The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone

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The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
17 December 2020

The institutionalisation of Bitcoin
Verbier
If 2020 has been the year of Covid-19, it has also been the year of Bitcoin. Indeed it is the year when Bitcoin
has come of age.

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GREED & fear is not only talking about price performance, though clearly that has been impressive with Bitcoin
up 474% from the March low and 214% year to date (see Exhibit 1), including a 9.2% gain yesterday while
GREED & fear was writing this! Rather what GREED & fear means is that this is the year Bitcoin has become
investible for institutions with custodian arrangements available and with prominent investors and indeed
institutional investors declaring that they have bought it. In this respect, Bitcoin has now become part of the
system with opportunities also for retail investors to buy into it via quoted vehicles, be it the Greyscale Bitcoin
Trust in America or the recently launched VanEck Vectors Bitcoin ETN traded on the Frankfurt exchange.

Exhibit 1: Bitcoin price

Source: Bloomberg

This is important since, before such arrangements were in place, there was always the risk that Bitcoin
accounts could be hacked. The other risk, of course, was that Bitcoin would be declared illegal because it was
used for nefarious purposes, such as illegal narcotic transactions. Still an asleep GREED & fear has only just
been made aware by a friend of the most remarkable development in this area, though it happened four
months ago. That was the announcements in mid-August and September by the Nasdaq-listed MicroStrategy,
a business intelligence software company, that it had invested in the Bitcoin equivalent of US$425m
(US$250m in August and US$175m in September), amounting to almost 100% of its own treasury funds, to
hold on its balance sheet. The aim is to make Bitcoin “the primary treasury reserve asset on an ongoing basis”,
along with cash and short-term investments, according to the company’s official US Securities and Exchange
Commission (SEC) approved Form 8-K. MicroStrategy invested a further US$50m in Bitcoin in early December,
with a cumulative holding of 40,824 Bitcoins.

Please see analyst certifications, important disclosure information, and information regarding the status
of non-US analysts at the end of this report.                                                             1
*Jefferies Hong Kong Limited
The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
This marks a watershed moment in GREED & fear’s view since the auditors approved MicroStrategy putting
Bitcoin on its balance sheet as did the SEC. Now it is true that the far more famous Square also announced in
October that it was investing US$50m in Bitcoin but that only amounted to 1% of the Silicon Valley company’s
assets. Such a small investment probably did not even have to be reported but in MicroStrategy’s case that
was certainly not the case.

GREED & fear must admit to never having heard of MicroStrategy previously. But the company seems to have
been investing in technology and software for 31 years. Since announcing its investment in Bitcoin, the
company’s market capitalisation has risen by 131% to US$2.77bn (see Exhibit 2) and the value of its Bitcoin
holding has almost doubled to US$917m. Intrigued by the motivation behind this investment, GREED & fear
decided to do something GREED & fear seldom does. That was to listen to a “podcast” featuring an interview
with the highly articulate CEO and co-founder of MicroStrategy, Michael Saylor. He is, by the way, no fast
money operator since he has been a public company CEO for 22 years since MicroStrategy’s listing in 1998.

Exhibit 2: MicroStrategy market cap

 3,500    (US$m)

                                                            MicroStrategy market cap
 3,000

 2,500

 2,000

 1,500

 1,000

   500
     Jan-20    Feb-20   Mar-20   Apr-20   May-20   Jun-20   Jul-20   Aug-20    Sep-20   Oct-20   Nov-20   Dec-20
Source: Bloomberg

The most amazing revelation is that he only started to look at Bitcoin in 2019, which is a lot later than GREED
& fear. He made the decision to invest the company’s funds in Bitcoin as a store of value in the spring after
seeing the monetisation triggered by the Federal Reserve’s extreme policy response to Covid-19, and then was
able to convince his fellow directors and get the lawyers and auditors to execute the process in a period of
only ten weeks.

Saylor views Bitcoin as the “ideal Treasury reserve asset”. But, more worryingly to people like GREED & fear
who own gold, Saylor argues that Bitcoin is “destroying gold’s value proposition” because Bitcoin has
“dematerialised gold”. GREED & fear has to admit that this argument has some real merit. GREED & fear has
commented before on several occasions that ownership of gold and Bitcoin are not mutually exclusive and
appeal to different generations (i.e. boomers and millennials). But gold bugs have to face up to the real risk
that risk averse capital, which would have otherwise gone to gold to hedge the obvious ongoing fiat paper
currency debasement in the G7 world, will now go to Bitcoin. In fact that process has already begun.
Meanwhile the brutal fact is that since the policies of extreme currency debasement began in America, which
GREED & fear will take from the commencement of quanto easing under Billyboy in late 2008, Bitcoin has
outperformed gold by 177,000-fold (see Exhibit 3). It is also the case that the supply of Bitcoin is shrinking,
under the quantitative tightening dynamic, which is certainly not the case with gold.

