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Market News 11 December 2017

This is my last Market News for 2017, save for next week’s 2017 review and 2018 ‘predictions’.

Thank you for ‘listening’.

I’ll be back in January, later over sooner.

Our offices close at 5pm on Wednesday 20 December after a brief chance to chat about Credit Agricole with those wishing to do so.

All else can wait until the New Year after you have enjoyed summer together.

Investment Opinion

Out of Jurisdiction? - An open question to the Treasury:

Has the election of the new Labour led government emboldened you to the extent that you feel it is appropriate to offer contributions on matters outside your brief?

According to the speech today, hosted by Treasury (delivered by a Professor from Auckland University) you seem to want the jobs of both the Minister of Finance and the Governor of the Reserve Bank.

Resilience and Reform – Towards a Financial Stability Framework for New Zealand

The promotional abstract:

The Memorandum of Understanding on Macro-Prudential Policy between the Governor of the Reserve Bank and the Minister of Finance is due to be reviewed in 2018.  But what should a decent institutional architecture for financial stability policy look like?  In this lecture, I consider the political economy of financial stability and examine some issues confronting the design and governance of “macro-prudential” policy.  I argue that the MOU review is an opportunity for a fundamental reappraisal of the financial stability framework in the light of developments in academic thinking, policy debates, and experience

Let’s leave the role of financial stability to the RBNZ and its experienced folk and keep bureaucrats’ academic thinking and policy debate teams out of it.

It’s true that we express plenty of opinions about the banks, and the central bank, from a perspective of how they may impact our clients, but we do not tell the public how to pursue insurance (outside our brief) even though we have an opinion on the subject (several actually, including one that has reached the District Court).

Subordinated Bonds – last week I spied a subordinated bond with an appropriate reward for a subordinated bond risk, unlike a few others on issue;

Accident Compensation Corporation has made shareholder loans to its partnership investment in Wiri Prison for 25 years at a return of 10.50% per annum (alongside its equity investment).

I’ll guess in the terms of agreement that there are repayment risks on these shareholder loans, but with the government as the client and a 25 year agreed term it seems unlikely that the loans will be defaulted on by the prison entity.

All it takes to ensure payment of the interest, plus a probable dividend, is to manage the clients of the business well, because as a country we clearly have plenty of clients.

Crypto Gold – Regardless of your opinion about crypto, digital, or alternative currencies in our financial future you really must take heed of the US Federal Reserve’s current opinion, which concluded by issuing a warning:

‘More serious financial stability issues may result if they achieve wide-scale usage. (Digital currencies are a) niche product that sometimes garners large headlines. (It) has no intrinsic value, is not the liability of a regulated banking institution, and in leading cases, is not the liability of any institution. Indeed, how to treat and define this new asset is complicated.’

The journalist, who is a believer and presumably owns a few Bitcoin, accused the central bank of arrogance and ignorance. He clearly believes in the world domination theory.

He seems to have forgotten that the excitement he proportionately aligns with his profit is measured in US dollars, not in consumer products that he has access to. Further, the financial markets that are embracing trading in Bitcoin are doing so to earn commission and the new Bitcoin derivatives (futures contracts) settle in US dollars (real money).

The value attraction for Bitcoin, that I see, is limited supply and decentralisation, plus a dose of anonymity.

Regular readers won’t be surprised to hear that I have the solution for central bankers to compete;

Central banks of the world should issue their own digital currencies, built on BlockChain technology and linked to gold as its limited supply tangible asset.

Gold will help arbitrage out global disagreement about the value of government guarantees that might otherwise have been offered, which have proven unreliable (Greece, Argentina, Zimbabwe, etc).

If the world is indeed seeking a more efficient (online, low cost), borderless, reliable, live payment method then armed with the confidence of good regulation (and crime monitoring) ‘my’ new digital currencies should more confidently find its place alongside FIAT currencies.

A crypto currency called Tether offers a similar theory by linking their currency unit to US Dollars held as real collateral, but this item isn’t as truly borderless and apolitical as gold would be.

Because central banks find it hard to agree internally, let alone with each other, I’ll leave the Bank of International Settlements to knock some heads and coordinate the finer details of my proposal.

Post Script: I already have two supporters for my proposal, ECB director Yves Mersch and Jens Wiedmann of Germany’s Bundesbank, who urge banks to move quickly toward live payment systems (Real Time Gross Settlement for everyone) if they wish to compete with current crypto currencies.

Yves and Jens haven’t yet solved the next step, which will happen when they read Market News tonight in France and Germany.

Irrigation - The past four months of weather should be a sharp jab in the ribs for the likes of Hawke’s Bay Regional Council and their failure with the proposed Ruataniwha dam and irrigation scheme.

