Brexit, sterling’s fall from grace, the collapse of the London housing bubble and the fractious politics of Theresa May’s Tory government in Westminster has made UK equities a pariah for global asset allocators. British equities exhibit metrics of investor pessimism last seen just after the epic failures of RBS, Lloyds HBOS and, yes, Barclays PLC in October 2008. The financial markets have derated the FTSE-100 index from 16 times earnings in to a mere 12.8 times forward earnings now even though the index companies derive 72% of their revenue outside the sceptered isle. This is surreal and one of the great valuation arbitrages in global equities.

British equities are now trading at their lowest levels since the Cameron – Osborne era circa 2014. My favourite stocks on the Footsie index include Shell, Anglo-American, GlaxoSmithKline, Shire PLC, Lloyds Banking Group and Barclays. BP owns 19% of Russia’s Rosneft and is thus vulnerable to the Kremlin’s retaliation. Each one of these British blue chips is a turnaround/story stock mispriced relative to its earning potential and franchise value. I believe sterling is still undervalued at 1.39 and that the “hard Brexit” risk premium demon that haunts the City of London will be exorcised by events. Sectors to avoid? Retail. Tesco, Sainsbury, Marks & Spencers.

Britain will continue to trade at a discount to Wall Street due to Brexit and the Footsie 100 index’s megacap low multiples energy/metals shares. There has been a brutal derating in British banks and Barclays, a historic High Street Quaker clearing bank whose pedigree goes back three centuries to the early Georgian era, trades at all of 0.6 times tangible book value.

I expect fund managers will eventually realise that the FTSE-100 index should be rerated, not dissed, amid a synchronized global economic expansion. UK Companies, ironically, generate higher operating profits than their peers in France or Germany since they do not have rigid, Stone Age labour markets dominated by trade union (Queen Maggie vanquished the Gorgon Scargill in 1984!) and regulatory burdens yet command a lower valuation. I concede that consumer confidence has plummeted since Brexit and the rise in food/petrol prices will hit consumer spending. Yet Unilever, Diageo, BAT and Reckitt and Coleman are global, not just Little England, brands. Still, I would avoid UK retailers and homebuilders like the plague. British Land trades at 30% below its net asset value. This only tells me that the stock market just does not believe the appraised value of Britain’s pre-eminent commercial property landlord.

UK banking is a classic valuation rerating candidate due to a steeper gilt yield curve. Mark Carney will the base rate in May and November due to inflation risk and Fed rate hikes. The end of the litigation cycle (PPI, LIBOR manipulation, mortgage securities fraud) and higher loan growth will boost the returns on equity and free cash flow of UK banks.

Energy and mining are 26% of the Footsie’s index at a time when I am bullish on UK names in these global sectors. This is the global macro milieu in which Rio Tinto, Glencore, BHP and Anglo-American rerate and I am also bullish on both BP and Royal Dutch Shell. In the stock market at least, cool Britannia lives on!

Share buybacks will also be a positive catalyst for UK equities in 2018 as they almost equal the 17 billion pounds in 2017 new equity issuance. Note that Lloyds announced a 1 billion pound share buyback plan last month and Royal Dutch Shell plans to spend $25 billion in share buybacks until 2020. Even Aviva plans to buyback 500 million pounds in preferred shares. This alone suggests UK boards believe their companies are undervalued relative to global peers. Share buyback are also correlated to anticipated rises in earnings and cash flows, surely a fundamental ballast for a British equities rerating in the year ahead. The metrics of relative valuations between London and New York also tell me that the “Brexit discount” is excessive and unrelated to corporate fundamentals.

Britannia no longer rules the waves but definitely rules the air waves, at least to this fan of FM 103.8! The Kremlin and Downing Street now face off in the most serious geopolitical confrontation since the end of the Cold War. The Russian secret service has been active in London since the Tsarist Okhrana hunted dissidents in the East End in the 1870’s. The influx of post-Soviet oligarchs in Mayfair, Belgravia and South Ken made Londongrad prime property white hot since the 1990’s. No longer!

