Type: Bullish BounceKey Levels:Resistance: 51337.62Pivot: 40983.5Support: 36394.02Preferred Case:Price breakout of the descending trendline resistance, signifying an overall bullish momentum. We can expect price to push higher up from the pivot level in line with 23.6% Fibonacci retracement towards 1st Resistance in line with 50% Fibonacci retracement. Our bullish bias is further supported by the Ichimoku cloud indicator where the price holding above it.Alternative Scenario:Alternatively, price can drop back down to 1st Support in line with 61.8% Fibonacci projection.
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Monday, February 7, 2022
USDCAD, H4 I Potential Rise Type
Type: Bullish BounceKey Levels:Resistance: 1.27943Pivot: 1.27156Support: 1.26647Preferred Case:With prices moving above the Ichimoku cloud, we see the potential for a bounce from our pivot at 1.27156 in line with horizontal overlap support and 50% Fibonacci retracement towards our 1st resistance at 1.27943 in line with horizontal swing high resistance and 61.8% Fibonacci retracement.Alternative Scenario:Alternatively, price may break pivot structure and head for 1st support at 1.26647, in line with the horizontal swing low support.
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Dollar Up, Euro Near Three-Week High as Central Banks Continue Hawkish Tone
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Euro near three-week top, but looming Fed tightening could help dollar
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Sunday, February 6, 2022
Companies can't ride out inflation by raising prices
Consumer-goods giant Procter & Gamble says consumers are switching to premium brands. Burberry has said it expects to have to put up the price of its coats and bags as costs increase. According to a Which survey, Waitrose has been putting up prices faster than rival supermarket chains and yet sails on regardless. Meanwhile, BT is pushing up broadband prices way ahead of inflation and even the mighty Greggs, hardly anyone’s idea of an upmarket brand, has put up the price of its sausage rolls. Companies are complacently assuming they can ride out a bout of inflation with higher prices. But is that really true?
Inflation: back to the Seventies?
Most of the developed world is witnessing a burst of inflation on a scale that it has not experienced for 30 years or more. In the US, prices are going up at an annualised rate of 7.2%. In the UK, inflation has hit 5.2% and, with energy price rises still to come, will probably go above 6% very soon. Of course, this might not be sustained. If oil and gas prices start to level off, and if supply chains that were snarled up by the pandemic straighten out again, prices may start to steady. But if wages start to rise more rapidly as well, and if central banks misjudge what policies are needed, then we may well find ourselves right back in a 1970s-style wage-price inflationary spiral.
For companies, that poses a real problem. Many of them seem to be assuming that, if costs are rising, they can just put up their prices. Everyone, from coffee chains to fashion brands to streaming services such as Netflix, has been putting up their prices. Costs are going up, they explain to anyone who might complain. We don’t have any choice but to charge a bit more. That is, of course, the easiest option. But there are two big problems with complacently assuming that prices can always be lifted at the same rate as inflation.
First, we are about to see a real squeeze on living standards. Take the UK, for example. Wages are now rising by 4% a year, but prices by 5.2%, and are set to rise even more steeply quite soon. It doesn’t take any great mathematical skill to work out that lots of people are getting steadily poorer. Once the energy-prices cap is lifted, and the ill-judged tax rises announced by the government come into effect, many households are going to be struggling to make ends meet. They will have to start making choices about what to cut out of the weekly budget. True, they will get rid of the luxuries first, but they will also cut out any items that have risen sharply in price.
Second, price rises open up space for lower-cost, smarter competitors to emerge. Every price rise creates an opportunity for a rival to come into the market. If they can find a way of offering the same product or service at a lower price, perhaps by finding cheaper suppliers, or operating more efficiently, then they can very quickly undercut you. And consumers who are feeling squeezed will notice very quickly.
A naive generation of managers
There is a generation of managers in charge that has never experienced inflation on a serious scale before. Prices are now rising at the fastest pace since the early 1980s. Warren Buffett is probably the only CEO who has been around for long enough to remember what that was like and how to deal with it: it is brutally hard to navigate; firms have to be vigilant, lean, efficient and move very quickly if they are to survive.