In the Wellington region, at least, between May and September we received an unusually high rainfall.

I remember thinking, ‘a few days break would be nice, but this rain is a natural competitive advantage for NZ’.

One month later (now) and the Wellington City Council has started water use bans (as has Napier ironically for this opinion).

I do like the forward planning aspect but if the Wellington Regional Council did not fill the reservoirs to the brim for summer’s known usage patterns I would question the competence of that forward planning.

If the likes of Hawke’s Bay primary industries now struggle for good ‘production’ rates, or worse they suffer a retreat in the value of their ‘stock’ I’d share the intensity of their disappointment.

We have it easily within our control to avoid this problem of water shortage in New Zealand.

I’ve been thinking – Kevin Gloag writes:

As the year draws to a close financial market participants who made predictions for the year will be readying themselves to be scored.

Our own Michael Warrington steps up next week.

The results of a survey published earlier this year, scanning a period of 10 years, highlighted for me just how difficult financial forecasting really is with investment analysts and other market experts achieving a success rate of only 50% on issues where they were certain of the outcome.

Needless to say on issues where they were less certain they fared much worse.

The two burning questions for most investors is when will the share market take a correction and what’s going to happen with interest rates.

During 2017 interest rates have remained very low as most expected but share markets have risen well above most people’s expectations.

In fact throughout the year most investment bankers, analysts and stock market gurus have been screaming correction, many still are, the question is when. No-one knows.

There is a mountain of daily information available on financial markets and everyone has an opinion and a theory and there are hundreds of different authors.

After years of reading there are some we have learned to pay attention to and I often jot down snippets of information that I think might be important in terms of trying to unravel the future.

We try and stay abreast of US market developments knowing that what happens in their equity and interest rate markets will also reach our shores.

You might ask how US equity markets have reached new highs this year when so many of the largest investors have been predicting a correction and betting against the market.

I read recently that high frequency traders, with their computer based trading systems, drive around 73% of daily volumes on US equity markets.

Their trading algorithms, known as “algos”, know what you are buying and selling and automatically execute trades based on pre-programmed criteria. They can process millions of trades in seconds and can predict market movements and speculate on trends.

In 2017 the trend and momentum has been up.

Momentum trading can go both ways.

Where New Zealander investors tend to be diversified across different asset classes Americans seem to invest primarily in stocks (shares) and more of this investing is now being done through index tracking exchange traded and mutual funds, which have experienced phenomenal growth in recent years.

When money is pouring into index funds the managers simply spread the money across all of the stocks in the index, usually weighted by market cap.

There has not been a significant market correction since the big flow of money into index funds began a few years ago.

As we have mentioned before it’s surprising just how few stocks have actually done the lifting as share markets have soared to new highs.

The S&P 500 index for example is up 15% year to date although one third of its stocks are down for the year.

Are share prices in the US out of whack with the US economy? The following two stats would suggest yes.

 Since 2009 the S&P 500 index has tripled while GDP growth has averaged only 2% per year.

In 2011 S&P 500 companies sold US$1.05 trillion worth of stuff, last year they sold US$1.16 trillion worth of stuff.

Since 2009 10 million people have dropped out of the workforce and the job market in the US is the same size today as it was 20 years ago.

The inputs to higher production are more available workers and productivity gains, neither of which is evident in the US economy today.

An article this week by Patrick Watson, one of John Mauldin’s team, outlined the current weak economic expansion in the US and what he sees happening next. I think it is well worth a read.

For those interested the article can be found here:

Looking elsewhere for guides to the future China’s huge debt expansion has seen its debt to GDP ratio blow out to an eye-watering 277 per cent.

 By comparison Greece’s debt looks quite modest at just 179%.

I’ve always believed that European banks would be at the epicentre of the next financial crisis and even though they talk up economic recovery in the region I think it is a bit like the recovery in the US – weak and running out of puff.

The biggest problem is debt.

The world now has twice as much debt as it did before the GFC and even at today’s historically low interest rates much of it still can’t be serviced.

I wasn’t surprised to read recently that total non-performing loans in EU banks are now greater than 1 trillion Euros or 5.4% of total loans, a ratio 3 times higher than any other region in the world.

10 out of 28 EU countries now have non-performing loan ratios above 10% with the highest being:

Cyprus       49%

Greece       46.6%

Slovenia     19.7%

Portugal     19.2%

Italy             16.6%

Ireland        15.8%

The Italian banks now house one third of all non-performing loans in the EU.

New ECB rules will soon require Banks to bring to account all non-performing loans where no security is held.

These write-offs will destroy capital – who is going to recapitalise the banks and at what cost?

All at a time when, because things are going so good, the ECB is about to halve its bond buying programme as it begins to wean the Eurozone economy off years of stimulus.