17 December 2020                                                                                                   2
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The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
Exhibit 3: Bitcoin price/gold price

  16                                                                      Bitcoin price / Gold price

  14

  12

  10

    8

    6

    4

    2

   0
     2010      2011      2012         2013   2014      2015        2016        2017        2018        2019   2020
Source: Bloomberg

This does not mean that GREED & fear is going to give up on gold. And the yellow metal should rally again if
the Fed stays doveish in the face of the dramatic cyclical recovery that is coming on the other side of the
pandemic, in line with GREED & fear’s base case. But GREED & fear is now going to do what GREED & fear
should already have done since owning Bitcoin was first recommended here back in June 2019 (see GREED
& fear - The dollar spasm, 27 June 2019), and since it became evident that institutional acceptable ways of
owning Bitcoin were becoming available. That is to introduce an investment in Bitcoin in GREED & fear’s long-
only global portfolio for US dollar-denominated pension funds, established at the end of 3Q02. The 50%
weighting in physical gold bullion in the portfolio will be reduced for the first time in several years by five
percentage points with the money invested in Bitcoin (see Exhibit 4). If there is a big drawdown in bitcoin from
the current level, after yesterday’s historic breakout above the US$20,000 level, the intention will be to add to
this position.

Meanwhile there is no need for GREED & fear to apologise for the original investment in gold when this portfolio
was launched at the end of 3Q02. It was made at the price level of US$323/oz.

Exhibit 4: Recommended long-only asset allocation for US-dollar-based pension funds
    Weight (%)                                                  Investment type
        45%                                                   Physical gold bullion
        30%                     Asia ex-Japan equities, weighted according to the long-only thematic portfolio
        20%                                             Unhedged gold mining stocks
         5%                                                         Bitcoin
Source: Jefferies

Returning to the more mundane subject of Federal Reserve mumbo jumbo, the latest Fed FOMC meeting on
Wednesday indicated a slightly less doveish outlook as a consequence of the vaccine news. But GREED & fear
is only talking about at the margin. The 2% inflation target is still projected not to be reached until 2023 while
most Fed governors assume shot-term rates will remain near zero for at least three more years.

GREED & fear repeats the point that by far the most important issue for financial markets in 2021 is how the
Fed responds when presented with evidence of cyclical recovery, as pent up demand is unleashed on the other
side of the pandemic. GREED & fear’s base case is that the Fed remains doveish even if only because the
system cannot afford higher rates. But it will be hard for Pivot to admit to this. The goal of the Fed’s new
forward guidance is seemingly to avoid the kind of market backlash that occurred in 2013, according to a Wall

17 December 2020                                                                                                     3
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The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
Street Journal article today (“Fed Reinforces Stimulus Will Be Open-Ended to Spur Recovery”, 17 December
2020). So far as GREED & fear is concerned, any hint of tapering will lead to a taper convulsion, not a tantrum.
Investors everywhere need to understand this.

Back in Asia, sentiment amongst foreign investors towards Korea turned much more positive this quarter as
the focus turned to owning cyclicals. This was reflected in foreigners turning largescale net buyers of equities
after having been net sellers for the preceding six quarters. Foreigners have bought a net W4.1tn worth of
Korean equities so far this quarter, after selling a net W34tn in the previous six quarters (see Exhibit 5). The
ironic point to GREED & fear is that foreigners entered the market after retail investors had been active buyers
all year, a point which has been highlighted in recent months by Peter Kim, investment strategist at Jefferies’
new Korea research partner, KB Securities. Domestic retail investors bought a net W58.8tn in the first three
quarters of 2020 and a further W5.4tn so far in 4Q20 (see Exhibit 6).

Exhibit 5: Quarterly foreign net buying of Korean stocks

   10    (Won tn)                                                                             Foreign net buying of Korean stocks

    5

    0

   (5)

  (10)

  (15)

  (20)
                             Sep-16

                                                                 Sep-17

                                                                                                       Sep-18

                                                                                                                                           Sep-19

                                                                                                                                                                               Sep-20
                    Jun-16

                                                        Jun-17

                                                                                              Jun-18

                                                                                                                                  Jun-19

                                                                                                                                                                      Jun-20
           Mar-16

                                               Mar-17

                                                                                     Mar-18

                                                                                                                         Mar-19

                                                                                                                                                             Mar-20
                                      Dec-16

                                                                          Dec-17

                                                                                                                Dec-18

                                                                                                                                                    Dec-19

                                                                                                                                                                                        Dec-20
Source: Bloomberg

Exhibit 6: Domestic retail investors' net buying of Korean equities

   30    (Won tn)                                                                  Domestic retail investors' net buying of Korean stocks
   25
   20
   15
   10
    5
    0
   (5)
  (10)
                             Sep-16

                                                                 Sep-17

                                                                                                       Sep-18

                                                                                                                                           Sep-19

                                                                                                                                                                               Sep-20
                    Jun-16

                                                        Jun-17

                                                                                              Jun-18

                                                                                                                                  Jun-19

                                                                                                                                                                      Jun-20
           Mar-16

                                               Mar-17

                                                                                     Mar-18

                                                                                                                         Mar-19

                                                                                                                                                             Mar-20
                                      Dec-16

                                                                          Dec-17

                                                                                                                Dec-18

                                                                                                                                                    Dec-19

                                                                                                                                                                                        Dec-20

Source: Bloomberg

The result of the renewed foreign enthusiasm is that Korea is at present the best performing market in Asia
Pacific ex-Japan year-to-date, a performance also helped by a 6.9% appreciation of the won against the US
dollar this quarter. The MSCI Korea has risen by 30.3% in US dollar terms so far this quarter and is up 35.5%
year-to-date, compared with a 16.2% gain quarter-to-date and a 17.2% gain year-to-date in the MSCI AC Asia

17 December 2020                                                                                                                                                                                 4
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The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
Pacific ex-Japan Index. This is Korea’s biggest outperformance against the rest of the region in a quarter since
3Q05 (see Exhibit 7).

