Sitting On The Mountain, Watching The Tigers Fight  Arminius Capital  11 January 2022 According to the Chinese zodiac, 2022 is the Year of the Tiger. Tigers are bold, powerful and dangerous, but in Chinese astrology they are also impulsive, short-tempered, and have difficulty getting on with others. There is an old Chinese saying about "sitting on the mountain, watching the tigers fight", which means that, when the situation is violent and confusing, it's best to stand back and see how things work out. There are a lot of tigers around this year: COVID-19 is not letting the world "go back to normal" any time soon. The US share market has enjoyed three years of spectacular returns, but 2022 will break the winning streak, as inflation persists, wages rise, profit margins fall, and earnings growth slows. The loss of a single Democratic Senate seat would push the US Congress back into legislative gridlock. The US Federal Reserve and other central banks will lift interest rates. In 2021 the Fed misunderstood inflation, and in 2022 it is likely to mishandle interest rate rises. Either it will raise rates by too little too late (and let inflation rip), or by too much too soon (and trigger a recession). Supply chain problems will diminish, but some shortages will persist in key industries such as computer chips until 2023. Asian demand for fossil fuels has already boosted the prices of oil, gas and coal. Global economic recovery will increase the demand for energy, pushing prices even higher. China's 2022 GDP growth will fall short of investors' optimistic forecasts, because the leadership is trying to accomplish three incompatible tasks at the same time - controlling COVID-19, mining more coal to prevent a power crisis, and reviving the residential property market. US Democrats and Republicans have their differences, but not one of them wants to be seen as a panda hugger. 2022 will bring more restrictions on technology transfers to China, more support of Taiwan, more complaints about Chinese human rights abuses, and more sanctions on individual Chinese companies - not quite a cold war yet, but a bit further into the icebox. No shortage of geopolitical flashpoints this year: e.g. Ukraine, Iran, Turkey, Taiwan, the South China Sea, Yemen, Myanmar, Ethiopia. The outlook for the Australian share market is better than for most of the world. Inflation is low, wage pressures are minimal, and the Federal election due by end-May is unlikely to produce major policy changes. As investors focus on fundamentals, stocks with solid earnings will come back into favour, and speculative stocks will lose popularity. For the big four banks, 2021 was the year of recovery: 2022 will be much harder, and the big banks are likely to underperform. Funds operated by this manager: Arminius Capital ALPS Fund, Arminius Capital GMMA Fund

Australian Big Banks are Back! Arminius Capital  17 November 2021 The three banks with September financial years - ANZ, NAB and Westpac - are almost back to normal. Cash profits and return on equity are still below FY19 levels, but it is clear that the COVID-19 crisis has not left any scars on the banking system. Most importantly, the banks' capital positions are once again "unquestionably strong": an average Common Equity Tier 1 (CET1) ratio of 12.7%, up from 11.4% in FY20, means that all the banks can afford share buybacks. So far, however, organic growth is modest. Most of the recovery in cash earnings came from the $820m writeback of provisions built up last year. The banks are still paying "customer remediation costs" for their crimes of fees for no service and other horrors revealed by the Hayne Royal Commission, but these should end in FY22. The ratio of operating costs to income is still too high, and the banks will need another two to three years to achieve their cost reduction targets. The fundamental problem is that banking is no longer as profitable as it used to be, thanks to increased competition, tighter regulation, and higher capital requirements. The KPMG chart below shows how the banks' average net interest margin (NIM) has slid steadily downward, from 3.0% two decades ago to only 1.86% now. In order to preserve their margins, the banks need to simultaneously cut their operating costs and increase their capital spending to improve their processes. CBA is leading the pack in both of these objectives, which is why it is the only one of the Big Four to have returned to its 2016 share price. Shareholders of the other three banks are well aware of the size of their capital losses over the last five years. This is also why CBA's dividend yield is less than 4.0% while the other three yield between 4.5% and 5.0%. FY22 results are likely to be similar to this year - modest organic growth, with profits buoyed by provision writebacks. But there will be complications. The first is that wholesale funding costs will increase as US and Australian interest rates rise, and the banks will lose some of the deposit inflow which was triggered by the COVID-19 panic. The second is that the Australian regulators will probably impose macroprudential controls to slow the pace of house price rises and to discourage borrowers from taking on excessive debt. The third is that the rise in CPI inflation will affect different sectors of the Australian economy in different ways, and may put an end to the improvement in loan delinquency rates. Our analysis suggests that the banks are fairly priced at present, as a sector with low earnings growth but also low risk. In the long run, the recent changes in industry structure will mean that bank earnings will grow more slowly than most companies in the S&P/ASX200 Index, making the banks attractive for income rather than capital growth.                                  