Market News 17 September 2018

President Erdogan is at it again in, naming himself as the new Chairman of Turkey’s sovereign wealth fund.

That’d be like Winston Peters naming himself Prime Minister of New Zealand.

Wait…. has that happened already?

INVESTMENT OPINION

Unlearn – What do we need to unlearn as investors to be successful in future?

I have spent various moments over the past couple of weeks asking myself ‘what do I need to unlearn?’

‘Am I letting any old thought processes, or firmly held beliefs, distort the clarity of the current situation?’

It is too easy to become complacent about how the dominoes (measurable risks) are stacked (old developed thesis on likely outcomes) and thus how they will likely fall once we spot the instigating force (breached pressure point)?

Over 33 years of involvement forecasting outcomes has never been as simple as my metaphorical dominoes present so it won’t be easy next time we experience dramatic change either.

One may as well spread the dominoes in random places around the room and still carry the view that they are all likely to topple at some point for reasons that are as yet unknown.

I listened (online, as you do) to an interesting interview of Ben Bernanke (US Federal Reserve), Tim Geithner (Federal Reserve Bank of NY) and Hank Paulson (US Treasury) reflecting on how they tackled the Global Financial Crisis; how it felt at the time given their skills and beliefs at the time and what they might change based on 10 years retrospective knowledge.

They all conceded that whilst they thought they knew which dominoes to remove from the sequence (my words not theirs), and removed them (by injecting massive sums of money), the confidence they presented in public was many times greater than their unspoken fear about the frightening possible outcome(s).

This disconnect reconciles well for me, as it should for all investors.

Nigel Latta would describe it as a tussle between each human’s reptilian fear (survival instinct) and the wider brain’s ability to assess facts.

I haven’t defined any old investment rules that I’d like you to unlearn, but as I write I have been thinking of a few threads, so I’ll phrase them as questions, that perhaps require new learning:

If a period of uncomfortable inflation returns to our economy will the Official Cash Rate (OCR) simply be lifted high enough to create a negative yield curve (short term interest rates above long-term interest rates) to pressure debt repayment or will macro-prudential tools be used more forcefully to ensure price stability?

Conventional thinkers will invest in expectation of higher interest rates.

I suspect we may need to unlearn this one and focus more on the use and impact of other regulatory tools used to control financial behaviour.

Do ultra-low interest rates (negative real yields) always deliver inflation?

It’s reasonably clear that very low interest rates result in higher relative use of debt and higher relative valuation of assets, but I think it is beginning to look as if the link between cheap money and inflation is weakening.

High debt levels, no matter how cheap, may be suppressing the wider population’s confidence with discretionary spending capacity (as it should when you’ve run out of your own and other peoples money! – Ed).

It’s only discretionary spending that can choose to continuously pay higher prices (inflation).

Does relatively high unemployment mean that an economy has capacity to expand further, without being inflationary?

NZ has expanded well without inflation during one of our fastest declines in unemployment that coincided with one of our highest levels of immigration.

What if that NZ unemployment ratio of about 4.00%+ of the economy is the equivalent of full employment as a consequence of our generous social support settings?

US unemployment is continuing to fall below that of NZ without the same level of social support.  

Maybe the current situation provides good reasons for NZ to push minimum wages up well beyond the level of our social benefits to either encourage more attempts to gain employment.

Businesses would like you to believe that higher wages (widely shared) will be damaging to the wider economy, to their business and thus to your share price, but what if higher minimum wages resulted in higher productivity?

What if Donald Trump isn’t a Goose, what if he really is a US Eagle?

No, that one’s a bridge too far in my quest to unlearn.

Financial markets, across all assets, continue to price in a fear of rises, or sharp rises, to interest rates. Believe it or not it holds back some of the bullish fervour that would otherwise be displayed in higher share and property prices.

What if their underlying thesis about interest rate behaviours over the next 10 years is wrong?

Stay on your toes. Keep iterating the possible outcomes. Keep getting financial advice for a different perspective.

I am happy to debate other firmly held beliefs that you base your investment decisions on.

Demographics – A couple of weeks ago I read a headline that unintentionally drew a smile; ‘Too many of us are aging at the same time’.

Clearly, we all fit into that cohort!

The article went on to discuss the importance of demographics on wider economic performance and used Japan as the canary in the mine that all other nations are watching.

Rather than just a rising average age within a rising population base Japan has already arrived at the point of a declining population.

The fear is that the population decline will undermine Japan’s economic performance, but maybe this is another belief that we need to unlearn. Maybe Japan’s equity will be passed down to a more financially active younger generation and maybe the country’s excellent export focus will expand further to sell more products abroad that are not required locally?