In fact the ECB and the Fed will be tightening at the same time by way of less bond buying with a combined $1 trillion of reduced liquidity forecast for next year, beginning in less than 4 weeks.

The Fed is also proposing to increase short term interest rates although I see zero chance of 4 increases during 2018 as is being predicted by Goldman Sachs.

Knowing how GS operates I guess that if this is what they are saying publicly they are probably positioning their own trading accounts for lower rates.

It might be no coincidence that Trump, who has surrounded himself with former GS executives, has recently nominated Marvin Goodchild, an advocate of negative interest rates, to one of the vacant seats on the Fed board.

I don’t know how the Fed and ECB together withdraw this much liquidity from global markets and still hold down interest rates.

Higher interest rates would mean higher debt servicing costs and this would spell disaster for many countries, businesses and households.

NZ’s household debt ranks 7th highest in the world, a field lead by Australia whose household debt totals 123% of its GDP and 190% as a proportion of disposable household income.

Imagine the carnage in NZ and Australia if mortgage rates increased by say 2.00%. Households would be snookered, as would the banks, as would the property market.

Home ownership in NZ might be at its lowest level in 65 years but we don’t want a price collapse induced by mortgage defaults.

Labour’s plan to build 100,000 houses over 10 years is very ambitious and roughly the equivalent of building Timaru every year for 10 years.

I’m not sure where the trades-people will come from to drive this bold plan. The building sector already appears fully extended and we will soon curb immigration.

Finally I read some stats recently which got me thinking about the reported level of child poverty in NZ.

In 1820 94% of the world population lived in extreme poverty. By 1990 it was 35% and 2015 9.6%.

40% of those who remain impoverished live in two countries – Nigeria and India.

Sadly a lot of children in NZ are doing it tough but is it the system letting them down or their parents?

The level of child abuse and number of children killed or badly injured by family members or caregivers is a national disgrace.

If you gave an extra $200 a week to the parents of the kids who are going to school in bare feet with no lunch do you think their situation would improve?

I think 2018 will be a year of considerable change and challenge.

Kevin Gloag

Investment News (Michael writes)

NZSIF – Patient investors in the NZ Social Infrastructure Fund will be pleased to have read the previous Annual Report and the latest Interim Report, which discloses imminent full investment and the likelihood of ongoing dividend flows after March 2018.

The slow journey to full investment has cost us some ‘Present Value’ on our money but in my view the prospects for good financial returns, including dividends, are upon us.

The interim report describes the updated Net Tangible Assets as being $1.18 per unit and there is a likelihood of 6-7 cents per unit in dividends 2018-2019 (rising from there I recall).

Patience is again rewarded.

UDC – I see that buyer of UDC, HNA Group (aka Hainan Airline), is being reported as selling some its assets, signalling a reversal of its strategic spending spree in recent years.

It’s hard to tell what this means for ANZ and its ‘as yet unconfirmed’ sale of UDC but it is now ‘late 2017’ so under the normal course of events I would have expected this sale to have been confirmed by now, based on what we were led to expect.

It does remind us of the influential reach of the Chinese government.

I hope UDC depositors don’t get tangled up in an unexpected turn for the agreement between ANZ and HNA.

Ever The Optimist – China is reported as reducing its import tariffs on approximately 200 items and leading us to believe that this strategic change will continue.

This contrasts with Donald Trump’s ‘keep them out’ approach for the US.

ETO II – NZ car sales again set an annual record, the fourth in sequence.

NZ is either getting something right for (and by) our businesses and the employed, or we are borrowing too much money!

ETO III - I attended a rubbish collection programme around the Wellington coastline recently (organised by Sustainable Coastlines) and was pleased to see two things:

Heaps of the younger generation out helping; and

Meridian Energy’s support for the co-ordinators.

Not a financial story, but one with optimism all the same.

ETO IV – I am pleased to read that ‘we’ of the previous generation get better with age; 1980’s band Depeche Mode is outselling young guns like Ed Sheeran based on 2017 tour statistics.

Investment Opportunities

Kiwi Property Group – has announced a new issue of 7-year senior, secured, bonds (NZX code KPG030).

We estimate an interest rate between 4.25% - 4.30% p.a. (set tomorrow).

The offer will be arranged by contract note, with KPG meeting the brokerage expenses.

Investors wishing to participate in this offer are encouraged to contact us no later than 5pm today, confirming an investment amount.

Payment will be required by 18 December.

Deal Lists for 2018 potential deals

Investore Property Ltd – senior bond;

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

We have contact lists for each of these offers that investors are welcome to join by contacting us.

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.


No further trips planned prior until the New Year.

Chris will be in Christchurch January 23 & 24 and Auckland January 30 & 31.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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