Many companies are very naively raising their selling prices. Perhaps even worse, many shareholders are assuming that the businesses they invest in can maintain their margins and perhaps even improve them while inflation is escalating. Over time, they will pay a high price for that. Consumers will notice and start to abandon businesses they feel are overcharging them. And competitors will see a space in the market and start to move in. The real winners from this bout of inflation will be the companies that hold their prices, offer value for money and, if necessary, take a hit to their margins. They will do a lot better over the next couple of years than those who think they can push up prices at the same rate as costs
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Saturday, February 5, 2022
Turkey's President Erdogan tests positive for COVID-19
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The curious case of Cox & Kings
In 2007, India’s most storied travel firm, Cox & Kings, signed a long lease to acquire a mountain in the Swiss Alps, grandly “re-branding” it under its own name. The move was typical of the historic company’s ambition to tap the growing appetite for travel among India’s middle-classes. Shortly after, it marked its 250th anniversary by floating on the Mumbai stock exchange. It has taken little more than a decade for the edifice to come crashing down.
A fall from grace
What a fall it’s been, says Indian legal website The Leaflet. CEO Peter Kerkar, the globe-trotting Stanford graduate who ran the group, is in a Mumbai jail accused of defrauding banks and plundering the company of hundreds of millions. His sister Urrshila, who handled the Indian business, lives in a faded mansion on the city’s seafront with their elderly father, awaiting her own possible summons. The Kerkars vehemently deny any wrongdoing, arguing that they’re the innocent victims of rogue executives and financial associates, and will fight to clear the family name. “You could call us dumb and dumber,” Urrshila recently told the Financial Times. “They’ve not found even a single rupee with Peter or myself… We haven’t taken the bloody money.”
The episode, described by a judge last year as a “fraud of epic proportions”, is the latest, and possibly final, chapter in the history of a company whose rise mirrors that of India. The firm got its start in 1758 when Richard Cox arrived as an agent “to supply British troops as they plundered the subcontinent”, quickly adding banking and shipping interests, says the FT: diamonds, rubies and other “colonial spoils” flowed through its accounts. Having merged, following the first world war, with rival Henry S. King & Co, the company was bought by Lloyds Bank, which split the business. It sold the shipping operation, which “began its transformation into a travel company”, says The Times. In the 1970s, Cox & Kings came under increasing pressure to sell itself as part of then-prime minister Indira Gandhi’s drive to “Indianise” colonial institutions.
Step forward, Ajit Kerkar – a London-trained hotelier, married to a Swiss interior designer, who ran the hospitality division of India’s largest conglomerate, the Tata Group. Teaming up with British PR executive Anthony Good, he acquired Cox & Kings in around 1980. In 1986, Kerkar brought his 20-something son, Peter, into the business, says Rediff. “Colleagues describe him as ambitious and intelligent, with a hands-off style” – apparently more at home in Hampstead, and at his Irish holiday house in Kerry, than in India, which he visited “barely three or four times a year for board meetings”. Married to Emma Tully, daughter of the BBC’s veteran Indian bureau chief Mark Tully, Kerkar Jr was a hit on the London business circuit (“very hail-fellow-well-met”, according to Rocco Forte), who lost no time striking deals in pursuit of his aim of becoming the Indian Thomas Cook. In 2011, Cox & Kings acquired the British educational tour group Holidaybreak for £312m, multiplying its debt fivefold.
The missing millions
With hindsight, it was downhill thereafter. Cox & Kings began selling business units in Europe, supposedly to pay down debt. But a later inquiry established that the proceeds had disappeared. Investigators, working through a list of allegedly fake customers and shell companies, has still not determined exactly where the group’s missing millions (it was valued at $1.2bn in 2018) have ended up. In 2020, Kerkar and several other executives, including chief financial officer Anil Khandelwal, were arrested. The mystery “darkened” when another finance manager was found dead on a railway track. The case has yet to go trial, and could embroil much of the Indian financial establishment – and even the government, says The Leaflet. “The curious case of Cox & Kings” could yet get nastier.
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Friday, February 4, 2022
Republican senator urges U.S. to monitor China's digital yuan push during Olympics
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Events to Look Out for Next Week
- Gross Domestic Product (GBP, GMT 07:00) –The UK economy was stronger than expected before Omicron hit. Monthly GDP data for November were a positive surprise, with a rise of 0.9% m/m that compensated somewhat for the disappointing October reading. The three months rate lifted to 1.1% from 0.9%, and while Omicron will have curtailed overall activity in December, the last quarter of the year doesn’t look quite as disappointing as previously feared. Higher energy prices remain the main driving factor for the spike in prices and the expected jump in the cost of living, which will likely slow GDP growth.