Exhibit 7: MSCI Korea relative performance against the MSCI AC Asia Pacific ex-Japan

Source: Datastream

The above is a reminder that Korea remains extremely geared to the external cycle despite all the negative
focus in recent years amongst investors, as well as GREED & fear, on the socialist redistribution policies of the
Minjoo Government elected in May 2017. It is also the case that these policies no longer look so extreme given
the policies implemented in the G7 world in response to the pandemic. As for the cyclical gearing, exports
have started to turn up. Total exports rose by 4.1% YoY in November, while exports to China rose by 1.2% YoY
(see Exhibit 8).

Exhibit 8: Korea export growth

  40     (%YoY, 3mma)
                                      Korean exports          Exports to China
  30

  20

  10

    0

  (10)

  (20)

  (30)
         Oct-11

         Oct-12

         Oct-13

         Oct-14

         Oct-15

         Oct-16

         Oct-17

         Oct-18

         Oct-19

         Oct-20
         Apr-11

         Apr-12

         Apr-13

         Apr-14

         Apr-15

         Apr-16

         Apr-17

         Apr-18

         Apr-19

         Apr-20
          Jul-11

          Jul-12

          Jul-13

          Jul-14

          Jul-15

          Jul-16

          Jul-17

          Jul-18

          Jul-19

          Jul-20
         Jan-11

         Jan-12

         Jan-13

         Jan-14

         Jan-15

         Jan-16

         Jan-17

         Jan-18

         Jan-19

         Jan-20

Source: CEIC Data

Traditionally Korea was a geared play on the OECD cycle. But this has changed significantly in recent years as
the share of exports going to emerging markets has increased dramatically. Emerging markets accounted for
62% of total Korean exports in 2019, up from 40% in 2000. By contrast, G7’s share of Korean exports has
declined from 43% to 24% over the same period (see Exhibit 9). China and Vietnam, for example, now account
for a combined 34% of Korean exports, compared with 13.5% for America (see Exhibit 10). This is a positive
dynamic, not a negative one, given the growing contribution of China and the emerging world to global growth.

Still the rally, and the retail contribution to that rally, means that Korea is no longer as cheap as it traditionally
has been. The MSCI Korea now trades on 13.4x 2021 consensus earnings based on 42% forecast earnings

17 December 2020                                                                                                    5
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The institutionalisation of Bitcoin - 17 December 2020 - Mercury Redstone
growth (see Exhibit 11). It is also worth noting the renewed decline in RoE in recent years though this should
be bottoming out. The Kospi ROE fell from 9.7% in 2017 to 4.3% in 2019 and is projected to rise to 11.5% in
2021, according to Bloomberg (see Exhibit 12).

Exhibit 9: Share of Korean exports (Emerging markets vs G7)

 65%                                 Exports to emerging markets         Exports to G7

 60%
 55%
 50%
 45%
 40%
 35%
 30%
 25%
 20%
         2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: CEIC Data

Exhibit 10: China, Vietnam and US shares of Korean exports

  50%
                                                 USA    China      Vietnam

  40%

  30%

  20%

  10%

      0%
          2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: CEIC Data

Exhibit 11: MSCI Korea 12m forward PE

 14    (X)                                                          MSCI Korea 12m forward PE

 13
 12
 11
 10
  9
  8
  7
  6
  5
    2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: Datastream, IBES

17 December 2020                                                                                                6
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Exhibit 12: Kospi ROE
16     (%)
                                                                                                    Kospi ROE
14

12

10

 8

 6

 4

 2

 0
           2002

                  2003

                         2004

                                2005

                                       2006

                                              2007

                                                     2008

                                                            2009

                                                                   2010

                                                                          2011

                                                                                  2012

                                                                                          2013

                                                                                                 2014

                                                                                                         2015

                                                                                                                 2016

                                                                                                                        2017

                                                                                                                                2018

                                                                                                                                        2019

                                                                                                                                               2020

                                                                                                                                                       2021
Source: Bloomberg

Exhibit 13: Cumulative net inflows into Korea investment funds investing offshore
     160 (Won tn)
     140
     120                                      Cumulative net inflows into Korean investment funds investing offshore

     100
      80
      60
      40
      20
       0
     (20)
   (40)
       2008     2009      2010     2011     2012     2013                  2014          2015     2016          2017     2018          2019     2020
Source: Korea Financial Investment Association (KOFIA)

Meanwhile the won’s recent strength, and the domestic stock market boom, has slowed down the previous
boom in investing in offshore markets discussed here a year ago (see GREED & fear - Kim and the appeal of
boring, 12 December 2019). Net offshore investment by Korean investment funds has totaled W21tn so far in
2020, compared with W45tn in 2019 and W24tn in 2018 (see Exhibit 13). The total amount invested by such
funds offshore is now W206tn (US$189bn). Still gung ho Korean retail investors have also bought a net
US$19bn worth of foreign stocks so far in 2020, of which US$16.8bn was in US stocks (see Exhibit 14). This
compares with net buying of “only” US$2.5bn of foreign stocks in 2019.

