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Market News – 18 November 2019

Sometimes I think people are just so keen to be heard they run the biggest flag they can find up the pole.

Last week I couldn’t understand why the television interviewer didn’t challenge the person asserting that a problem exists with people in the 55-90 years age group having more wealth than those in the 25-40 years age group.

No kidding.

Older generation citizens have been good savers, for longer periods of time and understand compounded returns.

They have also benefited financially from the sharp increases in the value of their properties, which I think was the focus of the gripe, but to the property owners this is just a roof that they still require whether it is valued at $100,000 or $1 million.

I don’t think my 25 year old was in the room to support the critic but I wish he had been so I could have started a lecture on simple things like second jobs, saving money, spending less, time value of money, compounding, cutting one’s cloth to suit etc.

Within our house the difference between the generations is seen based on which side of the bar they stood/stand at a young age.

The silly use of the phrase ‘OK Boomer’ to reject the older generation’s views is disrespectful of the effort the latter has made.

The silent, knowing, smile in response isn’t lacking thought.

The older generation are respectful enough to know ‘if you don’t have anything nice to say, don’t say anything at all’. They also know that they already have the resources to make decisions that suit their circumstances and that they represent the largest group of voters in the country.

Yelling at parliamentarians and television interviewers on this subject won’t gain traction.

INVESTMENT OPINION

Peak leverage? – Will we ever look back and be able to identify the period of time when the world reached peak leverage?

The point when the combined productivity of the world was insufficient to stand any show of repaying outstanding debts and was struggling to even service those debts on an annual basis.

I don’t know the answer to this question, but it is linked to a story I read during the week, which compared the previous biggest leveraged company takeover from 2007 to another new record being worked on today.

In 2007, one or two months prior to the disclosure of the US housing loan crisis and 12 months prior to the Global Financial Crisis that followed, private equity firms KKR (Kohlberg Kravis Roberts of Barbarians at the Gate fame - 1989) and TPG borrowed US$45 billion to buy Texas energy group TXU.

TXU eventually filed for bankruptcy.

In KKR’s defence they continue to be one of the most successful leveraged investors in the US over the past 30 years.

Today, the attempt at a new record for a leveraged takeover is a US$70 billion offer to buy drugstore company Walgreens.

The truth of the cliché is that records are made to be broken, but as TXU showed, so are foolish decisions.

Apparently, the gross volume of leveraged loans (odd use of the terms – meaning loans for corporate takeover activity) is now US$3.4 trillion, or twice the value of the ‘biggest share IPO ever’ market listing of Saudi Aramco’s oil business.

The UK central bank reports that the proportion of leveraged loans with no ‘maintenance covenants’ (rules and limits that must be achieved) has tripled since the time of the TXU deal (2007).

I know we’re not all that keen on oil anymore but I’d rather own Aramco than half the now riskier bonds issued to finance corporate takeovers around the world.

I wouldn’t expect to find such bonds in your Kiwisaver fund, but there’s no harm in checking.

Will the proposed leveraged takeover of Walgreens for US$70 billion look like peak leverage in the rear vision mirror?

The assumptions about gas sales for TXU were profoundly inaccurate. Will the assumptions about future drug sales in the US misunderstand the US government determination to reduce drug use in America?

Peak oil? – As many say they would like oil consumption reduced, and some would like the wells capped, Iran announces the potential for an additional 53 billion barrels from a new discovery in the south-west of its country.

This increases Iran’s reserves by 25% to 210 billion barrels.

Given the pressure being applied over Iran by the US, it’s not hard to imagine Iran using this oil resource to establish new global relationships elsewhere, without serious thoughts for the wider environment.

Shortly after reading this item I read another which was trying to debate when the point of peak demand for oil might be.

Many of you will be deflated to read that the current focus is 10-20 years from now and none of the content was willing to predict a rate of decline or whether there was a stopping point for oil use in the transport fleet thereafter.

Accelerating the decline will need governments of the world to regulate for greater electrical energy supply at pricing that comes in under the equivalent energy content supplied by oil.

I prefer not to enter the battery debate in this paragraph!

RBNZ OCR – The central bank surprised a few by not cutting the Official Cash Rate (OCR) last Wednesday, leaving it at 1.00%.

The market had factored in a 60% chance of a cut to 0.75%, so the majority were disappointed by the outcome.

The market was correct to hold its debate between 1.00% and 0.75% outcomes because this was exactly the debate held within the central bank’s committee. Increases were not on the agenda.

A variety of shares fell in price shortly after the announcement, which is surprising to me given the one-day term for the OCR relative to the multi-year time horizon when investing in company shares.

Further, it isn’t credible to think of 1.00% as a cost of funds and be disappointed if you are a borrower and contemplating the costs of being in business, or the opportunity costs of an investor in shares (or getting out of shares).

Some may view it as the equivalent of counting sheep, but I think the statements are useful reading for investors; they can be found on the central bank website here:

https://www.rbnz.govt.nz/news/2019/11/official-cash-rate-unchanged-at-1-percent

 

Quick Attitude Change – The US Federal Reserve cut interest rates by 0.25% at their recent meeting but they then tried to make it very clear to the market this was the last cut based on the foreseeable data.