- Trade Balance (GBP, GMT 07:00) – The UK trade deficit is expected to have narrowed to 14.2 bln in December, from 11.34 bln in the previous month.
Click here to access our Economic Calendar
Andria Pichidi
Market Analyst
Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
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China's stockmarket gets ready to roar
“As the Chinese year of the tiger begins, the… market is set to really bare its teeth,” says Kate Marshall of Hargreaves Lansdown. In 2008 China accounted for 15% of the emerging market stock index, but its shares have since risen to one-third. “Chinese middle and upper income groups are forecast to expand by over a third of a billion people by 2030,” roughly equivalent to the US population. Not for the first time, Asia looks set to be the “engine of global growth”.
Chinese stocks had a terrible 2021
Despite that, “Chinese stocks had a terrible 2021”, says Jacky Wong in The Wall Street Journal. A regulatory crackdown on education and tech stocks – “Alibaba lost nearly half of its market value in 2021” – combined with a slowing property market saw the large-cap CSI 300 index finish last year down 5%.
Yet 2022 may be better. While most central banks hike interest rates, China has eased monetary policy in recent months to cushion the effects of the property downturn. That should provide a “tailwind” to equities, which look cheap: on 12.1 times forecast earnings, the MSCI China index trades below its five-year average valuation.
Wall Street is almost entirely bullish, agrees Sofia Horta e Costa on Bloomberg. Marko Kolanovic of JPMorgan forecasts that the MSCI China index will “surge almost 40%” this year. “That bet isn’t going so well.” The CSI 300 fell 7% in January and entered a bear market, having fallen 20% since a February 2021 peak.
The ongoing property market fallout, earnings downgrades and Omicron restrictions are keeping the market subdued for now, says Sean Taylor of DWS. But come the second quarter “targeted government support” will boost growth and should see stocks start to outperform.
Big tech is out of favour
China may also dodge the West’s Covid-19 hangover. While debt has soared elsewhere during the crisis, China’s non-financial-sector debt fell by 7% to 265% of gross domestic product by the third quarter of last year. The “de-leveraging” campaign that has hit the property sector is bearing fruit. “In the last Year of the Tiger, 12 years ago, China successfully overtook Japan as the world’s second-largest economy.” This year could bring a similar leap in markets.
The upcoming Winter Olympics and a busy political year should see Beijing prioritise stability in 2022, says Reshma Kapadia in Barron’s. That “lowers the odds of further dramatic regulatory crackdowns”. Still, “the online businesses, e-commerce companies and gaming” stocks that dominated the last decade are now out of favour, says Pradipta Chakrabortty of investment manager Harding Loevner. Instead, the climate favours smaller firms in sectors such as industrials, healthcare and IT, says Kapadia.
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Central-bank monetary tightening rattles tech stocks
Global markets caught a bad case of the January blues. America’s S&P 500 ended last month down more than 5%, its worst monthly performance since March 2020 and its worst start to a year since 2009. Big tech firms led the rout, with the tech-heavy Nasdaq Composite falling almost 9%. Japan’s Nikkei 225 dropped 6.2%. The pan-European Stoxx 600 retreated 3.9% in January for its worst month since October 2020. The FTSE 100 ended the month up 1.1%, but the more domestically focused FTSE 250 finished down 6.6%.
The key theme so far this year has been “the hawkish pivot by multiple central banks”, say Henry Allen and Jim Reid of Deutsche Bank. On 31 December, interest-rate markets were pricing in about three increases by the US Federal Reserve this year. By the end of January, that number had risen to almost five. Money looks set to get tighter “much earlier than anticipated”.
That’s a headwind for fast-growing technology stocks in particular, says Patrick Hosking in The Times. Many investors are betting that firms with “innovative intellectual property” or dominant market positions but few or no profits so far can reap big rewards in the future. But higher interest rates make “expected profits in five, ten or fifteen years look dramatically less appealing than hard profits today”. With rates “so close to zero”, even “modest rises” have a huge impact.
This month’s market “spasms” show that investors are having a difficult time coming “to terms with the end of the era of free money”, says The Economist. Some thought it would “pretty much last forever”. Hence corporations and housebuyers binged on debt during the pandemic, while government borrowing soared. We are about to find out just how vulnerable the world economy is to higher debt servicing costs.