Finally, on Covid, Korea has so far continued to avoid complete lockdowns as the number of cases has
fluctuated, though of late there has been a notable deterioration. The 7-day average daily Covid case count
has surged from a low of 69 in early October to a record 908 on Wednesday, with the daily case count
exceeding 1,000 over the past two days. While the 7-day average daily death count has also risen from 1 in
late October to 10, with a record 22 deaths on Wednesday (see Exhibit 15). Still, total confirmed cases and
deaths are running at “only” 907 and 12 per 1m of population respectively.

17 December 2020                                                                                                                                              7
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Exhibit 14: Korea retail investors net buying of foreign stocks

  3,500            (US$m)
  3,000
                                                                                                                         Other foreign stocks                                   US stocks
  2,500
  2,000
  1,500
  1,000
    500
      0
   -500
 -1,000
                     May-11
                              Sep-11

                                                May-12
                                                          Sep-12

                                                                            May-13
                                                                                     Sep-13

                                                                                                       May-14
                                                                                                                Sep-14

                                                                                                                                  May-15
                                                                                                                                           Sep-15

                                                                                                                                                              May-16
                                                                                                                                                                       Sep-16

                                                                                                                                                                                         May-17
                                                                                                                                                                                                  Sep-17

                                                                                                                                                                                                                    May-18
                                                                                                                                                                                                                             Sep-18

                                                                                                                                                                                                                                                May-19
                                                                                                                                                                                                                                                         Sep-19

                                                                                                                                                                                                                                                                           May-20
                                                                                                                                                                                                                                                                                    Sep-20
            Jan-11

                                       Jan-12

                                                                   Jan-13

                                                                                              Jan-14

                                                                                                                         Jan-15

                                                                                                                                                    Jan-16

                                                                                                                                                                                Jan-17

                                                                                                                                                                                                           Jan-18

                                                                                                                                                                                                                                      Jan-19

                                                                                                                                                                                                                                                                  Jan-20
Source: Korea Securities Depository

Exhibit 15: Korea Covid-19 7-day average daily new cases and deaths

  1000                                                                                                                                                                                                                                                                                       12
                                                                                                                           Korea daily new cases, 7dma                                                       Daily deaths, 7dma (RHS)
                                                                                                                                                                                                                                                                                             10
   800

                                                                                                                                                                                                                                                                                             8
   600
                                                                                                                                                                                                                                                                                             6
   400
                                                                                                                                                                                                                                                                                             4

   200
                                                                                                                                                                                                                                                                                             2

     0                                                                                                                                                                                                                                                                                       0
                                                                               23-Apr

                                                                                                       21-May
                                           12-Mar

                                                         26-Mar

                                                                                                                                                                                                                                                              19-Nov
                     13-Feb

                                27-Feb

                                                                                                                                                                                                                             8-Oct
                                                                                                                             18-Jun

                                                                                                                                                     16-Jul

                                                                                                                                                                 30-Jul

                                                                                                                                                                                                                                                                           3-Dec
                                                                   9-Apr
          30-Jan

                                                                                          7-May

                                                                                                                                                                            13-Aug

                                                                                                                                                                                         27-Aug
                                                                                                                                           2-Jul

                                                                                                                                                                                                                                                   5-Nov
                                                                                                                                                                                                    10-Sep

                                                                                                                                                                                                               24-Sep

                                                                                                                                                                                                                                       22-Oct
                                                                                                                  4-Jun

Source: Korea Centers for Disease Control & Prevention

Exhibit 16: Philippines 7-day average daily Covid new cases and deaths

Source: Department of Health

Elsewhere in Asia, it is interesting to note that the Covid cases are down significantly in the Philippines and
now look to be well past the peak. The 7-day average daily Covid case count has declined by 72% from the
peak of 4,477 in mid-August to 1,272, while the 7-day average daily Covid death count has fallen by 80% from

17 December 2020                                                                                                                                                                                                                                                                                 8
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107 in mid-September to 21 (see Exhibit 16). The number of active cases also peaked at 83,109 in mid-August
and has since declined by 69% to 25,695. While hospitalisation rates are also way down. Nationwide ward bed,
ICU bed and isolation bed occupancy rates have declined from 58%, 56% and 54% in late July to 26%, 41% and
36% respectively (see Exhibit 17).

But, despite all this, the Philippines is ending 2020 still in various forms of lockdowns, most particularly Metro
Manila where public transport is still only operating at around 40% of capacity.

Exhibit 17: Philippines hospital bed occupancy rates for Covid-19

Source: Department of Health

The impact of the extended lockdowns continues to show up in the labour market. The national adult jobless
rate was still a horrifying 39.5% in September, though down from the peak of 45.5% in July, according to Social
Weather Stations (see Exhibit 18). The economic consequences of the lockdown also continue to be reflected
in third quarter data with real GDP declining by 11.5% YoY, though that was an improvement from the second
quarter which saw the biggest YoY decline (16.9%) since the quarterly data series began in 1981 (see Exhibit
19).