​​Market View – Airbnb will destroy the hotel and airline industries 

Airbnb is the largest, fastest growing hospitality network in human history, an online global (only 19% of its listings are in the US) home sharing site with inventory of 5 million rooms whose revenue is growing at 100% a year. Airbnb adds 300,000 news users and 60,000 rooms to its network each week. In contrast, Marriott – Starwood, the world’s largest hotel chain, has 1.2 million hotel rooms and exhibits 8 to 10% revenue growth.

In the 1950, a mere 25 million people in the world traveled beyond their own country. Now 1.2 billion people cross international borders each year, led by 200 million outbound tourists from China alone. The nomadic DNA is still embedded in human beings 10,000 years after the first settled civilizations emerged on the banks of the Euphrates, the Tigris, the Nile, the Indus and the Yangtze. Yet technology is changing the very concept of a home for the 150 million active users who constitute Airbnb’s community.

Brian Chesky and two roommates founded Air Bed and Breakfast in San Francisco in 2008 as he had only $1000 in the bank and the rent on his flat was $1150. So the three friends advertised for guests and served them breakfasts. Chesky’s eureka moment was an insight. A stranger who enters your home is no longer a stranger but a friend. In 2005, Hurricane Katrina displaced the population of New Orleans. White hotels jacked up their prices, thousands of people opened their homes for free to victims of the national disaster. Half the population of Syria are now refugees. Where is the Arab Airbnb for refugees?

Airbnb is now valued at $30 billion. Yet Chesky financed his start up in 2008 via credit card debt and selling meals branded as Obama O and Cap’n McCain during the election season of 2008. All its angel investor prospects backed out, one even asking Chesky “Is this the only idea you are working on” and declining his offer for a 10% stake in the company for a mere $150,000. A decade later, that $150,000 is worth $3 billion. Yet once the Airbnb offering went viral on the Internet, Silicon Valley’s top venture capitalists and Google Capital invested in the startup, even though paid search was 9% of advertising budget. I remember Airbnb’s first funding round in the Valley at a pre-money valuation of $1 billion in 2011. Seven years later, investors from the UAE who invested in that round have made 30 times their money. Welcome to the surreal, fabulous world of unicorn investing where fairy tales can and do happen. Airbnb is now the world’s second most valuable tech startup after Uber.

With $5.6 billion in cash on its balance sheet, Airbnb has no need for an immediate IPO. Airbnb can raise all the money it needs in the private markets from the world’s preeminent investors, as attested by its last $850 million mega funding round. The company is also now profitable? Chesky envisions the Airbnb active user community will reach 1 billion by 2025. If so, Airbnb will be the world’s first $100 billion unicorn.

Since my wife refuses to use Airbnb (what if the host is an axe murderer, kidnapper or Ebola virus carrier?), I confess I have never experienced the product. Yet my 20 year old son and his friends, all McGill University undergrads, spent spring break in a penthouse while I remember my Penn friends and I camping on the beach in Fort Lauderdale. The world has changed on a scale unfathomable to the pre-Internet generation. Airbnb now offers even rentals in Tuscan villas, Loire Valley chateaux, Bavarian Alpine castles and Richard Branson’s Caribbean island on its platform. Airbnb’s next move will be in aviation, tours and co-living. The world’s biggest airline will be Airbnb Airline!

Airbnb is an existential threat to the hotel and airline industries worldwide. I was shocked when a friend told me he paid a mere $30 a night to stay in an Airbnb room in Tecom, where I know more than 20 offplan hotel have been sold to poor investors. The traditional hotel could be as doomed to extinction as the shopping malls, travel agent, black and white television, bookstore and brontosaurus. Not surprisingly, hotel owners and tax starved municipalities have launched a bitter (but futile) backlash against Airbnb. Accor Hotels and Wyndham Worldwide have even bought rival upscale home sharing sites.

Airbnb makes it impossible for hotels to fleece their clients with outrageous fees on services or drinks. As Airbnb expands exponentially in the Middle East, greedy, rent gauging landlords will go extinct like the dinosaurs. That much, at least, is certain.

