Author: Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters. Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis. Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events. He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
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Epic v. Apple (AAPL)

Apple logo

If Fortnite-maker Epic Games’ Australian legal challenge against Apple is successful, the tech giant may be forced to loosen its grip on its valuable mobile app ecosystem, with Epic arguing that competition law obliges Apple to allow rival stores and payment processing mechanisms on its devices.

Currently, the Apple-controlled App Store is the only way to get apps to consumers on iPhones, which make up more than half of all in-use smartphones in Australia. And all payments for digital goods, in-app purchases and subscriptions must use Apple’s payment mechanism, from which, in most cases, Apple takes a 30 per cent commission.

ACCC: Rod Sims
ACCC chair Rod Sims

Australian Competition and Consumer Commission chair Rod Sims said the Epic case was a well-timed test of the current competition laws, which were recently revised to better prevent misuses of market power

“Apple, as one of the two main app stores, is in a very strong position. It would seem like they have quite a lot of market power and can set the terms and conditions under which various apps operate,” Sims said. (from Tim Biggs at The Age)

Epic Games lawsuit

Epic Games filed suit against Apple in the US District Court for the Northern District of California, on August 2020, challenging Apple’s restrictions on apps from having other in-app purchasing methods outside of the App Store. Founder Tim Sweeney had previously challenged the 30% revenue cut that Apple takes on each purchase made in the App Store. Epic made changes in Fortnite intentionally to bypass the App Store payment system, prompting Apple to block the game from the App Store and leading to the Epic lawsuit.

Epic also filed another lawsuit against Google (GOOGL) the same day, which challenges Google’s similar practices on the Google Play app store for Android, after Google pulled Fortnite following the same update. (Wikipedia)

Apple Segments

Apple Inc. AAPL Segments

Services only account for 20% of revenue (FY20) but gross margins (66.0%) are more than double that of products (31.5%). The contribution towards overall operating profit of $66.3 billion is likely to be disproportionately high.

Conclusion

Apple would take a significant profit hit if its monopoly hold over app registration (via its App store) and processing of digital payments was removed. The company is already backing off from its former uncompromising stance, offering to halve commissions on sales via the App store (including In-App purchases), but only for developers with sales of less than $1 million. Allowing free competition from competing app stores and digital payment processors would compress margins even further.

Disclosure

Staff of The Patient Investor do not directly or indirectly own shares in the above company.

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George Orwell and the appeal of Fascism

George Orwell reviewed Hitler’s Mein Kampf in March 1940. His last paragraph is particularly revealing:

“Also he [Hitler] has grasped the falsity of the hedonistic attitude to life. Nearly all western thought since the last war, certainly all ‘progressive’ thought, has assumed tacitly that human beings desire nothing beyond ease, security and avoidance of pain. In such a view of life there is no room, for instance, for patriotism and the military virtues. The Socialist who finds his children playing with soldiers is usually upset, but he is never able to think of a substitute for the tin soldiers; tin pacifists somehow won’t do. Hitler, because in his own joyless mind he feels it with exceptional strength, knows that human beings don’t only want comfort, safety, short working-hours, hygiene, birth-control and, in general, common sense; they also, at least intermittently, want struggle and self-sacrifice, not to mention drums, flags and loyalty-parades. However they may be as economic theories, Fascism and Nazism are psychologically far sounder than any hedonistic conception of life. The same is probably true of Stalin’s militarised version of Socialism. All three of the great dictators have enhanced their power by imposing intolerable burdens on their peoples. Whereas Socialism, and even capitalism in a more grudging way, have said to people ‘I offer you a good time,’ Hitler has said to them ‘I offer you struggle, danger and death,’ and as a result a whole nation flings itself at his feet…..”

David Wood suggests that society may have eliminated many of the challenges that they faced 80 years ago but this makes us even more vulnerable today. If people don’t have real struggles to overcome, or enemies to fight, they will invent them…..

George Orwell on Hitler's Mein Kampf

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Time to get on with the serious business of beating COVID-19

Conservative news channel Fox News have called the election in favor of Joe Biden.

FoxNews: 2020 election

Trump and a few die-hard supporters insist that they will mount a legal challenge to overturn the election result. Here is a quick assessment of his chances by Neal Katyal, professor of National Security Law at Georgetown University and former US Acting Solicitor General (2010-2011):

Neal Katyal

There were 128,412 new COVID-19 cases on Saturday, November 7, bringing the total number of Americans infected to just under 10 million.