Exhibit 18: Philippines adult jobless rate
  50 (%)                                                                                                                Philippines SWS adult jobless rate

  40

  30

  20

  10

    0
        1993
               1994
                      1995
                             1996
                                    1997
                                           1998
                                                  1999
                                                         2000
                                                                2001
                                                                       2002
                                                                              2003
                                                                                     2004
                                                                                            2005
                                                                                                   2006
                                                                                                          2007
                                                                                                                 2008
                                                                                                                         2009
                                                                                                                                2010
                                                                                                                                       2011
                                                                                                                                              2012
                                                                                                                                                     2013
                                                                                                                                                            2014
                                                                                                                                                                   2015
                                                                                                                                                                          2016
                                                                                                                                                                                 2017
                                                                                                                                                                                        2018
                                                                                                                                                                                               2019
                                                                                                                                                                                                      2020

Note: % of the adult labour force without a job at present and looking for a job. Source: Social Weather Stations

17 December 2020                                                                                                                                                                                             9
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Exhibit 19: Philippines real GDP growth

  15 (%YoY)
                                                                     Real GDP growth
  10

   5

   0

  (5)

 (10)

 (15)

 (20)
     1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: CEIC Data, Philippines Statistics Authority

Exhibit 20: Philippines fiscal balance as % of GDP

   2    (%GDP)

   0

  (2)

  (4)

  (6)

  (8)

 (10)

        2020F
        2021F
        2022F
         1985
         1986
         1987
         1988
         1989
         1990
         1991
         1992
         1993
         1994
         1995
         1996
         1997
         1998
         1999
         2000
         2001
         2002
         2003
         2004
         2005
         2006
         2007
         2008
         2009
         2010
         2011
         2012
         2013
         2014
         2015
         2016
         2017
         2018
         2019
Source: CEIC Data, Bureau of Treasury, Development Budget Coordination Committee (DBCC)

As elsewhere, the Philippines has engaged in aggressive fiscal easing this year with a forecast fiscal deficit
of P1.4tn or 7.6% of GDP this year, the highest since 1985 (see Exhibit 20). But the real dramatic shift has
been in monetary policy where Bangko Sentral ng Pilipinas (BSP) has gone unorthodox, in terms of
implementing both quantitative easing and what Jefferies’ Philippine research partner Regis Partners calls
“direct monetisation”. The BSP’s direct purchases of government securities under repo agreements rose from
P300bn in March to P540bn in October and is expected to rise to P850bn in 2021, while the central bank has
since March bought an additional P1tn worth of Treasuries in the open market as of August, the latest data
available (see Exhibit 21).

The central bank effectively funded about 77-81% of the issuance of Treasury bonds in the first eight months
of 2020, according to Regis. The central bank has also said it will keep up its bond buying programme for at
least the next two years.

17 December 2020                                                                                           10
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Exhibit 21: BSP holdings of domestic securities (open market operations) and govt securities under repo agreements

 3,000 (P bn)

 2,500                                                                                   Domestic Securities                                           Gov't Secs Under Repo Agreement

 2,000

 1,500

 1,000

   500

      0
                    Jan-20                         Feb-20                     Mar-20                      Apr-20                      May-20                       Jun-20                          Jul-20                     Aug-20                     Oct-20E                     Jan-21E
Source: Bangko Sentral ng Pilipinas (BSP), Regis Partners

As for conventional monetary policy, the central bank has since February cut the overnight reverse repurchase
rate by 200bp to 2.0%, including a 25bp cut in November following a pause since July. It has also cut the
reserve requirement ratio by 200bp in late March to 12% and is authorised by the monetary board to cut a total
of 400bp in 2020. But no more RRR cut has been announced since then. The central bank kept its policy
unchanged in today’s monetary policy meeting.

The move to unorthodox monetary policy has been positive for the stock market, sending a clear message to
domestic fund managers to switch out of bonds and cash. Philippine M1 growth and M3 growth were 22.4%
YoY and 11.8% YoY respectively in October (see Exhibit 22). The result is that the stock market has rallied
sharply so far this quarter without foreign net buying. The PSEi Index has risen by 24.5% so far in 4Q20, while
foreigners have sold a net US$425m over the same period (see Exhibit 23).

This divergence is almost unprecedented for the Philippines. It in part reflects domestic equity funds
dramatically reducing their cash holdings during the second half of 2020. The estimated cash levels of local
funds have declined from 11.2% in May to 6.3% in October, according to Regis (see Exhibit 24).

Exhibit 22: Philippine M3 growth and M1 growth

 40 (%YoY)
                                                                                                                                                                                           M3 growth                                     M1 growth
 35
 30
 25
 20
 15
 10
  5
  0
               May-10
                        Sep-10

                                          May-11
                                                   Sep-11

                                                                     May-12
                                                                              Sep-12

                                                                                                May-13
                                                                                                         Sep-13

                                                                                                                           May-14
                                                                                                                                    Sep-14

                                                                                                                                                      May-15
                                                                                                                                                               Sep-15

                                                                                                                                                                                 May-16
                                                                                                                                                                                          Sep-16

                                                                                                                                                                                                            May-17
                                                                                                                                                                                                                     Sep-17

                                                                                                                                                                                                                                       May-18
                                                                                                                                                                                                                                                Sep-18

                                                                                                                                                                                                                                                                  May-19
                                                                                                                                                                                                                                                                           Sep-19

                                                                                                                                                                                                                                                                                             May-20
                                                                                                                                                                                                                                                                                                      Sep-20
      Jan-10