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Investment Bank Outlook 04-02-2022
Credit AgricoleAsia overnightWhile equity markets in North America were rattled by a sell-off in technology stocks following a hawkish turn by the ECB and BoE, strong earnings from Amazon helped bolster market sentiment in Asia. At the time of writing, S&P 500 futures were up by over 1% and Asian bourses were trading mixed in light trade around the Lunar New Year holiday period. Ahead of US non-farm payrolls data later today, G10 FX traded tight ranges in the Asian session with the EUR, NZD and SEK modest outperformers against a slightly weaker AUD and USD.CitiEuropean OpenMarkets were relatively quiet ahead of NFP. However, the influence of yesterday’s decisions by the ECB and BoE continued to reverberate in markets. DXY was down a tad, while UST bear flattened modestly. The effects were mostly seen in the rates space, where JGB futures lower sharply, while Aussie 10y yields were up by 10bps to 1.97%. Equity markets were interesting, with S&P Eminis and Nasdaq100 futures recovering in Asia hours, after a slump closer to the NY close. Asian equities were higher, with HSI leading gains at 3.30%. Oil held onto its gains from the NY session, with prices above 90 for both WTI and brent. There was little new in the Statement of Monetary Policy from Australia. Meanwhile in EM, KRW was up 0.75% back under the 1200 handle, with a CPI print of 3.6% (above market expectations of 3.4%). THB similarly saw support from a hot CPI print to gain +0.6%.Looking ahead, payrolls are top of mind. Non-farm payrolls for USD and CAD payrolls will be seen simultaneously at 13:30 GMT. Meanwhile in the UK, we will see BOE's Broadbent and Pill speak at 12:15 GMT, which we will watch closely for additional hawkish comments. EUR will see Germany Factory Orders at 07:00 GMT.G10 In FocusA macro lensUSD continued its dip into the Asia session, as G10 currencies gained following yesterday’s hawkish surprise from ECB and BoE, and as we head into Non-farm payrolls. UST bear flattened today, led by gains in the front end. Our trader Hideyuki Liu writes the following:–ECB Lagarde's shocking pivot yesterday where she remarked the "situation has changed" and the ECB is "ready to adjust all of our instruments, as appropriate" has clearly had a profound impact on market participants. JGB futures opened lower sharply this morning, despite no particular news out, as any prior dovish messaging by central bankers have now been shown to flip shockingly swiftly. Global bond futures have all traded lower in today's Tokyo session, including treasuries, with desk flows seen from both FM and RM in 10y to 30y; selling has also been seen going through broker screens in 5s as well, and the curve has bear flattened. The central bank policy tightening has once again pushed itself to the forefront thanks to the dual hawkish deliveries by both the BOE and ECB yesterday.
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Markets don’t fear a Russian invasion of Ukraine
“We are in the unusual position of global headlines and politicians warning of the risk of a major war, and yet markets…remain mostly unconcerned,” says Michael Every of Rabobank. The massing of more than 100,000 Russian troops on Ukraine’s borders has not gone unnoticed – but the consequences so far have been very limited.
True, Russian assets have sold off as foreign investors anticipate more sanctions, to the point where some Russian company valuations have started to “look frankly absurd”, say Robert Armstrong and Ethan Wu in the Financial Times. Gazprom, which is benefiting from high oil prices, trades on a price/earnings ratio of just three and a 17% dividend yield for the year ahead, for example. Yet in other respects, investors don’t seem to be positioning for conflict, says Katie Martin in the same paper. If they were, you would expect them to rush into classic safe-havens such as the Swiss franc and Japanese yen, US government bonds and gold. Instead, January has seen US bonds sell off and the franc dip against the dollar. The “yen is flat” and “gold is a snooze fest”.
Western politicians are suggesting that a Russian invasion of Ukraine could be just weeks away, but investors seem inclined to agree with the Ukrainian government, which has been downplaying the threat. “The belief in Kyiv is that Vladimir Putin’s goal is the long-term destabilisation of Ukraine, and that the Russian leader may have other objectives than invasion,” say Dan Sabbagh and Luke Harding in The Guardian. These include forcing the West to accede to its demands, such as a block on Ukraine and Georgia joining Nato.
Chaos in commodities
If these assumptions are wrong, there will be “huge market implications”, says Every – including a flight to safe-haven assets and turmoil in many commodities. Rabobank analysts reckon that even a limited war could send oil up to $125 a barrel from about $90 a barrel now. In the most extreme (and unlikely) scenario, where US sanctions cut Russia off entirely from supplying world energy markets, oil could hit $175 a barrel.