Daily New COVID-19 Cases reach 128,412

This has the potential to overload the health care system and shut down the economy. We need to ignore the sideshow and focus on what can be done to stop this. Before it’s too late.

Quote for the Week

Crisis does not change who you are.
Crisis reveals who you are.
~ Jakub Janda

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Still counting…….and still rising!

Three days have passed since the election and there is still no clear result.

Fox Election Results

There are currently five states still in play: Alaska, Georgia, Nevada, North Carolina, and Pennsylvania. With 270 electoral votes needed to win, Biden needs 6 more electoral votes — any one of the last four (GA, NV, NC or PA) would do it.  If conservative Fox News call the result in favor of Joe Biden, we will know it is all over for Donald Trump.

There are wild claims of missing ballots and vote rigging aimed at destroying credibility of the election result, plus conspiracy theories and fake videos alleging election fraud circulating on social media. We saw similar videos circulated after the 2014 Scottish independence referendum. Some were so amateurish as to be laughable — with looped video run in reverse in an attempt to portray an election official as counting the same ballot over and over again, complete with a voice-over with a heavy Russian accent — but some are now likely to be far more professional. Social media companies will need to crack down on organized disinformation campaigns.

Requests for recounts are fair enough in a hotly-contested race but are unlikely to change the outcome. Allegations of election fraud are far more malicious, especially when made in the mass media rather than in court. In the end, any such allegations will need to be tested in a court of law which will act as the final arbiter.

Still Rising!

The election is distracting us from an even more serious threat to the country: daily cases of COVID-19 in the US reached a new record high of 121,888. Failure to curb the current rate of transmission threatens to overwhelm the health care system and bring the economy to a standstill.

Covid19: New US Cases

The last thing we need is to neglect the COVID-19 campaign while the election arm-wrestle descends into an all-in brawl.

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Why Today’s Fiscal Stimulus Is Not Like WWII | Eric Basmajian

https://youtu.be/Rq5aBHsz0V0

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Garry Kasparov: Propaganda

Garry Kasparov: Propoganda

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Bearish divergence warns of tech stock retracement

The US recorded more than 75,000 new COVID19 cases on July 16th. The CCP must be smiling behind their masks after successfully containing last month’s outbreak in Beijing.

COVID19 Daily New Cases

Source JHU CSSE

Technology stocks have screamed upwards despite the chaos, but bearish divergence on Twiggs Money Flow now warns of selling pressure. Expect retracement to test support at 2650 on the Dow Jones US Technology Index.

DJ US Technology Index

Dow Jones Banks Index is a more realistic representation of the broader US economy. The weak rally has fizzled out, with a Money Flow peak at zero now warning of strong selling pressure. Breach of short-term support at 320 would signal another test of primary support at 270/280.

DJ US Banks Index

Government support can only cushion the impact of a massive surge in unemployment for a limited time. Then we will witness the full extent of the damage.

Continued unemployment claims jumped to 17.355 million on July 4th, up by 840,000 from a week earlier. Judging by the rising virus count, further increases are likely.

Continuous Claims

But that is only the tip of the iceberg.

The latest Department of Labor update shows 32 million people claimed unemployment insurance benefits in all programs for the week ending June 27.

Department of Labor: PERSONS CLAIMING UI BENEFITS IN ALL PROGRAMS

…..21% of the 152.4 million non-farm workforce in February 2020.

Pandemic Unemployment Assistance (PUA) under the CARES Act, signed into law on March 27, 2020 provides benefits to those individuals “not eligible for regular unemployment compensation or extended benefits under state or Federal law or pandemic emergency unemployment compensation (PEUC), including those who have exhausted all rights to such benefits.”

The S&P 500 is inching upwards, reflecting the tug-of-war between technology stocks and the broader market. We expect retracement of the Technology Index to cause another test of support at 3000 (on the S&P 500).

S&P 500

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Nasdaq: Devil take the hindmost

I am fond off quoting Jesse Livermore’s maxim “You don’t argue with the tape” but Livermore was a keen student of market conditions and based his decisions on far more than just price action in the market.

We are witnessing a spectacular stock market rally, driven by retail investors and hedge funds piling into the market while institutional investors are sitting on the sidelines.

