Busy morning on a cold day!

Tencent released their Q3 earnings after the close in HK this morning.

• Revenue RMB 80.6B ($11.716B) versus estimate 80.41B
• Revenue +24% YoY and +9% QoQ
• Social Networks revenue growth RMB 18.2B +19% YoY; Online Game RMB revenue 25.8B -4% YoY
• Advertising Media RMB 5.1B +23% YoY; Social networks advertising 11.1% +61% YoY
• Gross Profit RMB 35.5B +12% YoY
• Operating Profit RMB 27.9B ($3.402B) +22% YoY
• Net Profit to Shareholders RMB 23.3B +30% YoY
• Net Income RMB 23.33B versus estimate 18.39B
• Operating Margin 34.6% -5% YoY; Net Margin 29% -1% YoY
• WeChat users 1.08 billion +10.5% YoY; 100mm user increase YoY (Wow!)

Takeaway: Tencent’s self-imposed austerity plan has worked fantastically well in the quarter. As much as I love WeChat, the reality is Tencent’s core business is gaming which has faced pressure from the government’s scrutiny of how much time minors are spending online. The company has fifteen games waiting for regulatory approval. Much like Facebook after their IPO, Tencent has been slow to increase advertising on WeChat. In the face of slowing gaming approval, Tencent has accelerated monetization of WeChat. If the gaming approval process clouds part (fingers crossed) we could see further revenue acceleration. Tencent stock (700 HK) is off 42% from its high. Naspers, the South African newspaper company that invested in Tencent in its infancy and owns 1/3 of the company, is up 3% in Johannesburg.

Retail Sales: 8.6% versus estimate 9.2% and Sept’s 9.2%
Industrial Production: 5.9% versus estimate 5.8% and Sept’s 5.8%
Fixed Asset Investment: 5.7% versus estimate 5.5% and Sept’s 5.4%
New Loans: 697B versus estimate 904B and Sept’s 2.205B
Financing: 728B versus estimate 1,300B and 2,205B

Takeaway: IP and FAI surprised to the upside though retail sales and loan activity came in a little light. Loan activity highlights the success of slowing credit growth though the policy makers are worried about the private sector’s access to credit. IP and FAI could be showing the effects of gov’t stimulus and/or tariff front running. Retail sales was off though shoppers may have held off waiting for Singles Day. Housing sales appears to be slowing which limits big ticket item purchases. Auto sales have fallen though many potential buyers could be waiting for a potential auto tax cut. In reading a sell side report on consumer sentiment, mainland respondents are not concerned about a trade war at this point.

After the close MSCI released their pro forma for their December Semi Annual Index Rebalance (SAIR). The June and December SAIRs are major events as opposed to quarterly share adjustments. On a percentage basis there are not major changes though when we look at the number of stocks some interesting changes appear. For one Turkey lost 6 of its previous 24 securities though it only reduces the country weight from 0.7% to 0.6%. China’s percent weight increases slightly from 30.5% to 30.9% due to 12 additions offsetting 10 deletes. Stepping back:

• China will be 463 of 1,129 EM stocks.
• China’s % weight of 30.9% compares to EM Europe/Africa/Middle East’s weight of 14.1%
• China’s % weight of 30.9% compares to EM Latin America’s weight of 12.7%
• China’s 463 companies compares to EM Europe/Africa/Middle East’s 146 companies
• China’s 463 companies compares to EM Latin America’s 108 companies
• The indice’s #2 country weight South Korea is 14.4% and 114 stocks
• The indice’s #3 country weight Taiwan is 11.6% and 86 stocks
• The indice’s #4 country weight India is 8.2% and 78 stocks
• The entire Frontier Markets Index has a market cap of $109 billion. China is ~14X larger at $1.5 trillion.In the years to come

China’s % and weight will grow as:

1. The 2019 proposed inclusion factor for Chinese A shares is raised to 20% from 5% (235 Chinese A Shares had 5% of their market cap added to MSCI indices in 2018).
2. The increase of more Chinese companies lowers the market cap threshold for Chinese companies (in 2017 China was comprised of 150 companies)
3. Within the SAIR document, MSCI will add companies with unequal voting structures to their indices which will add 5 Chinese companies (apparently Chinese entrepreneurs have learned something from their US equivalents).
   
   

Hang Seng declined -0.54% in light volumes -12% day over day with 20 advancers and 26 decliners. AIA declined -1.93% worth -45 of the indice’s 138 point loss. Energy was weak with CNOOC -4.65% and PetroChina -3.57%. Within the MSCI China All Shares’ HK companies, real estate gained +1.05% on chatter of home purchase restrictions being lifted. Market was relatively flat though energy was off -3.27% and healthcare -2.72%. Southbound Connect volumes were light with sellers outpacing buyers slightly. Tencent was the second most heavily traded Connect name with 2 to 1 buyers.

Shanghai & Shenzhen declined in afternoon trading -0.85% and -0.4% in above average volume but off 10% day over day. It appears that short term traders took profits following Monday and Tuesday’s strong gains. Within the MSCI China All Shares’ mainland stocks, energy took it on the chin -2.25% followed by staples -1.97% and financials -1.3%. The latter sectors experienced the profit taking in the “white horse” names ie mega/large popular stocks like food & beverage ie Kweichow Moutai and brokerage stocks. Mega and large caps saw outflows while small caps saw inflows. Northbound Connect volumes were light as sellers slightly outpaced buyers by a thin margin.

Gov’t revenue, ie taxes paid, declined 5.1% YoY as tax cuts kick in.

• CNY 6.95
• Curve shifted lower though long end really came down! I need to do more work on this. This was a BIG move!
• Yield on 1 Day Chinese Gov’t Bond 1.85%
• Yield on 10 Year Chinese Gov’t Bond 3.42%
• Yield on 10 Year China Development Bank Bond 4.04%
  

Commodities surprisingly firm as FAI and IP higher