Market News – 24 February 2020

Presumably for the purpose of comedy, President Trump has pledged a budget surplus to the electorate, 11 years after he leaves office and quite possibly after he leaves this lifetime.

INVESTMENT OPINION

Cheap and then plentiful – The most recent testimony from the US Federal Reserve Governor (Jerome Powell) to the Senate has reinforced my current view that interest rates will remain very low for the rest of my career, and quite possibly longer than that. (why would your demise be a significant waypoint? – Ed)

Powell advised the Senate that in the event of another economic slump the central bank would cut interest rates to 0.00% but it doesn't not support the use of negative interest rates.

Thereafter they would supply as much money as the economy needed to get back on a growth trajectory again (read – printing money, via wide ranging asset purchases).

In taking this position Powell and the other US Fed board members are endorsing the Japanese method (controlled at 0.00% and buy every asset offered for sale) and rejecting the European method (negative interest rates are fine, it's just a price).

Although I note that the European Central Bank also offers to buy assets from all-comers.

Europe's test of a negative interest rate environment has been useful, but even they seem to consider it a failure and are now laying the political groundwork for a retreat from this setting. Certainly, new ECB chief Christine Lagarde believes it is a failed policy.

The banks will thank her for this because negative interest rates seem to have threatened their balance sheets and it's a fair statement that the central banks cannot tolerate this new threat given the many others at the banks doors.

Having just visited Japan I do wonder whether the US understand this country, and if they do not understand them, then they may not understand why Japanese monetary and fiscal policy will draw different outcomes that will likely be experienced in the US under similar financial settings.

There is something fundamentally wrong with central bank policy (government) when they think they can become the owner of all assets produced by the economy that are unwanted or unaffordable for others.

Unaffordable at 0.00% interest rates?

This process implies that the ballooned scale of debt globally will gradually be transferred from private hands to public hands, which implies it will be serviced by taxpayers.

These policies make it unrealistic to expect deflation. Cheap money is driving necessary assets, such as houses, well away from the average income which will feed back into a need for higher incomes, and some inflation.

Therefore, if I stick with the current 2.00% inflation targets, 0.00% interest rates deliver negative real returns when lending money, so investors are left with very strong incentives to own real, tangible and productive assets.

The investment banking community see that they can finance this investment environment knowing that a proportion of the financing will come from central government, via a central bank's money printing programmes!

It is madness really.

Governments should set good regulation and then step back from the private business arena, not finance it. (ranting? – Ed)

Yes.

I do not expect government to behave the way I believe they should.

They are doing what caused to me to launch this paragraph; cutting the cost of finance and then providing excess cash to the economy if it looks less than robust, or highly paid tarot card readers predict that it will be so.

With an increasingly strong stance, it looks to me that rewards from fixed interest investing will deliver negative real returns and that is anathema to savers.

Talk to your usual financial adviser, or us, about how you should react to this.

AirBNB – has been the most successful of the 'sharing assets' platforms and they are now showing a shrewdness not understood by the likes of Facebook.

Rather than dig a deeper hole with respect to where their business is domiciled for tax, AirBNB appears to be interacting with central and local government offering value in other ways.

They are willing to add local levies to the platform and to provide user data to IRD to ensure local property businesses are reporting appropriately.

NZ may not manage to collect tax on AirBNB's slice of the revenue, but you can bet councils and central government will be pleased to have excellent regulatory oversight and revenue collection from the local users.

I was told last week by a long term accommodation provider that AirBNB had added a useful marketing tool, but it had also reduced their tenancy by 30-50% (mixture of seasons) because the number of beds on the market had increased significantly.

I understood his own concerns, but AirBNB has directed revenue to other parts of our economy in a way that simply wasn't possible in the past, which feels like good news to me.

Now, if regulation and tax collection improve from the accommodation channel it feels like a successful development.

AML effectiveness – I don't like using a flippant tone, but the latest theft of identity information by hackers (breach at a Kiwisaver provider) leaves me thinking that more crime is occurring as a result of the huge increase in retention of personal information required by the Anti Money Laundering legislation, not less.