The Nasdaq 100 broke through resistance at 10,000, new highs signaling a fresh primary advance. Bearish divergence on Twiggs Money Flow index may warn of selling pressure but it is hard to argue with the tape. Only a fall below 9500 would signal another decline and that seems unlikely at present.

Nasdaq 100

Even retail sales (ex food) have recovered sharply, from -15.3% in April to -1.4% in May (annual % gain).

Retail Sales (ex Food)

Light vehicle sales are more sluggish but June sales of 13.05 million are still a sizable bounce.

Light Vehicle Sales

So why are many old investment hands acting with such caution?

We know that the efforts to contain the COVID19 outbreak are struggling, with over 60,000 new cases per day, but the economy still seems in good shape.

COVID19 Daily Cases

Source JHU CSSE

Let’s look at where the money is coming from.

Federal Debt

Treasury debt has expanded by more than $3 trillion in the last four months (March 9 – July 9) as the government does everything in its power to cushion the economy from an unprecedented shutdown. Rescuing airlines, bailing out Boeing, emergency business loans, job preservation schemes, and supporting Fed purchases of a wide variety of financial assets to keep the plumbing of financial markets open. Every way they can, government has been flooding the market with money and some of that has found its way to the stock market. Whether through boosting stock purchases, enabling companies to raise debt or boosting consumer spending to buoy up sales, the market is flying on borrowed money.

Steep up-trends like this typically end in a blow-off. A trend is self-reinforcing if rising prices attract more investors who in turn bid up prices even further. A steady influx of new investors is required to sustain the trend, else it dies.

Similar self-reinforcing cycles are evident in nature, where they expand violently outward at an exponential rate until they run out of fuel. The fuel driving the event may differ, from dry tinder in a forest fire, warm ocean temperatures in a hurricane, consumable vegetation in a locust plague, …..or exposed population in a virus outbreak. The cycle expands, feeding on itself, until the fuel is exhausted.

A stock market blow-off is no different. The up-trend will continue for as long as rising prices are able to attract new investors. It will stop when the source of new money dries up. In this case, when Treasury tries to slow the unsustainable growth in federal debt. Then it becomes a case of devil-take-the-hindmost as a preponderance of sellers attempt to offload their stocks on a rapidly shrinking pool of buyers.

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COVID19: The new normal

COVID19 looks like it will be with us for some time. The US has to guard against a second wave, destroying any hard-won gains.

Daily Cases

Especially with the upsurge in daily cases in Mexico.

Daily Cases

Australia has been fortunate to catch the outbreak early.

Daily Cases

But international travel is likely to remain restricted for a long time. When you have new outbreak hotspots like Brazil….

Daily Cases

and Pakistan appearing on the radar.

Daily Cases

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Macquarie Group Ltd (MQG)

Stock: Macquarie Group Ltd
Exchange: ASX Symbol: MQG
Date: 11-May-20 Latest price: $108.50
Market Cap: $38.8 bn Fair Value: $125.42
Forward P/E: 15.6 FV Payback (Years): 11
Forward Dividend Yield: 4.09% CET1 Capital Ratio: 12.2%
Financial Y/E: 31-Mar-21 Rating: HOLD
Sector: Financial Services Industry: Capital Markets
Investment Theme: Dividends & Growth LT Trends: none

Summary

We consider Macquarie (MQG) to be priced at below fair value, but the technical outlook is bearish.

We rate the stock as a long-term HOLD because of its strong cash flows and competitive position. Weighting is 5.0% of portfolio value.

Valuation

We project flat annual revenue growth in the next 12 months, recovering to 8% in the long-term, with a provision of $1.5 billion to cover further impairment charges and under-performance of market-facing businesses. Estimated fair value is $125.42 with a payback period of 11 years.

The payback period recognizes MQG’s strong market position but also the uncertainty of financial markets.

Technical Analysis

MQG is in a primary down-trend and we expect another test of primary support at 70 before the bear market is over. Trend Index and Momentum below zero both warn of bearish market sentiment. Respect of primary support would provide a solid base for a new primary up-trend. Breach is unlikely but would flag another decline and a strong bear market.

Twiggs Trend Index & Twiggs Momentum (13-week)

Company Profile

Macquarie Group is Australia’s only sizable investment bank. Internationally diversified, the group employs 15,849 people in 31 countries, with its head office in Sydney, Australia.