David Colman, from our office, has visited Japan several times and he really likes the country. I sense a personal need for a research trip there some time soon.

Fortunately, for this item, we have a client in Japan (ex-pat Kiwi) so I was able to enquire of him:

Will Japan need to invite more foreigners to settle in Japan to offset their population decline?

What is happening on the ground with Japanese demographics?

The response was remarkable, to me at least.

The declining birth rates have two drivers, fertility (a problem felt widely outside Japan also) and a younger generation that is widely disinterested in marriage and having children.

Actually, he said surveys are reporting that many are disinterested in sexual relationships with remarkable proportions not entering such relationships by their mid 30’s.

‘Official Japanese government statistics show that 42 per cent of single men aged 18–34 have never had sex, and 44 per cent of women in the same age group haven’t either.’

‘National Institute of Population and Social Security Research said that people aren’t getting married, they’re not having sex, they’re not having babies.’

His work role saw him involved with large groups of tertiary aged students and he witnessed a rising tide of discontent with a society that rewarded people based on age and not skill.

‘Being told what to think constantly instils either obedience or rebellion and the youth are making their protests heard not by talking but by simply not getting married and women seeking men's jobs so this paradigm shift which was once a ripple is becoming a tidal wave.’

How might they encourage more foreigners to participate in their economy?

‘They are trying to attract more international students but the demographics of who can come, want to come and actually come is not always revealed. The Japanese government is now offering money for students to come and study. Ironically in 2017 it included 122,000 Chinese and 4,000 American so the programs are mostly attracting Asian countries.’

Getting work visas is difficult and time restrictions are common (3-6 years).

So, what are the visible impacts on investment?

‘25% of houses are empty’.

‘I only pay $300.00 US a month for my house (not in Tokyo) and this is far cheaper than owning a property’. (Especially if values continue to fall)

In New Zealand, maybe this means our smartest property supply strategy should be to invest in more retirement villages to free up suburban housing supply for younger people to use.

Many people raise an eyebrow at retirement villages either through displeasure at the high fees or the implication that it confirms one as being ‘over the hill’.

However, in my experience through one family member and your varied input it is clear to me that these villages provide a high level of service, opportunities for activity and access to plenty of community interaction for very healthy outcomes. This is good news for our wider communities.

So, property investors, when we notice that not even Ryman Healthcare, and its peers, wants to build more accommodation it may well be too late to trim your overweight property portfolio!

I like that the Japanese young are expressing themselves strongly, disrupting what sounds like generations of obedience that became too extreme. I suspect that this greater freedom of expression will be quite vibrant for Japan’s economy, even if they must sell more of what they produce internationally.

In fact this vibrancy may already be well under way.

The Nikkei 225 (Japanese share market index) has enjoyed a robust 10-year period of rising prices (from 8,000 to 22,000), like the rest of us, but this followed 20 years of a declining trend from 25,000 to 8,000.

Demographers would declare Japan a basket case, but it would appear that their young disagree.

Insider Trading – confidence in the operation of financial markets will take a knock if the Financial Markets Authority is unable to secure a conviction for insider trading in its current case against Mr Sansom.

In simplified terms, the case is about a person inside a business passing non-public information to a person outside the business who then arranged a transaction in the shares of that NZX listed company.

The first case ended with a hung jury, surprisingly. This may disclose a lack of depth in the public knowledge of financial markets and abuse of non-public information, or it may disclose a weakness in the FMA’s approach to the case.

Maybe in cases such as this one the regulator should be able to insist on a judge alone hearing, or be able to do so if it is a follow up to a hung jury?

A not guilty result from this case would make no sense to anyone other than a clever legal defence team, who would also be the only financial winners from the situation, being paid far more in fees than Mr Sansom ever stood to make from his share trading.

INVESTMENT NEWS

Reading – For those of you who are enthusiastic readers of useful material with an investment perspective, I’d encourage you to read the recent speech from the governor of the Reserve Bank.

It’s greatest take away point for me was a reminder to lift one’s horizon to longer term thinking when investing and avoid a disruptive short-term focus.

Follow this link if curious: https://www.rbnz.govt.nz/research-and-publications/speeches/2018/speech2018-09-07

Crypto Currency– Have you noticed how quiet the subject of crypto-currency has become?

The business media do not like reporting how ‘bad’ something is becoming. (unless it’s an opposing public policy view – Ed)

The ‘get excited’ headlines around Bitcoin and its peers crowded out many stories during 2016 and 2017 as their market price soared, whilst intrinsic value sat unchanged.