                                 Jan-11

                                                            Jan-12

                                                                                       Jan-13

                                                                                                                  Jan-14

                                                                                                                                             Jan-15

                                                                                                                                                                        Jan-16

                                                                                                                                                                                                   Jan-17

                                                                                                                                                                                                                              Jan-18

                                                                                                                                                                                                                                                         Jan-19

                                                                                                                                                                                                                                                                                    Jan-20

Source: CEIC Data, BSP

17 December 2020                                                                                                                                                                                                                                                                                           11
Please see important disclosure information at the end of this report.
Exhibit 23: Cumulative foreign net buying of Philippine stocks

Source: Bloomberg, Philippine Stock Exchange

Exhibit 24: Estimated local fund cash levels (% to NAV, AUM-weighted)
 12%

 10%

  8%

  6%

  4%

  2%

  0%
                Feb-17

                                                                      Feb-18

                                                                                                                            Feb-19

                                                                                                                                                                                  Feb-20
                                           Aug-17

                                                                                                 Aug-18

                                                                                                                                                       Aug-19

                                                                                                                                                                                                             Aug-20
                                                    Oct-17

                                                                                                          Oct-18

                                                                                                                                                                Oct-19

                                                                                                                                                                                                                      Oct-20
                         Apr-17

                                                                               Apr-18

                                                                                                                                     Apr-19

                                                                                                                                                                                           Apr-20
                                  Jun-17

                                                                                        Jun-18

                                                                                                                                              Jun-19

                                                                                                                                                                                                    Jun-20
       Dec-16

                                                             Dec-17

                                                                                                                   Dec-18

                                                                                                                                                                         Dec-19

Source: Various funds' fact sheets, REGIS estimates

From a valuation standpoint, the stock market is on 18x 12-month forward earnings based on the PSEi
universe. This is based on Regis’ assumption of a 90% return to normal by the end of 2021 in terms of
economic activity. A potential positive is that a pending tax bill, if implemented, will reduce the corporate
income tax rate from 30% to 25% retroactively to July 2020. If this occurs, it will increase the forecast earnings
growth by about 5-7 percentage points from the current Regis forecast of 34% in 2021.

If this is all positive, the risk next year for foreign investors is that the currency takes the pressure as a result
of the aggressive monetary easing. This risk will increase if rising commodity prices, particularly a rising oil
price, cause a rise in inflation at a time when domestic purchasing power is under pressure from the lack of
employment.

Still the peso has so far remained remarkably stable against a weak US dollar, though in a sign of vulnerability
it has begun to underperform other Asian currencies since mid-August. The peso has underperformed the
Bloomberg Asia Dollar Index by 3.5% since mid-August (see Exhibit 25). GREED & fear would certainly not have
a weighting in the peso or in Philippine bonds in an Asian currency or bond fund.

One explanation for the currency’s resilience of late has been evidence of capital inflow, as reflected in the net
errors and omissions item (or so-called net unclassified items) on the balance of payments. Net errors and
omissions rose from an outflow of US$2.83bn in 2018 to an inflow of US$3.88bn in 2019 and US$2.06bn in
17 December 2020                                                                                                                                                                                                           12
Please see important disclosure information at the end of this report.
the first three quarters of 2020 though, significantly to GREED & fear, they fell to an outflow of US$709m in
3Q20 (see Exhibit 26). The most plausible explanation for this previous capital inflow remains mainland
Chinese money related to the offshore gaming boom, as previously discussed here (see GREED & fear - Asean
blues, 6 August 2020).

Exhibit 25: Peso performance relative to Bloomberg Asia Dollar Index
    6       (%YTD)

    4

    2

    0

    (2)
                                                                                                                   Peso against US$
    (4)                                                                                                            Bloomberg Asia Dollar Index
                                                                                                                   Peso relative to Asia Dollar Index
    (6)
                                                                  May-20

                                                                                                                           Sep-20
                                                                                                              Aug-20

                                                                                                                                           Oct-20
                                                                              Jun-20

                                                                                                                                                           Nov-20
                                                                                              Jul-20
                                       Mar-20

                                                       Apr-20
          Jan-20

                                                                                                                                                                      Dec-20
                       Feb-20

Source: Bloomberg

Exhibit 26: Philippines balance of payments: Net unclassified items
    8 (US$bn)
                                                                               Net unclassified items                                 Annualised
    6

    4

    2

    0

    (2)

    (4)

    (6)

    (8)
           2006

                     2007

                                2008

                                                2009

                                                           2010

                                                                  2011

                                                                           2012

                                                                                       2013

                                                                                                       2014

                                                                                                                2015

                                                                                                                         2016

                                                                                                                                    2017

                                                                                                                                                    2018

                                                                                                                                                               2019

                                                                                                                                                                      2020

Source: BSP

Still it now looks to GREED & fear as if the offshore gaming boom has peaked amidst growing anecdotal
evidence that Philippine offshore gaming operators (POGOs) are leaving, a trend which is already causing a
negative impact on both residential prices and commercial rents. Office rents have declined by 10-15% since
peaking in 1Q20, while residential condo prices are down 5-20% over the same period (see Exhibits 27 and
28).

There are two reasons. The first is a crackdown on POGOs from China. The second is that the Rodrigo Duterte
government imposed a 5% tax on turnover (i.e. the amount bet) in September.

