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Market News 1 March 2021

From a distance one gains more perspective.

Through the lens of the new, awesome, Mars rover (Perseverance) I wonder what scientists (or Martians) think of what is happening back on earth.

After recently listening to one of the greatest guitar solos of all time (Comfortably Numb - Pink Floyd) I read a funny line ''that the repeated playing of this track was the sole reason that aliens had not invaded Earth''.

Now, those aliens probably view us as a great comedy show.

For a while they had the Trump show. Now they can ponder Bitcoin passing the $1 trillion market value level, making it the fifth most ''valuable'' entity (publicly traded) on the planet.

The aliens are surely amused at the collective price paid for shelter here on earth too.

They'll not be surprised by our Covid19 situation given how lowly we value health and food producing entities with none in the top 10 for listed businesses globally.

Funny old place, Earth.

INVESTMENT OPINION

SPAC's– Here's another anecdote for how people are playing fast and loose with their savings, or worse, with other people's money; they are paying $58 to buy shares in businesses where the only asset is $10 cash (per share).

SPAC – Special Purpose Acquisition Company

Market participants are setting up these shell companies, selling them at $10 per share and listing them on the stock exchange, before setting out to try and buy a target company.

What is the mental block to logical conclusions that sees investors willing to pay $58 to buy $10?

I doubt any New Zealanders are this foolish, but I'm willing to sell $10 notes every day at $58 if anybody feels the need to access such a service.

As a listed company a SPAC doesn't have some, as yet undisclosed pot of gold valued at $48 per share; material announcements must be made to the market.

Buyers of $10 shares at $58 must somehow believe that the management of the SPAC will easily find a discounted gem in the rough, that nobody else has seen.

That is an unrealistic long-shot, not a 5.8:1 odds on bet.

I am pleased we don't have this phenomenon here on the NZX because it would be tiring explaining the illogical to the parishioners of the churches of Tesla and Bitcoin, pondering if there was a new brighter religion in town.

It is doubly interesting that people are still willing to use money to chase such ideas when a simple increase to long term interest rates over the past fortnight has put the frighteners up investor opinions for businesses that actually make profits.

Funny old place, financial markets.

MPS – The enthusiastic among you will have now read the Monetary Policy Statement released by the central bank last week (you too need perspective – Ed).

In it the governor explained that he was not increasing the Official Cash Rate above its 0.25% level and their commentary, plus financial market analysis implies an expectation of little change prior to 2023.

Financial markets efforts to be concerned about inflation are trying to imply a very modest increase in the OCR during 2022, but not even as far as 0.50%.

Investors should not be expecting large increases to short term interest rates for years in my view.

For a little fun, and definitely for investor benefit, long term interest rates are rising at present. Not far, from your perspective, but it is a meaningful rise for those with their noses pressed against the financial markets windscreen (+1.00% during the past month).

Investor benefit refers to bond returns beginning to rise above inflation targets and thus a chance to again deliver positive real returns.

I do expect this change in market conditions to steepen the yield curve (higher longer term interest rates) so investors working to a good strategy, enabling longer term investment choices, will earn more than those holding excessive sums in short term deposits.

I remain convinced that short term deposit rates will be the poorest returns (reward for risk over time) for the balance of my career.

Most of you have noticed that returns on all bank deposits are very low now, essentially all below 1.00% regardless of term.

Some of this relates to the decline in nominal interest rates, part of which relates to the change in central bank strategy (1) and part to the current emergency funding settings (2) and I don’t think items 1 or 2 will be unwound for years, hence my view about returns on short term deposits.

(1) Central banks spent the past three decades trying to pre-empt inflation with sharp increases to short term interest rates whenever inflation signals appeared, no matter how small.   There has been a substantial change in this philosophy, especially in the US, which is the most influential central bank; they are all now conceding that full employment is a more important objective and monetary policy will tolerate inflation that ''averages'' the central target. Central banks will now set Official Cash Rates looking back in time, after they have evidence of inflation outcomes, monitoring the average relative to employment data. This is the biggest change in such a strategy since the very start of my career in the mid 1980's (when the fight against inflation was the be all and end all). As I see it, not only will short term fixed interest investments (deposits and bonds) be the least rewarding for risk now, but you'll be the last to receive additional reward even if all the markets signals are indicating that you should be paid more. Should you avoid short term fixed interest investment? No, it remains the least volatile asset type and is an important part of your personal strategy for financing your lifestyle, but don't overweight the sector.