Macquarie was innovative in setting up large infrastructure funds which provided a captive client for the group but most of these were dissolved after the 2008 global financial crisis and have been replaced as an income source by other annuity businesses. FY20 net profit contribution by activity:

MQG Profit Contribution by Division - FY20

Asset Management (MAM) manages infrastructure and real assets and securities investments for both retail and institutional clients in Australia and the US, with a total of $A607 billion under management in FY20.

Corporate and Asset Finance (CAF), with an asset and loan portfolio of $A21.3 billion (FY19) was broken up and integrated into MAM, CGM and Macquarie Capital in FY20.

Banking and Financial Services (BFS) has a retail deposit book of $63.9 billion, an Australian loan and lease portfolio of $A75.3 billion and a wealth management platform with funds of $A79.1 billion (FY20).

Commodities and Global Markets (CGM) offers broking, trading, hedging and finance on global securities markets including equities, fixed income, foreign exchange and commodities.

Macquarie Capital (MC) provides corporate finance advisory and capital raising services to corporate and government clients.

International Income

MQG International Income - FY20

International income1 is net operating income excluding earnings on capital. Australia2 includes New Zealand.

Competitors

Macquarie competes with local commercial banks, fund managers and securities houses, and — with 67% international income in FY20 — a multitude of international investment banks.

Performance

Annuity-based businesses performed well in FY20 but cyclical, market-facing divisions experienced a significant fall in net profit contribution.

Asset Growth

  • MAM assets under management grew 10% to $605.7bn in FY20, compared to $551bn in FY19;
  • Banking & Financial Services (BFS) loans and leases grew 20% to $75.3 bn, funded by a 20% increase in deposits to $63.9 bn.

Segments

Market-facing businesses under-performed in terms of net profit contribution1 in FY20:

  • Commodities and Global Markets (CGM) were level with FY19; while
  • Macquarie Capital (MC) fell 75% after a stellar 89% increase in FY19.

Annuity-style businesses improved in FY20:

  • Asset Management (MAM) was up 16%;
  • Banking & Financial Services (BFS) were up 2%.

Net Profit Contribution1 is calculated before unallocated corporate costs, profit share and income tax.

Return on Equity

Return on equity fell to 13.6% due to an 88% increase in impairment charges ($1.04 bn compared to $552 m in FY19), related to the COVID19 outbreak and weak results from market-facing businesses.

MQG Return on Equity and Return on Assets

Margins

Staff costs are Macquarie’s largest operating expense. Long-term growth in the ratio of Net Income to Employment Costs reflects Macquarie’s increased ability to leverage operating expenses.

MQG Net Income/Total Compensation

Assets under management

Assets under management have grown at a compound annual rate of 6.4% over the last 10 years (FY10 to FY20).

Earnings per share

Earnings per share (EPS) has grown at a compound annual rate of 8.6% over the last 10 years or 9.6% over the last 5 years.

MQG EPS

We project long-term growth of 8% in annuity-based assets (AM, BFS & CAF) and in earnings per share.

Capital structure

CET1 (Common Equity Tier 1) Capital Ratio improved to 12.2% in FY20 (FY19: 11.4%) calculated on risk-weighted assets using APRA Basel III standards.

The unweighted CET1 Leverage Ratio, based on total credit exposure, however, weakened to 5.1% in FY20 .

Capital ratios are adequate but not strong by our standards.

Dividends

Dividend payout of $4.30 (40% franked) for FY20 is down 25% compared to FY19 ($5.75 and 45% franked). We consider the dividend payout ratio of 56% (FY20) to be sustainable.

Forward guidance

Guidance for FY21 has been withheld because of uncertainty surrounding the COVID19 outbreak.

We have made a provision of $1.5 billion to allow for uncertainty over further impairment charges and under-performance of market-facing businesses.

Strengths & weaknesses

Macquarie is a world-leading infrastructure fund manager and in an excellent position to capitalize on massive expected investment in global infrastructure and renewable energy over the next decade.

Weaknesses

Like most investment banks, Macquarie relies on market knowledge and resourcefulness to identify new opportunities and innovate existing businesses. While they have an excellent track record, they can still make mistakes.

Cyclical fluctuations may affect performance.

BFS exposure to the highly-priced Australian property market is a vulnerability.

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.

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