17 December 2020                                                                                                                                                               13
Please see important disclosure information at the end of this report.
Exhibit 27: Philippines office spot rents
 1,800 (P/sqm/month)               Makati Premium          Makati Grade A       Ortigas Grade A            BGC Grade A

 1,600

 1,400

 1,200

 1,000

   800

   600

   400
         1Q13            1Q14            1Q15          1Q16           1Q17            1Q18          1Q19          1Q20
Source: Colliers, Regis Partners

Exhibit 28: Philippines residential condo prices
  350,000 (P/sqm)                         Makati Premium           Rockwell Premium          Bonifacio Premium

  300,000

  250,000

  200,000

  150,000

  100,000
            1Q11        1Q12          1Q13      1Q14        1Q15       1Q16      1Q17        1Q18          1Q19     1Q20
Source: Colliers, Regis Partners

The other risk to the peso is that it is simply not cheap. The real effective exchange rate has appreciated by
15.5% since February 2018 and is up 57% since 2004 (see Exhibit 29). Meanwhile a positive for the currency
and, more importantly, for an economy whose biggest export remains people, is that the remittances from
overseas workers have been much less badly hit by the pandemic than earlier feared. After an initial 19.3%
YoY collapse in cash remittances in US dollar terms in May which was the biggest monthly YoY decline since
January 2001, it is a positive surprise that remittance were only down 0.9% YoY in US dollar terms in the first
ten month of 2020 and were up 2.9% YoY in October (see Exhibit 30). Similarly, BPO revenues have also held
up better than expected with the feedback that BPOs continue to take up new space.

17 December 2020                                                                                                           14
Please see important disclosure information at the end of this report.
Exhibit 29: Philippines real effective exchange rate

            (2010=100)                                                                          Philippines real effective exchange rate
    120

    110

    100

     90

     80

     70
          1994
                 1995
                        1996
                               1997
                                      1998
                                             1999
                                                    2000
                                                            2001
                                                                   2002
                                                                          2003
                                                                                 2004
                                                                                         2005
                                                                                                2006
                                                                                                        2007
                                                                                                               2008
                                                                                                                      2009
                                                                                                                             2010
                                                                                                                                     2011
                                                                                                                                            2012
                                                                                                                                                   2013
                                                                                                                                                          2014
                                                                                                                                                                 2015
                                                                                                                                                                        2016
                                                                                                                                                                               2017
                                                                                                                                                                                       2018
                                                                                                                                                                                              2019
                                                                                                                                                                                                     2020
Source: BIS

Exhibit 30: Philippines overseas workers cash remittances %YoY

    50 (%YoY)
                                                                                                               Overseas workers cash remittances %YoY
    40
    30
    20
    10
     0
   -10
   -20
   -30
   -40
         2000

                 2001

                          2002

                                  2003

                                             2004

                                                     2005

                                                               2006

                                                                          2007

                                                                                  2008

                                                                                           2009

                                                                                                       2010

                                                                                                               2011

                                                                                                                        2012

                                                                                                                                    2013

                                                                                                                                            2014

                                                                                                                                                     2015

                                                                                                                                                             2016

                                                                                                                                                                        2017

                                                                                                                                                                                2018

                                                                                                                                                                                          2019

                                                                                                                                                                                                     2020
Source: CEIC Data, BSP

Meanwhile it is worth noting, in the context of the anticipated cyclical rebound in 2021, that the Philippines
had enjoyed an already extended eight-year-long investment cycle and related credit cycle prior to the
pandemic; though investment momentum has slowed in recent quarters. The annualised gross fixed capital
formation to GDP ratio has fallen from a 35-year high of 27.4% in 1Q19 to 23.1% in 3Q20 (see Exhibit 31).

As for credit growth, total banking system loan growth was only 0.8% YoY in October, down from 10.8% YoY
in March (see Exhibit 32). Still there remains room for credit expansion since the gross loan-to-deposit ratio
of the banking system is only 74%, though up from 63% in late 2013. Meanwhile, inflation remains, for now at
least, within the central bank’s target range of 2-4%. Headline CPI inflation was 3.3% YoY in November while
core CPI inflation was 3.2% YoY (see Exhibit 33).

17 December 2020                                                                                                                                                                                            15
Please see important disclosure information at the end of this report.
Exhibit 31: Philippines annualised gross fixed capital formation as % of nominal GDP

     28        (%)                                                                                 Annualised gross fixed capital formation as % of nominal GDP

     26

     24

     22

     20

     18
           2001

                         2002

                                          2003

                                                       2004

                                                                      2005

                                                                                       2006

                                                                                                    2007

                                                                                                                   2008

                                                                                                                                    2009

                                                                                                                                                 2010

                                                                                                                                                                2011

                                                                                                                                                                                 2012

                                                                                                                                                                                              2013

                                                                                                                                                                                                             2014

                                                                                                                                                                                                                              2015

                                                                                                                                                                                                                                           2016

                                                                                                                                                                                                                                                          2017

                                                                                                                                                                                                                                                                           2018

                                                                                                                                                                                                                                                                                        2019

                                                                                                                                                                                                                                                                                                       2020
Source: CEIC Data

Exhibit 32: Philippines banking system loan growth

20        (%YoY)
                                                                                                                                                                                 Philippines banking system loan growth