Russia is also a significant metals producer – it accounts for about half of global nickel exports and a quarter of the aluminium market, according to Rabobank. “Any disruption to flows of… metals, including palladium, nickel and aluminium, could propel prices sharply higher,” says Alexander Nicholson on Bloomberg. For a small taste of what might happen, note that in 2018 the US imposed sanctions on aluminium giant Rusal, only to learn that “cutting off supplies from Russia’s commodities producers” can wreak “havoc on manufacturing supply chains”.
Finally, Russia is the world’s biggest wheat exporter, with Ukraine in fifth place. The countries’ food exports mostly pass through the Black Sea, close to the potential conflict. “About half of all wheat consumed in Lebanon in 2020 came from Ukraine,” says Alex Smith in Foreign Policy. Egypt, Malaysia, Indonesia and Bangladesh are also big buyers of Ukrainian wheat. A decade on from the Arab Spring, which was triggered by rising food prices, war in Ukraine could send another wave of political turmoil “across Africa and Asia”.
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How UK banks went from Big Bang to universal failure
It all started with the Big Bang in 1986. That was Margaret Thatcher’s attempt to shake up the cosy relationships in the City of London and build a globally competitive financial services industry of which the country could be proud. The old separation between brokers and jobbers (market makers), and between retail and investment banking, were dismantled and cleared away – without much consideration of whether there were sound reasons for these divisions to exist, like Chesterton’s Fences.
Retail banks such as Lloyds, Barclays and Midland were allowed, if not encouraged, to own stockbroking firms. The likes of de Zoete Wedd, Hill Samuel and Samuel Montagu were bought by UK retail banks. Other brokers such as Phillips & Drew, Warburg’s and Smith New Court were bought by large investment banks from overseas. UK banks expanded into new territories and built empires where the sun never set. Banks attracted a new breed of rocket scientists and physicists to help them price complex derivatives. A new model emerged: “universal banking”, implying a bank could do everything under one roof. London became a centre of global financial competition.
The Big Bang was good for London as a financial centre, but there were two questions no one thought to ask: was it good for customers, and was it good for shareholders? The answer to both questions is an uncontroversial “no”.
Few benefits for customers
Barclays’ fixed-income division may have risen up the corporate-bond underwriting league tables, but it is hard to see how this brought any benefits to a Barclays current-account customer, for example. Even for retail banking products, having a current-account relationship with one bank doesn’t mean a better mortgage deal or cheaper home insurance. It is almost always true that customers do better to look at the best-buy tables than trust their bank to cross-sell to them. This is especially true of mortgages, where high house prices mean a large mortgage over 30 years is very sensitive to the interest rate offered, and hence customers would be mad not to go to a mortgage broker to find the best deals on offer. The same logic applies to credit-card customers, driven by eye-catching balance transfer rates. So using current accounts to cross-sell additional banking products has proved more difficult than universal bank management would like to admit.
It is even harder to see how a customer of what was once Midland and is now part of HSBC benefits from the parent company’s high market share in Hong Kong, let alone the ill-advised expansion into Mexico, Brazil, Argentina, or risky US subprime mortgages. It is patently ridiculous to claim that HBOS, the UK’s biggest mortgage lender, was somehow helping local borrowers in Halifax by also lending money to fund the buy-out of M Resort Spa Casino in Las Vegas in the run-up to the global financial crisis in 2007-2009. Indeed, HBOS’s management were securitising their high-quality UK mortgages and selling them in financial markets, and replacing these assets with collateralised debt obligations (CDOs) sold to them by US investment banks, which contained packaged up lower-quality US subprime mortgages.
No economies of scale
Aside from customers, the universal banking model has not been kind to shareholders either. The UK banks have underperformed the FTSE All Share index since 2002. Yes, even before the financial crisis banks were unloved by fund managers, who worried about overleveraged balance sheets, and how sustainable returns on equity would turn out to be. As it happened, the fund managers were right to be wary.
As the pull of size and consolidation worked on UK banks like gravity, this was justified in the name of efficiency. The trouble is that there is very little evidence that big banks are more efficient. Instead, they became in danger of collapsing under their own weight, like financial black holes. The cost/income ratios for large UK banks such as Barclays, HSBC, Lloyds and NatWest were all above the 60% level in the 2020 financial year – not much improvement from cost/income ratios seen ten, 20 or even 30 years ago. The smaller UK mortgage banks such as Northern Rock (before it failed) operated a more efficient model, with a cost/income ratio close to 30%.