ANZ's cash profit of $6.2bn (218c per share) slightly exceeded market expectations, because stronger markets income offset a 4% increase in costs as well as ongoing customer remediation costs. The full-year dividend of 142c was higher than 60c in FY20 but still below 160c in FY19. During the latest half-year, ANZ's residential loan book declined by 1% against system growth of 4%. This disparity highlights the inadequacies of ANZ's mortgage processing systems, which the bank has acknowledged and is devoting capex to improving. FY22 earnings and dividends are expected to be flat, but ANZ is trading on a lower P/E than the other three, so the medium term may see some price gains through re-rating. Commonwealth Bank's trading update for the September quarter disappointed the market, with the CBA share price falling 8%. Despite above-system loan growth, cash profit for the quarter was flat at $2.2bn and net interest margin fell significantly. A single quarter is not necessarily an indicator of the 2022 result, but it does reinforce our view that the banks face a difficult competitive environment. NAB reported a $6.6bn cash profit (199c per share) and lifted its full-year dividend to 127c (a 64% payout ratio), which was better than 60c in FY20 but still below 166c in FY19. The result was free of notable items and other one-offs. Management indicated that future dividends would be 65% to 75% of cash earnings. During the half-year, NAB grew its gross loans and advances (GLA) as fast as system growth or faster. The bank has simplified and automated its mortgage approval process: 30% of Simple Home Loans are expected to be approved in one hour, and 60% within one day. Westpac is lagging behind the other three big banks. FY21 cash earnings of $5.4bn (146c per share) are equivalent to a return on equity of 7.6%, well behind the Big Four average of 9.9%. Westpac's cash earnings suffered from a notable items charge of $1.6bn, and the September 2021 half year was disappointing, with expenses rising and margins falling. The FY22 dividend of 118c (an 81% payout ratio) was better than 31c in FY20 but well below 174c in FY19. The share price has fallen 9% since the result - the market clearly does not believe that Westpac will achieve its announced cost reduction targets on time. Funds operated by this manager: Arminius Capital ALPS Fund, Arminius Capital GMMA Fund

Japan Edges Closer to Confronting China Arminius Capital  05 November 2021 A change of Prime Minister usually doesn't result in much change in Japanese policies, because almost all Prime Ministers are created by the Liberal Democratic Party machine, which pursues power rather than policies. But the new PM, the 64-year-old Kishida Fumio, has made some Cabinet appointments which might lead to major changes. Of course, all the top Cabinet posts went to long-serving party stalwarts in order to pay Kishida's debts to the faction bosses who supported him, but he also added several of the LDP's rising stars to his Cabinet. The most surprising appointment was to a newly created job - Minister of Economic Security. Kishida described the role as "securing strategic technology and goods and preventing technology leaks so we can achieve a self-sufficient economic structure." That translates to ensuring semiconductor supply and innovation, strengthening cyber security, and thwarting Chinese theft of Japanese intellectual property. The new Minister has of course denied that the economic security measures have anything to do with China. What is really interesting about the job is that its theoretical functions cut across several existing ministries, which will cause vicious turf wars with entrenched bureaucracies. The new Minister will only be able to do his job if he has the firm support of the Prime Minister. Fortunately, the new Minister seems to have all the right qualifications and connections. Kobayashi Takayuki is the product of an elite education (Kaisei Academy, Tokyo University Law School) and an elite career path (Ministry of Finance, Japanese Embassy in Washington). On the way, he also picked up a Master of Public Policy degree from Harvard's Kennedy School of Government. We will watch Minister Kobayashi's progress with great interest. Funds operated by this manager: Arminius Capital ALPS Fund, Arminius Capital GMMA Fund