t really added that much to the resale value. It looks like a textbook property bubble.  The price per square foot might not match London, Hong Kong or Shanghai, but already we see prime plots that are going for 4 times Sydney and nine times surrounding Brisbane which reminds me of the 2003-6 boom in Dublin, when ‘everyone’ was a property developer and the mortgage cost on a new property in a field fifteen miles outside Dublin ended up costing more than the rent on a super-prime property in the city centre. Even before the financial crisis hit, stocks like Bank of Ireland had seen their share prices halve as the property bubble burst. They then halved again, and again. During the actual crisis from September 1998  to March 2009 the share price of BoI fell from Eu60, to Eu2.3 and even now are only around Eu7.3. The point of this is not to evoke the financial crisis, rather to say, that even without the financial crash, the bursting property bubble in Ireland had already taken the BoI share price down almost 85%, from Eu350 to EU60. Back then, there were various signs, vacant properties, mainly in new developments, were soaring, while the rental yield was dropping rapidly and was below bond yields. Interestingly this index shows South Brisbane houses yielding 2.7% last year, which is below Australian Treasuries (and obviously below most equity yields). Sydney is even lower. To stress, this is not supposed to be an in depth study on the Australian property market, but when we have one survey showing yields below ‘risk free’ , we have an upcoming surge in supply - media reports suggests +35% of properties coming onto the market in Sydney for example – we have anecdotal evidence of classic Dublin or Miami like speculative behaviour and we have a Royal Commission and regulators hammering down on the big banks for slack lending procedures then we have the  recipe for a ‘correction’.

So to conclude, in what is a relatively quiet week for Asia , geo-politics continues to dominate noise markets, notably metals and energy, while equities try and make sense of what might happen with trade at the micro level. With the assorted May Bank holidays there is a feeling of caution and flattening of positions and some talk of ‘where we are in the cycle’, not least as the dollar has begun to firm again and some investors are worried about emerging markets and their dollar sensitivity. Rather than simple historic correlations, I believe we need to take account of structural changes, not least the difference between current account deficit countries – essentially borrowing dollars and thus sensitive to higher rates and a higher dollar – and current account surplus countries. It seems no coincidence that some of the LatAm currencies are struggling – in Argentina this week rates are being hiked to try and control a collapsing currency. This only serves to highlight the contrast between north Asia, where Taiwan, South Korea and China count as emerging markets, with struggling primary producer economies in South America and elsewhere. This is increasing the trend towards splitting Asia, if not Greater China, out from traditional benchmark emerging market indices.

The recent (and ongoing) structural changes in Chinese and HK financial markets have been brought sharply into focus by the upcoming Xiaomi IPO, which will have both a dual listing and, apparently a CDR, or Chinese ADR. This will have far reaching importance for the savings and investment industry in greater China as it will enable Chinese investors to participate more fully in the transformation from an almost pure banking to a mixed banking and capital markets financial system. We have frequently said that China does not need western capital, it has arguably too much already, but it needs western help to direct it efficiently to the right places.

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