(2) The emergency funding settings are the other reason that banks will offer you lower interest rates on deposits now. Evidence explained last week – A 5-year bank deposit offers about 0.90% p.a. but a bank issued 5-year bond (same default risk) offered 1.43% (this would be 1.50% today). Under the new emergency funding settings offered by our own central bank, banks' were offered another source of funding (Funding for Lending Programme - FLP), which means less funding required from depositors; and The Core Funding Ratio (CFR) was dropped from 75% to 50% of a bank's funding. The higher CFR meant the banks had to fight a little harder to convince you to place deposits to help fund the bank. This resulted in higher relative interest rates on deposits. Cutting the CFR target to 50% of their funding was a dramatic change to the obligation and investors felt it immediately in the interest rates offered on term deposits. Banks have far less incentive to 'pay up' on term deposits, and no incentive to do so on funds that can be withdrawn with less than 32 days notice from the depositor. I don't see these conditions changing for a long time; hence my view that returns on term deposits (especially short terms) will be low relative to most alternatives for a long time. Even if economic and employment conditions improve, think about the new funding mix; the RBNZ has more control over how banks can use the FLP by adjusting conditions of its use but changing the OCR is blunt and impacts even those borrowers who don't deserve to be penalised. You'll have observed that the government is trying to add 'monitoring house prices' to the central bank obligations. OCR changes will have less impact than conditions on FLP use by the banks.

Might the RBNZ increase the CFR target again?

Maybe, but the CFR setting was brought in out of concern for access to liquidity by the banks after the tension experienced during the Global Financial Crisis (GFC) and the new FLP (above) and the Large Scale Asset Purchase (LSAP) programme (central bank buying bonds from the market) solves this liquidity risk.

I don't yet foresee an increase to the CFR off the new 50% level.

I hope those explanatory dominoes fell in a helpful sequence for you, albeit leading you to the deflating conclusion that bank deposits will be unappealing (relative reward for risk) for many years ahead.

This does, however, unintentionally (?) steer you closer to our lair (office? – Ed) to receive financial advice on how to manage your investment portfolio on this evolving playing field.

It is hard to say without bias, but I quite like this outcome. Said, of course, with the best possible of intentions because we are continuously concerned about assisting you to position your investment portfolios well.

BOE Youngster – The statement that most caught my attention last week was one made by the youngest member of the Bank of England's monetary policy committee, Gertjan Vlieghe.

Vlieghe said in response to a question about interest rate settings that ''he did not expect British interest rates to return to levels common before the 2008 financial crisis during his lifetime''.

I am constantly challenging myself, and others, not to only rely on our training, or recent understanding, as we look forward and try to estimate what will happen next in financial markets.

It was nice to hear the perspective of a younger member of an important policy setting group.

US GDP - Whilst in NZ we seem to be experiencing the likelihood of negative GDP data (recessionary forces) the US Federal Reserve is conservatively forecasting a growth rate of +5.00% for their year and a variety of analysts are forecasting numbers more like +7.00%.

The BNZ kindly invited me to a presentation by the bank's head of Markets in the US. He is 'very, very' positive about the US prospects in the year ahead based on the combination of Covid19 bounce-back and the enormous sums of money being pushed into the economy by the federal government.

I described above the reasons that I don't expect NZ short term interest rates to rise, well the US Federal Reserve Chair (Jerome Powell) is even more adamant that they will not be increasing these interest rates, or applying more financial pressure, for years to come.

Powell wants full employment.

Back in the era of President Clinton a catch cry of ''It's the economy stupid'' was launched to confront political acceptance of recessions. Today the central bank no longer wants you to focus on inflation ''it's about full employment stupid''.

EVER THE OPTIMIST

S&P Global Ratings lifted New Zealand's credit ratings, back to AA+ for international (foreign currency) obligations and AAA for domestic NZD obligations.

It is interesting for this upgrade to happen now, when our financial capacity is clearly weaker (more debt, less sovereign income) than it was 1-2 years ago.

Nonetheless, we shall accept the applause.

ETO II – Vaccinations

More people have been touched by the needle than the virus.

Vaccinations delivered – 225 million

Total (recorded) Corona Virus cases – 113.5 million

Active Cases – 21.8 million

Daily rate of new cases – holding around 300,000

People in serious condition – 91,000

The BNZ presenter agrees that the Covid risk is declining fast; vaccine quality and rollout is putting 'us' back in control and that the US is likely to re-open for widespread business in offices from 1 September 2021 (allowing the population to enjoy summer from remote locations, holiday season etc).

Israel appears to now be providing evidence about when it gets hard to convince the population to accept the vaccination, being somewhere near 50% of the population. They have delivered the first dose to 51% and the second dose to 36%.

Second dose numbers are rising quickly, but first dose numbers have begun to slow down. The daily rate of 'jabs' is now falling behind that of many other nations of similar size.

I suspect the world will need some relatively strong incentives to increase the ''jab ratio'' beyond 50% of the population, incentives such as no border crossing without evidence of vaccination or high antibody levels.

Given the pressure placed on the health system (read cost) maybe governments should link good health behaviour to the pricing of all prescriptions?

Investment Opportunities

Infratil Bond – The 5-year bond (maturing 15 March 2026) offer yielding 3.00% remains open to investors.

This bond offer will be closing soon (10 March).

TRAVEL

Edward Lee will be in Auckland (Remuera) 11 March and Auckland (CBD) 12. March. Nelson (PM only) 14 April and Blenheim 15 April

Johnny will be in Christchurch 11 March

Please contact our office for an appointment or if you would like us to visit your area please let us know.

Thank you

Mike Warrington 

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