My own experience of banking efficiency as an employee supports this. Over the years I have worked at both large banks (Credit Suisse, Societe Generale) and smaller brokers (none of which have survived to the present day.) Arriving at any small broker on my first day of work, my IT systems were set up, my Financial Services Authority registration had been transferred over and my new colleagues were pleased to see me. At large banks the first day tended to be shambolic. Most conversations with HR and IT started with the sentence: “Oh, hello! We didn’t know you were starting today”.
That’s because bringing all the banking activities under one roof created more complexity than any efficiency savings. Banks still needed to spend lots of money on technology systems. And any savings from streamlining the back office were lost, because they needed to employ an army of legal and compliance staff to manage conflicts of interest, for instance building “Chinese walls” to keep employees with inside information separate from market-facing roles and prevent the bank being fined by the regulator. The huge increases in computing processing power and decline in the cost of computer hardware hasn’t benefited shareholders in banks at all. By December 2014, Antony Jenkins, the then-chief executive of Barclays, was admitting that the universal banking business model was dead. Diversifing by business, customer and geography hadn’t worked.
Banks have many challenges
In recent years, low interest rates have made life even harder for banks. Most of the time, banks make a margin on their retail deposit funding, because their average interest costs are below central bank rates. But when base rates drop below 1%, margins shrink because the banks can’t charge customers enough for looking after their savings (notwithstanding the efforts of some European banks to levy negative rates on retail deposits). As interest rates rise, analysts expect banks to increase revenue. Still, while margins are set to improve, technology spending is likely to rise even faster and bad debts are hard to predict.
Setting aside the barrage of regulatory fines, the other reason that banks have struggled to generate the return on equity (ROE) that the market wants (10%) is that the regulator has demanded that they fund their balance sheets with less debt and more equity. Larger banks that are judged “systemically important” have to fund with even more equity, because of the serious consequences of failure. In very simple terms, that even bankers can understand, if the “R” of ROE stays the same but the denominator “E” increases, then it is a mathematical inevitability that ROE will fall.
A further problem is that banks tend to reward their loyal customers with worse deals than the new customers they are trying to tempt away from other banks. In the short term, this strategy works. Customers have better things to do than check they’re still getting a good deal every couple of months. But over time, the strategy is bad news for shareholders. It’s terrible for banks’ brands to use inertia from loyal customers to generate high returns. Thus the last few years have seen disruptive new entrants, such as Atom, Monzo, Starling and Funding Circle.
In theory, these financial technology (fintech) firms can offer more competitive services because they don’t have legacy IT system costs or a branch network. That said, given that the disrupters tend to be loss-making, it could just be that their services are being funded by deep-pocketed venture capitalists.
Last year the UK saw $11bn of investment into fintech. There were 713 deals, with Revolut, Monzo, and Starling in the top five amounts raised. Zopa, the peer-to-peer lender founded almost 20 years ago, still managed to raise $220m from SoftBank’s Vision Fund 2. The UK fintech sector seems particularly good at attracting capital, because that $11bn is more than double the next largest in Europe: Germany ($4.4bn), followed by France ($2.3bn) and Sweden ($1.7bn). Overall, $24.3bn was invested across the continent in 2021, with the UK representing nearly half (45%).
Most disrupters aren’t disrupting
That sounds impressive, yet the pandemic has not been the boon for fintech that it has been for tech firms, as Marc Rubinstein points on Net Interest, his financial sector blog. Monzo’s fund raise in May 2020 was at a 40% discount to its previous funding round. German digital bank N26, funded by Peter Thiel, pulled out of the UK after finding the competition too strong.
Meanwhile, branch-based challenger bank Metro Bank has fallen 95% since its initial public offering (IPO), while peer-to-peer lender Funding Circle is down 75% since its IPO at the end of 2018. These have not been anyone’s idea of a successful investment.The problem is that UK banks’ core business of taking customer deposits and lending out money is highly competitive. Thus the fintech winners are not the ones trying to re-invent universal banks. Revolut and Wise (formerly TransferWise) show that fintech isn’t just about technology, it’s also about finding the areas of greatest risk-adjusted return. They have focused on cross-border payments, attacking the huge difference between the currency rates available to large corporate clients in wholesale markets and the price that retail banking customers pay.
