Market News – 12 August 2019

There was a headline last week that adopted the ‘embarrass by exposure’ stance but in my opinion, it was something to be proud of.

The article was taking a shot at the Financial Markets Authority.

The FMA was forced under the Official Information Act to release costs of legal cases against the badly behaved.

Rob Everett, and the board of the FMA, should adopt a new stance and publish these cases and their costs every time. They should be proud of their work in pursuing the ‘bad’ (my term) and then enthusiastic about publishing the outcomes, including costs, so that industry and the public see them demanding good behaviour under legislation.

For too long regulators have hidden behind a fear of cost when being asked to do their jobs properly, enforce regulations and standards, and this simply provides more room for bad behaviour.

The ‘badly behaved’ will take advantage of any weakness seen from the regulators. All parents know this.

So, Rob, after the FMA successfully concludes any case against the ‘bad’ may I suggest that you publish a summary of the circumstances, including costs, and the benefits to the community (public and financial) and distribute the report to the media, your Minister and place it on your website.

It should be a badge of honour.

INVESTMENT OPINION

Interest Rates – I thought I was throwing cold water around last week on this subject, yet this week interest rates have taken an even more stark move lower.

The US Federal Reserve and the Reserve Bank of NZ have done what markets expected and cut their respective overnight interest rates. (see OCR comments below)

However, sentiment linked to the trade war between the US and China and plus the escalating political tensions in various locations, but most heated in Hong Kong, are progressively removing almost all confidence that remaining optimists hung on to.

On July 31 (two weeks ago) the 10-year US Treasury bond offered a market yield of 2.00%. At the time of writing that yield is 1.74%. Note that the overnight cash rate in the US is around 2.25% at present.

In NZ our 5-year benchmark rate (swap rate) was around 1.50% only a month ago, yet today it is threatening to fall below 1.00%.

These are very large moves for long term interest rates, but of more concern is how fast these moves are happening.

For the sake of reference, the yield on a 5-year NZ government bond (default risk free) is about 0.82% and the 10-year bond yields about 1.10%.

Remember that NZ’s inflation target is +2.00% and expectations are currently about +1.80% so investors are accepting ‘default risk free’ with negative real yield expectations over the 5-10 year period ahead of us.

When lending to companies, with additional risks of default, investors deserve higher returns (credit margins). Yields on bonds issued by companies do indeed offer higher yields than government bonds, but I suspect you will be uninspired to hear that yields on all of these bonds are now below 3.00% and for the most part are within 0.25% - 0.50% of falling below 2.00% yields.

You’ll recall me discussing the new 5-year bond from Westpac last week, issued with a yield of 2.22%. This bond is now trading at a market yield of 1.75% and as an old financial market colleague points out to me, people who purchased this bond have enjoyed a +2.28% value gain in two weeks (59% per annum! – Ed).

This return won't perpetuate, but it is true that good value is still found in long term fixed interest investing (it temporarily protects you against declining interest rates).

If you are planning to arrange some new term deposits in the banks, please act sooner rather than later.

I expect that none of this continuous chatter from us about falling interest rates will be a surprise to you now. We’ve spoken about this probable future for interest rates for some time now; it no longer feels like a time warp.

The warnings remain real, to keep fully invested, because the ‘positive’ yields that remain on offer in NZ differ from the negative interest rate returns on US$12.5 Trillion bonds around the global markets.

I don’t want to believe that negative interest rates (yields) are probable in NZ. I know they are possible, as are most outcomes in financial markets, but probable?

Am I beginning to look a little naïve in thinking negative interest rates in NZ are improbable?

This subject is becoming one of consequential opposites; the lower interest rates go and the more commentary it inspires, the lower an investor’s returns (and level of interest – pun) become and the less they are interested in reading about it.

It is what it is, and we cannot simply close our eyes.

OCR – My first reaction is that the Reserve Bank overplayed its hand last week by cutting our Official Cash Rate by 0.50% (OCR now at 1.00%).

They used two bullets to kill the rabbit, which lay dead after the first shot.

The governor then reinforced the energy in the change by warning that further interest rate cuts are likely and negative interest rates will be used if necessary.

Take that.

It was far more than the market had forecast.

During the past 20 years OCR changes had settled into 0.25% increments when changes were announced with only two periods of exception; 2001 when the Twin Towers in NY were attacked, and in 2008 for the Global Financial Crisis.

There is one other outlier in March 2011 where Dr Bollard cut 0.50% in response to a very strong NZ dollar and the US government was threatening to not approve increased use of debt (we know how that ended – Ed).

So, 0.50% movements in the OCR have been linked to disturbing economic events and I don’t see today’s conditions being as disturbing as the GFC.

Maybe the situation in Hong Kong and the escalating trade war are parallel to the political stability concerns of the September 2011 attacks. Clearly Adrian Orr and his committee believe so.

Let’s take note of their concerns. They allocate a lot of skilled time to the permutations.

Adrian Orr quite rightly said that investors will need to pursue a higher proportion of productive investment assets, reducing their fixed interest asset allocations as interest rates track into negative real yield territory. We wholeheartedly agree.

The other thing that Adrian Orr would like from you is to spend more money please. Keep the economic wheel turning.

I’d be grateful if you didn’t share this last point from the governor with my wife; she has enough shoes (can you ever have enough? – Mrs Ed.)

Demographics – I read an excellent article summarising global demographic data last week. It reminded me of another book I had read years ago on the same subject and the cornerstone importance of global populations in economic outcomes.

The article reminds us that globally, outside India and Africa, the world’s fertility rates forecast declining population for many nations and given the rate of change between about 1970 (5 children per mother) and now (2cpm) there is a significant change developing between the age quartiles.