The Fed will have been feeling railroaded by both President Trump’s rhetoric and the weight of financial markets where vast sums had been invested promoting the expectation of recessions and the need for interest rates to be cut further.

The Fed has effectively stopped the bus.

Trump’s reaction was to yell even more loudly.

The market’s reaction was more realistic; it has backed off and now prices in the probability of the economy being OK, inflation existing and thus allowed longer term interest rates to rise again above the level of short-term interest rates.

Maybe the Fed governor recognised that he was being led around by the nose when it’s he who is expected to be the leader, so he changed the tune.

Good on him.

 

Infratil – Announced its half year results last Wednesday.

Given the volume of you with investments in their bonds and shares I thought I’d draw your attention to the good result (albeit well forecast) and to encourage you to visit the online presentation to stay informed about the new collection of risks within the portfolio.

https://infratil.com/assets/imported/nzx/Infratil-Interim-Results-Presentation-to-30-September-2019-311735.pdf

I happen to think the result is a little understated, given the way things are accounted for, but that’s better than the opposite.

I look forward to their new investment thesis playing out over the coming five years, especially for the shareholders.

UOC010 – 10 years ago when the University of Canterbury (UOC) issued its first bond to the market, with NZX code UOC010, we hoped it would deliver many more bonds from all of the universities, but this didn’t happen.

Only one year after the depths of the financial crisis, led by a Vice-Chancellor (Dr Rod Carr) with financial market experience (BNZ and RBNZ), UOC asked investors to lend them money so they could accelerate the improvements being pursued by the university.

Using the university’s very strong cash flows to bring forward its capital spending programme made a lot of sense to us then and we were pleased that our clients energetically supported the new concept and invested in the bond offer.

The ten years bonds had two different interest rates (7.25% then 5.77%) over periods of five years (2009 – 2014 – 2019).

Today’s lower interest rates should be making it even easier for universities to bring forward such programmes but it’s just not happening via bond offers, sadly.

UOC010 bonds reach their maturity next month (15 December) and we’ll be sad to see this risk type depart our client portfolios.

The UOC010 bond offer had another novelty; it offered investors the opportunity for philanthropy toward the university. The choices were to reduce the interest cost to 0.00% or to gift the principle sum to the university at maturity, or both.

Around the world many of the world’s wealthiest citizens donate huge sums to the tertiary education institutions that helped them on their way, with competitive egos often defining the scale of donations, but it has not been common in NZ.

UOC was clearly keen to make public its willingness to promote the concept of philanthropy toward universities. The options were spelt out well in the prospectus of the day. Good on them.

However, I think the final letter issued in the lead up to maturity reads more like the messages on torn off pieces of card held by the frustrating beggars lining some of our city streets.

At launch the label used was ‘Fixed Rate Bond with Philanthropic Options’ yet the maturity letter now describes it as the ‘Philanthropic Bond Scheme’. It now encourages bond holders to ‘consider making a philanthropic donation’ just in case they forgot this option from the outset.

It applies more pressure by thanking ‘all who have elected to donate interest or capital’ thus far. The register will know this specific list, so they could have received differently worded letters of thanks without trying to guide the heat of an incandescent spotlight on the other bondholders.

They don’t stop there.

They offer websites, names, phone numbers and email addresses for those wishing to make contact to make their belated donation. The only thing not included is their ApplePay, Splitwise, PayPal or Bitcoin account details.

It would have been appropriate in the letter of thanks to have a single paragraph about the final opportunity for exercising the Philanthropic Option, but not to make the entire letter a plea for donations.

The latest letter was written by the new Vice-Chancellor and she may not have realised the subtlety of the Philanthropic Option in the original offer document.

Dr Carr has been ‘moved’ on by his children to accept the role as the first Chairman to the Climate Change Commission (think Zero Carbon Act), where they want him to deliver his next meaningful impact on society. He has quite the CV now.

If you hold UOC010 bonds there is no action you need to take. The bonds will be repaid on 15 December. There will be no reinvestment offer.

NZ Post Bond – Recent increases to longer term interest rates have been very helpful to holders of NZ Post bonds (NZP010).

The interest rate reset on these bonds (last Friday) was 4.23%, something to be pleased about in the current market conditions.

Less happily, Infratil’s perpetual bond was reset to 2.67% for the year ahead.

EVER THE OPTIMIST

Continuous small gains can add up to a large snowball.

Improved trade agreements with China and a newly developed agreement between 15 nations in the Asia Pacific region (excluding India at this point, sadly).

I have been pleased to see our government continue negotiations with all possible trading partners because we will need this diversity to help insulate ourselves from the worst behaviour of the most powerful political forces around the world.

Politicians and negotiators seem excited about gimmicky names for these trade agreements, but I have intentionally avoided using them.

INVESTMENT OPPORTUNITIES

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL

Edward will be in Auckland City this Thursday 21 November, then in Napier on 2 December and Blenheim 4 December.

Mike Warrington

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