​​Currencies – Japan is the Empire of the Rising Yen 

I had published a column in the KT just last week predicting a 2000 point fall in India’s BSE-Sensex index but even I was surprised by its 510 point fall in a single session.

Despite higher US Treasury bond yields and imminent Federal Reserve monetary tightening, the Japanese yen has risen as much as a stellar 6% against the US dollar in 2018 alone. Geopolitical risks, trade tensions, flows into the Japanese stock market, safe haven bids on Wall Street sell offs, end of Japanese fiscal year repatriation flows and fears about a rollback of the Bank of Japan’s epic asset purchasing program have all contributed to spasms of yen strength. Deutsche Bank argues that, as in Europe in early 2017, global investors are taking a FX unhedged bet on Japanese assets and its currency strategists believe the yen will grind higher to 100 against the US dollar by end 2018.

The Tokyo money market could well be the crucible for the stronger yen. The Bank of Japan has begun to discreetly reduce its quantitative easing purchases of Japanese government bonds (JGB) as it seeks to slow down its monthly QE purchases to ¥40 trillion at a time when Japan experiences its highest consumer growth rate since the end of Tokyo land share bubble in 1990. This trend, if it accelerates, means the Japanese yen moves higher even though Abenomics’s “second arrow” once meant a lower yen to boost Japan Inc.’s global exports.

Secretary of State Rex Tillerson’s humiliating sacking by Twitter, Gary Cohn’s resignation and rumours about tensions between the President and National Security Advisor Lt. – General HR McMaster reinforces investor disillusionment with the Trump White House. This means selling the US dollar even as the US economy reaches the limits of the Federal Reserve’s growth and inflation mandate.

The rise in the Japanese yen and Swiss francs against the Canadian dollar, the Aussie dollar, the Kiwi dollar and the greenback tell me that trade tensions and the UK/NATO spat with Russia over the Salisbury spy poisoning case are leading to higher risk aversion in the global foreign exchange market. I believe the strength of the British pound on its crosses and the fall of Euro/yen to 130 reinforces this conclusion, as does the fall in the ten year US Treasury note yield to 2.83%. This is entirely justified since President Xi Jinping’s decision to anoint himself China’s first autocrat – for life since Chairman Mao, Trump’s selection of a ultra-hawkish CIA director as America’s top diplomat to replace Tillerson, Vladimir Putin’s military interventions in the Crimea and Syria and the latest UK-Kremlin tensions mean Great Power conflict is now the defining feature of international relations. Political risk now haunts financial markets. This trend is bullish for the Japanese yen and the Swiss franc and bearish for emerging markets/commodities/currencies. As I watch CNBC reminisce about J.P. Morgan’s shotgun marriage with Bear Stearns, I cannot hold back my fear that excessively indebted banks and governments could teeter on the edge of default as US dollar interest rates continue to rise. For now, the disappointments in US housing starts and expectations that Jay Powell will not rock the boat at his first FOMC conclave means a “soft” US Dollar Index trending as low as 89.

It has not surprised me to see the Canadian dollar plummet to lows at 1.31 as Planet Forex reprices policy risk in Ottawa. The Bank of Canada will simply not raise its policy rate amid such an unsettled international milieu, the reason the loonie has tanked in the past month. The FX option market premium skews tell me that the smart money expects the recent bearish trend for the loonie to continue.

I have been long sterling since 1.32 and see no reason to book profits even though it is possible that the City of London could be hurt by Putin’s retaliation against Britain. Sterling is anchored by the prospect of a Bank of England base rate hike in May and November as Governor Carney simply cannot ignore the post referendum increase in UK food and petrol prices. Theresa May’s decision to expel 23 Russian (Soviet?) “Undeclared intelligence officers” (That is, spies!) boosts her stature in the Conservative Party as well as in Whitehall/Westminster. Germany and France’s decision to back Britain against the Kremlin is also cable bullish, though I wonder if a reelected Chancellor Merkel will help the Brexit talks. To confirm upside momentum, I need to see sterling stage a decisive breakout above 1.40, which will happen next week.