Global fertility rates are struggling to hold at 2 children per mother as the declining trend continues.

The number of young productive people present to assist the elderly is falling fast as a ratio and thus delivering rather serious financial consequences, especially to those nations that have already overspent for lifestyles that were not affordable.

Globally we have just crossed over the point where people 65+ years of age exceed people under 5 years of age.

Japan and Europe saw this crossover happen in 1978 and 1965 respectively. China reached the crossover in 2002 and this demographic data is affecting economic performance for all of them.

Interestingly the demographics in the US are more balanced.

It has taken about 50 years for the world’s progressive change in the shape and scale of a family to put us in the position of demographic mismatch, and the disruptive forces that will result, so it’s entirely reasonable to believe that it will take another 50 years (two generations) for a more balanced position to be reached.

The irony is that many of the world’s older population view children as replacing them as producers and as supporters for them in old age yet from what I see it will be the retired who are supporting grandchildren financially over the next 25 years.

That financial support from grandparents will not come from the attractive returns on savings, which we all now know are shrinking fast, but from the passing of equity from one generation to another (possibly leap frogging one in the process).

Think of it as re-opening the pocket money routines for your grandchildren, but make sure they mow your lawns and help you with technology and the modern methods of interaction with the world.

Guardians of NZ Super is good for NZ and we should continue contributing to this fund. Kiwisaver is a good vehicle for NZ, and for teaching the young about the lost art of saving.

I happen to agree with those in politics who are calling for an increase to the age of entitlement for National Super. If enough lead time is given savings can be accumulated. Peter Dunne’s proposal for discounted early access made sense for those with compromised life expectancy.

Last week Mainfreight reminded us all that it tries to work to a 100-year strategy; retirement villages should be doing the same thing with their property portfolios because it is entirely possible that by the year 2070 the residents of my Dad’s retirement village will be 25-40 years of age.

The demographic trends are a clear contributor to today’s economic circumstances and because the demographics are not changing fast it seems very likely that the economic situation won’t either.

Japan has a head start on most of us. Maybe a research trip is required.

Fed Now – The US Federal Reserve reminded us that crypto currencies remain a curiosity for them and not an embedded feature of future payment systems.

The Fed has announced the development of a real time payment system (named FEDNOW), finished by 2024 and accessible by all 10,000 US banks (this number was hard to comprehend!).

Current real time payment ‘Apps’ are dependent on the payer and payee both being on the same application, which very often they are not. It’s likely that the majority of the retired generation don’t even use an App for payment.

The Fed is correct that for real economic benefits all members of the population and all businesses need to be able to participate in a real time payments system. The marketing line is ‘ubiquitous, safe, efficient’.

The plan is to provide live (real time) banking every day of the year.

The initial payment limit will be US$25,000 until systems are tested and proved but this clearly covers the majority of transactions within an economy.

The rising use of electronic accounting, and invoicing, should so easily link to a FEDNOW styled payment system and dramatically reduce waiting times for payment (unlike the behaviour of Fonterra and Fletchers in NZ who enforce delayed payments on small business – Ed).

Next, we need other central banks globally to follow up by establishing their own trusted live payment services, which could then allow far more efficient foreign exchange settlement services between countries.

If anything, it is a disappointment that our central banks have taken so long to deliver improved payment systems given the current age of technology development but if they want to describe crypto currencies as ‘investments not currencies’ they will need to improve payment systems for legal tender currencies.

Voting season – I have been invited to vote at annual meetings for a few of my investments.

Fortunately, I no longer need to take action as I have put in place a Standing Proxy (at both Computershare and Link Market Services) assigning my votes to the NZ Shareholders Association to act on my behalf.

I like that my vote is being applied, and applied well, increasing its leverage by consolidating it in the hands of the NZSA who by now surely are acting as proxy on millions of shares in various companies.

If you have applied your own Standing Proxy to the NZSA, well done.

If you have not, and would like to do so, let us know by email and we will email you the forms and a page describing the steps to take to put your Standing Proxy in place.

Vital Healthcare – The VHP managers have spent (wasted?) $4.3 million evaluating a deal that they did not do.

You don’t get many guesses as to who benefited from the spending.

To put this amount into perspective, VHP’s dividend could have been increased by 10% if they had not ‘wasted’ this money elsewhere.

EVER THE OPTIMIST

 

Unemployment falling to an 11-year low at 3.90% is surely good news, even if this is now old data.

However, someone cleverer than me will need to explain the simultaneous increase in benefit claims (11% year on year) whilst the economy says it is crying out for more employees?

ETO II – consistent with the above story on employment privately held company Datacom (partly owned by Guardians of NZ Super) added approximately 1,200 new employees in the year to March 2019!

INVESTMENT OPPORTUNITIES

Napier Port – Hawke’s Bay Regional Council must be very pleased with their recent share float.

Enormous demand led to a high share price of $2.60 presenting impressive funding to the Napier Port for its future development.

Investors outside the region, and the services of the lead managers, received few if any shares.

I hope the success of this Mixed Ownership Model share float is copied by other council’s around the country.

The NZX will welcome Napier Port to the market and invite other such businesses to follow.

New Bonds – we are told to expect some new bond offers in the weeks ahead.

Once details are known, you’ll read about them here. We will also broadcast them to those on our ‘all new issues’ list (which people are welcome to join).

TRAVEL

Kevin will be in Christchurch on 5 September.

Edward will be in Auckland on 4 September, in Wellington on 12 September, in Napier on 16 September.

 

 

Mike Warrington