POSTED BY ANGUS GEDDES
The markets got off to a roaring start this year which has left many wondering if the rally is sustainable, and even more anticipating a decent selloff in the market. There can be no doubts that sentiment is running high. And I have to say that I am in the camp that also expects markets to correct, however, I don’t believe the “looming” correction will prove to be much beyond 5% and 10%. My argument is that pretty much everyone has the same view and this will make it difficult for markets to “initially” correct much beyond this.
The “fear within” has become conditioning. Everyone I spoke to over the holiday break has a dread of 2008 recurring. I think that in itself is significant, because markets only deliver the “worst when least expect it”. I’m not proclaiming that markets are not susceptible to a reaction. After the strong start to the year, the markets are. But we could also just as easily witness the rally to continue in earnest, albeit with some checks and balances along the way.
One argument that has been persistent in the media is that the current bull run is long in the tooth. There is merit to that argument, however this cycle by definition has to be different from predecessors over the past few decades. This rally and indeed, economic cycle follows a once in a generation financial downturn, which remains fresh in the minds of all who lived through it. It is only human nature to expect the worst after calamity and this was exactly the pattern in the 1930s. For now I expect markets to defy the obvious in terms of expectations. and follow the path of least resistance.
Sector in focus: Macau has its Mojo back
Macau casino gross gaming revenue (GGR) came in at 22.7 billion patacas (US$2.8 billion at current exchange rates) in December 2017, representing a 14.6% year-on-year gain. Although that gain was below expectations, this was put down to the luck factor’ in VIP gaming (i.e. VIPs won more games in the month than they typically do statistically) and it was the 17th consecutive month of year-on-year gains in gaming revenue.
The December haul took full year 2017 gaming revenue to 265.7 billion patacas (US$33b), compared to 223.2 billion patacas in 2016.
That marked an impressive 19.1% increase and the first year of gaming revenue growth after three prior years of declines.
In 2014, the first cracks appeared in Macau’s massive gaming market, with a slight 2.6% year-on-year decline in gaming revenues. It was much more painful in the following year, with Macau gaming revenue plummeting 34.5% compared to 2014. In 2016 the market almost stabilised, with just a modest 3.3% drop and later in the year I saw signs this was likely the nadir for the Macau casinos and begun recommending several names listed in Hong Kong and the parent of Wynn Macau, Wynn Resorts – listed on the Nasdaq exchange.
The year-on-year declines in Macau’s gaming revenue stemmed from the Chinese government launching an anti-graft campaign and the mainland Chinese economy slowing. The anti-graft campaign prompted many high-flyers to reduce flamboyant spending and that hit VIP traffic to Macau particularly hard. There were many scandals regarding Chinese officials using jaunts to Macau to launder money gained from bribes or embezzlement.
Macau had also seen its gaming revenue enjoy explosive growth after becoming a Special Administrative Region (SAR) of China in 1999. Prior to that Macau had been a Portuguese colony for centuries.
Previously known as Asia’s Monte Carlo, or the Las Vegas of the East, due to the benefits Macau enjoyed under the “one country, two systems” blueprint, proximity to China and the Chinese affinity for gambling, restrained by an official ban on the mainland, Macau grew to be the world’s largest gambling hub by a country mile. By 2010 it was already around four times the size of Las Vegas for gambling revenue.
The long-term prospects for Macau gaming remain tremendous and the declines from 2014 through 2016 mostly represent growing pain, so in my view it isn’t time to fold cards on the sector yet.
A shift towards a more family friendly approach like that transformation Las Vegas has undertaken will benefit Macau and Mainland China as outward bound tourism is set to continue to grow strongly in the years ahead. China’s outbound tourism is expected to grow at a double-digit pace for many years yet, as the percentage of Chinese with passports is still quite low and spending power of the middle class is growing. Combined with new infrastructure build-out and the new and yet to be opened attractions in Macau and its appeal as a tourism and gambling destination is compelling. Mass market gaming is higher margin than VIP play and is generally accompanied by significant non-gaming spending.
Fat Prophets bullish call on the Macau casino players was well before most of the big investment banks turned positive on the theme. It has also proved lucrative with solid to stellar returns on the Hong Kong-listed casino operators and Wynn Resorts over the past year.
The Hong Kong-listed shares of Sands China are up 20% over the past year, while MGM China shares are up 55% and Wynn Macau shares have surged 83%. We hold these stocks in the Global Contrarian Fund, as well as in the Global Opportunities and Asian portfolios. Wynn Resorts is also a beneficiary and a holding in the Global Opportunities and US portfolios. Wynn Resorts has also had a stellar 12 months, with the shares up 82%.
Wynn Macau and Wynn Resorts have been the biggest winners over the past year, largely due to the stronger than expected return of VIP players. The opening of the luxurious Wynn Palace in late 2016 dovetailed with the return of premium mass and VIP players to Macau.
Wynn Palace has proved to be a huge contributor and there is scope for further improvements yet at Wynn Palace in our view, as its operations are optimised. Wynn has a strong track record with its property openings, putting relatively little marketing spend into new properties until it establishes a baseline. The company then has generally turned these ‘careful’ openings into strong commercial successes.
There is still plenty of scope for margins to improve at Wynn Palace, but that is to be expected and should play out as the property settles in and foot traffic increases in the future. The property still faces some impediment in the sense that it is still surrounded by construction.
In Japan on Friday, robotics leaders Fanuc and Yaskawa Electric rose 2.96% and 3.75% respectively. Given advances in robotics technology and artificial intelligence (AI), investors expect good long-term growth prospects for the robot giants. Fanuc is a holding in the Global Contrarian Fund and the Global Opportunities and Asian portfolios. Yaskawa is held in the Asian portfolios.