Ten years ago there was a complaint to the Office of Fair Trading by consumer groups because banks were charging 3% on foreign currency transactions. Some debit cards also added a further fee of £1.50 per transaction, while using a bank card to withdraw cash abroad could cost up to £4.50 a time. At the time a spokesman for the British Bankers’ Association (BBA) blamed the high fees on foreign payment systems, saying “transaction costs abroad are driven by the costs of overseas payment systems, often in countries where free banking does not exist”.
Of course, this was nonsense. And hence both Revolut and Wise were founded by eastern Europeans who were appalled at the price gouging from banks when they wanted to send money home.
Wise and Revolut: the two winners
Wise was originally a way to send money to bank accounts overseas (see below). It unbundled a specific financial product and offered better value than the competition, with no cross-subsidisation.
Revolut began as a pre-paid card and an app for spending money abroad. It planned to levy a small fee every time a customer used the card, but realised that there wasn’t enough money in this to support the cost and started charging subscriptions. It is remarkable that an app can charge customers up to £13 a month, while UK retail banks with higher-cost branches and legacy systems struggle to convince customers to pay anything. Rather than lower costs, Revolut is able to make money by charging customers to access services they value, such as crypto trading, which has done well over the pandemic. That said, Revolut’s subscriptions made it £222m of revenue in 2020, but direct costs and administration expenses meant that the business made a loss of £207m the same year.
Wise and Revolut attracted millions of customers, despite not having a banking licence. They had an e-money payments institution licence, which means that they weren’t able to lend out money to borrowers and take credit risk. Instead, they have to keep customer funds in cash or other low-risk alternatives. (Revolut was granted an EU banking licence last year.)
So the great irony of fintech is that technology has not meant bigger, more efficient banks. Nor has it allowed new entrants using technology to disrupt saving and lending. The real success story is built on the fact that wholesale customers who deal in large size receive a better price than individuals. That’s true in any industry and financial services is no different. That was the original reason for brokers (who bought and sold on behalf of retail clients) and jobbers (who made a market and dealt wholesale). Wise and Revolut have used technology to reduce the size of the retail versus wholesale price difference. That outcome is light years away from anything foreseen at Big Bang.
Is Wise worth 90 times earnings?
Wise (LSE: WISE), which has a March year end, put out a third-quarter trading update in mid-January. It’s enjoying strong growth, transferring over £20bn in the three months to December, up by 38% from a year ago. So far this strong transaction growth has meant reducing costs, the benefit of which it shares with customers by driving down fees, while generating cash for reinvestment.
The firm says that over the last year it dropped prices across 50 currencies and fees are now 0.60% of transaction value on average, nine basis points lower than a year ago. It was profitable in the first half of the year, to September 2021, making £19m, and analysts are forecasting profits to reach £150m in the 2024 financial year, according to data from SharePad.
Analysts covering Wise are forecasting around 24% revenue growth in 2023 and 2024, and the total addressable market for cross-border transactions is huge. There were around £2trn of global cross-border payments made by individual consumers in 2020. Around two-thirds of that is done by banks – Wise estimates that it has a market share of around 2.5%. That £2trn pool is also growing.
Like many fast-growing tech stocks, the shares look expensive. The forecast price/earnings (p/e) ratio is 90 and price/sales (p/s) ratio is 15, according to SharePad.
This approach to growing fast and sharing efficiencies with users is similar to Amazon’s. Even after 25 years of growth, the “Everything Store” now has revenue of half a trillion dollars, but shows no signs of going ex-growth. It trades on a forecast p/e of 70. In his 2005 letter to shareholders, Jeff Bezos described Amazon’s strategy in this way: “Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long-term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon”.
Wise, like Amazon, intends to expand its product offering. It recently launched a service called “Assets” for UK customers. They can now transfer balances to an index fund, while still being able to spend or transfer money overseas as though the balance were still held in cash.
There are risks to Wise. One concern is the co-founder, Taavet Hinrikus, selling 11 million shares last year, and entering a loan agreement with Goldman Sachs where up to 49.6 million shares would be pledged as security. There’s also a dual share structure common to many tech stocks. The founders hold B shares that have nine times more votes than the A shares. That lets them keep control even if they decide to cash out their A shares.
I think the bull case is relatively easy to make, but the high valuation multiples mean that if the company disappoints, then it’s likely to be punished severely. For every Amazon-style investment, there are plenty of Groupons and Pelotons that don’t receive much attention – once hyped stocks that failed to deliver.
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