15

10

 5

 0
                                                                     Aug-18

                                                                                                                                                                                 Aug-19

                                                                                                                                                                                                                                                                                             Aug-20
                                          May-18

                                                                                       Oct-18

                                                                                                                                                      May-19

                                                                                                                                                                                                   Oct-19

                                                                                                                                                                                                                                                                  May-20

                                                                                                                                                                                                                                                                                                               Oct-20
                                                   Jun-18

                                                                                                Nov-18

                                                                                                                                                               Jun-19

                                                                                                                                                                                                            Nov-19

                                                                                                                                                                                                                                                                           Jun-20
                                                                              Sep-18

                                                                                                                                                                                          Sep-19

                                                                                                                                                                                                                                                                                                      Sep-20
                        Mar-18

                                                            Jul-18

                                                                                                                                    Mar-19

                                                                                                                                                                        Jul-19

                                                                                                                                                                                                                                                Mar-20

                                                                                                                                                                                                                                                                                    Jul-20
                                 Apr-18

                                                                                                                                             Apr-19

                                                                                                                                                                                                                                                         Apr-20
      Jan-18
               Feb-18

                                                                                                         Dec-18
                                                                                                                  Jan-19
                                                                                                                           Feb-19

                                                                                                                                                                                                                     Dec-19
                                                                                                                                                                                                                              Jan-20
                                                                                                                                                                                                                                       Feb-20

Source: BSP

Exhibit 33: Philippines CPI inflation and BSP policy rate
     12 (%)                                                          BSP key overnight RRP rate                                                                                  Core CPI inflation                                                                  CPI inflation

     10

      8

      6

      4

      2

      0

     (2)
           2002

                          2003

                                          2004

                                                        2005

                                                                        2006

                                                                                        2007

                                                                                                         2008

                                                                                                                      2009

                                                                                                                                     2010

                                                                                                                                                      2011

                                                                                                                                                                   2012

                                                                                                                                                                                   2013

                                                                                                                                                                                                   2014

                                                                                                                                                                                                                 2015

                                                                                                                                                                                                                                 2016

                                                                                                                                                                                                                                                 2017

                                                                                                                                                                                                                                                                  2018

                                                                                                                                                                                                                                                                               2019

                                                                                                                                                                                                                                                                                               2020

Source: CEIC Data, BSP

17 December 2020                                                                                                                                                                                                                                                                                                   16
Please see important disclosure information at the end of this report.
Analyst Certification:
I, Christopher Wood, certify that all of the views expressed in this research report accurately reflect my personal views about the
subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly,
related to the specific recommendations or views expressed in this research report.
Registration of non-US analysts: Christopher Wood is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC
and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC,
a FINRA member firm, and therefore may not be subject to the FINRA Rule 2241 and restrictions on communications with a subject
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As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in
this report receives compensation based in part on the overall performance of the firm, including investment banking income. We
seek to update our research as appropriate, but various regulations may prevent us from doing so. Aside from certain industry
reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's
judgement.

Investment Recommendation Record
(Article 3(1)e and Article 7 of MAR)
Recommendation Published                     December 17, 2020 , 09:05 ET.
Recommendation Distributed                   December 17, 2020 , 09:05 ET.

Explanation of Jefferies Ratings
Buy - Describes securities that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month
period.
Hold - Describes securities that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within
a 12-month period.
Underperform - Describes securities that we expect to provide a total return (price appreciation plus yield) of minus 10% or less
within a 12-month period.
The expected total return (price appreciation plus yield) for Buy rated securities with an average security price consistently below
$10 is 20% or more within a 12-month period as these companies are typically more volatile than the overall stock market. For Hold
rated securities with an average security price consistently below $10, the expected total return (price appreciation plus yield) is
plus or minus 20% within a 12-month period. For Underperform rated securities with an average security price consistently below
$10, the expected total return (price appreciation plus yield) is minus 20% or less within a 12-month period.
NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable
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average group P/E, sum of the parts, net asset value, dividend returns, and return on equity (ROE) over the next 12 months.

Jefferies Franchise Picks
Jefferies Franchise Picks include stock selections from among the best stock ideas from our equity analysts over a 12 month
period. Stock selection is based on fundamental analysis and may take into account other factors such as analyst conviction,
differentiated analysis, a favorable risk/reward ratio and investment themes that Jefferies analysts are recommending. Jefferies
Franchise Picks will include only Buy rated stocks and the number can vary depending on analyst recommendations for inclusion.

                                                                                                                                        17
Stocks will be added as new opportunities arise and removed when the reason for inclusion changes, the stock has met its desired
return, if it is no longer rated Buy and/or if it triggers a stop loss. Stocks having 120 day volatility in the bottom quartile of S&P
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a recommended portfolio of stocks and is not sector based, but we may note where we believe a Pick falls within an investment
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Risks which may impede the achievement of our Price Target
This report was prepared for general circulation and does not provide investment recommendations specific to individual investors.
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Distribution of Ratings
                                                       Distribution of Ratings

                                                                  IB Serv./Past12 Mos.                JIL Mkt Serv./Past12 Mos.

                         Count              Percent            Count              Percent             Count             Percent

BUY                       1530              58.06%               138               9.02%                14               0.92%

HOLD                      970               36.81%               25                2.58%                6                0.62%

UNDERPERFORM              135               5.12%                 2                1.48%                1                0.74%

                                                                                                                                   18
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