In 2018 though the market price has been falling, and graphically speaking looks rather unimpressive.

Electricity Review – The initial review is out from the Electricity Advisory Panel (EAP) and it has provided reminders to the government about the various stress points or inequities within the electricity market, but it has not presented a ‘bad guy’ if the government wanted to place one in the stockades and punish them for over-charging retail consumers.

In fact, the government might find themselves in the stockade because GST and Transpower were the clearest drivers of price increases that I spotted, but GST won’t go away (neither should it) and we learnt a lot about poorly maintained transmission during the Auckland failure.

Price competition is available, and the retail consumer must accept a large portion of the remaining responsibility for not making sufficient effort to ensure their household is receiving the most competitive price on offer.

The EAP estimated that ‘on average’ NZ households could save $200 per annum via switches to the cheapest provider, and whilst none of us are ‘the average’ the point was that consumers are leaving a lot of value on the table for the generators.

The big five generators/retailers still control 90% of the consumer accounts.

It was remarkable to learn that something between 30-40% of consumers have never addressed the potential to change their electricity supplier; this lethargy plays in to the hands of the generator/retailer businesses.

The annual rate of change is reported as being about 20% of the industry, meaning that 80% are not actively watching their pricing options. This is a disappointing result given the ease with which one can change suppliers.

By reference, the EAP reports that Australian consumer behaviour (lethargy) is very similar to that of New Zealanders.

The higher profit margins gained by generators from the inactive are used to present competitive prices and free televisions to those who actively seek better service and pricing.

And, herein lies the investment point from this ramble; consumer lethargy leaves comfortable profits on the table for energy companies – Genesis, Mercury, Meridian, Contact and Trustpower. Investors know this, and their share prices lifted following the initial report when it didn’t deliver any apparent new regulatory threats.

To some extent these companies will be pleased with the government’s wider energy programme because of their increasing focus on use of renewable energy, which will require them to increase their generation capacity to sell more electricity (think electric vehicles, bans on mining, rejection of coal etc).

With more than a little bias, Z Energy should be pleased about the reminders in this EAP report for consumers to seek competitive electricity pricing, something their new subsidiary Flick Electric does very well.

Nasdaq – It was nice to read about the NZX forming a stronger relationship with the Nasdaq exchange in the US (signed a memorandum of understanding with US tech-heavy bourse, which will let top-tier American companies apply for a secondary listing locally).

In the immediate future I hope this enables the NZX to quickly add a ‘Nasdaq’ fund to its Smart Shares suite of Exchange Traded Funds, because technology focus is one obvious risk that is absent from the offering, yet this sector has been the fastest growing in the past 15 years.

Growth in the use of Smart Shares (+32% over the past 12 months) has quietly been one of the NZX’s success stories while headlines focused on the lack of new listings.

Opening new doorways to international investment risk at lower price margins will be good for NZ capital markets (and its retail investors).

EVER THE OPTIMIST– NZ’s June quarter GDP growth was at the better end of the expected range (+0.80%, bring the past year to +2.50%).

This was well above the central bank’s forecast of +0.50% so may remove some of the fear of an interest rate cut ahead of us.

INVESTMENT OPPORTUNITIES

Turners Auctions – has announced its offer of a small subordinated bond with a three-year term and a 5.50% interest rate.

This offer closes at midday on Monday 24 September, so if you are planning to invest, now is the time to act (by delivering an application form to us).

The Public Disclose Statement with its application form is available on the Current Investments page of our website.

Summerset Group – new 7-year senior bond was issued last Friday, and the interest rate was set at 4.20% per annum, which is a good result for investors.

Thank you to all who participated in this bond offer through Chris Lee & Partners.

If any investors missed this issue and would like to purchase these bonds they should contact us urgently.

Property For Industry – is the next senior bond of the rank with its 7 year bond and a 4.15% minimum interest rate set.

We have a list for all investors wishing to participate in this bond offer.

If you wish to participate in this bond offer, please advise us of your firm request by 5pm this Thursday (20 September). Allocations will occur on Friday with payment due later next week.

PFI is meeting the brokerage costs of the issue, clients do not pay brokerage.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (New Issues) email group, which can be done via our website or by emailing a request to us to be added to this list.

TRAVEL

Chris will be in Christchurch on 18 and 19 September.

Mike will be in Tauranga on 5 October.

Kevin will be in Christchurch on 27 September and Ashburton on 31 October.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

 

Any person is welcome to contact our office to arrange a free meeting.

Michael Warrington