I know it's not that simple, but the huge escalation of businesses holding copies of passports, bank accounts, IRD numbers, etc. relates directly to AML obligations.

The failure of our government to establish a central point for AML verification forced all organisations to gather the same information and it was inevitable that this resulted in a variety of security protection, which is regularly being breached.

Every month we seem to be told about another breach of security and the release of deep pools of personal identity data.

Who is the greater threat; those who try to launder money from crime, or those who are compromising personal identities?

Sorry another rant which means nothing to our obligations and your investing.

Rio and Tiwai nonsense – Not so long ago the CEO of Tiwai's aluminium smelter was courting all media outlets to trumpet his request for pricing subsidies to avoid shutting down the smelter.

Today, when challenged about cleaning up toxic waste in Southland, he cannot be reached for a response.

Which also means that he has said more than enough for us to understand what he stands for.

HSBC – Hong Kong & Shanghai Banking Corporation, now HSBC Group, but actually a British institution (started by a Scotsman according to Wiki), is to cut 35,000 employees globally.

This sounds dramatic but is 'only' 15% of the global staff roll, like a business with 100 staff trimming 15.

It is though, a big enough signal to disclose the bank's view about weaker economic and financial activity over the coming 24 months or so.

All the large investment banks have behaved this way during my career; dramatic staff cuts to reduce cost and test for inefficiencies within when storms form on the horizon.

My key message is to look for others in the sector to copy HSBC which would further validate financial concerns about performance for the 24-month period ahead of us.

Harmoney– So, peer to peer lending has failed.

Harmoney has announced that it will no longer accept retail investors as lenders on its platform to borrowers.

Lending will all be supplied by wholesale lenders, which is consistent with the changes across the no-bank sector (F&P Finance, UDC etc) but this is not what peer to peer lenders intended for their business model.

They will need to re-brand because their lending has become much the same as all others; robotise the lending (risk matrix analysis) and sell the loans to large scale lenders who seek diversity.

Heartland Bank – however, continues with its successes (including their part ownership of, and lending to, Harmoney).

If you are a shareholder in HGH you may enjoy reviewing their interim results, which are well presented and include a 1 cent per share increase in the dividend.

They spell out clearly where the business is expanding well (Home equity release, Vehicle lending, Online lending) and areas where they intend to reduce exposures (larger scale rural sector lending).

Here's a link to their reporting: https://shareholders.heartland.co.nz/shareholder-resources/reports-results-presentations

HGH is on track to meet the new Reserve Bank capital settings and given the 2% price discount on the Dividend Reinvestment Programme they may well get there through natural expansion alone.

Unless they were to buy another business… then new capital would be required.

Bank Deposits – The ANZ kindly sent me a chart last week explaining that declining use of bank deposits, in response to the lower relative returns, will likely contribute to 'economic headwinds' over the 12 months ahead because credit may be restricted (access) or restrictive (price rise).

Banks can borrow money via bonds from NZ and international investors, and they do so in large volumes, but they also need to borrow money from the public by way of deposits.

Historically, use of bank deposits might decline when yields on bonds offered higher returns so lending evolved amongst the lending product types (bonds and deposits) but the money typically remained within the fixed interest category.

This time is different.

Retail investors are baulking interest rates which now sit so close to inflation that no real return is available, and this has resulted in those investors moving some of their funds into higher risk categories (property, shares… hopefully not Bitcoin).

If you think about the circuit that money traces after a transaction, the cash removed from a bank deposit to buy shares will often make it back to the same banks, deposited by a different person, but it is likely that the average duration (term) of the money re-deposited will shorten, which is not ideal for the banks.

EVER THE OPTIMIST

Rocket Lab continues to claim space in this part of Market News.

This time they have been selected by NASA as a 'provider for a small satellite mission to the same lunar orbit as Gateway, which is intended to be an outpost for astronauts to visit the moon more regularly'.

It's very cool to see New Zealand involved in such discussions.

INVESTMENT OPPORTUNITIES

Oceania Healthcare Bond – Oceania announced its intention to issue their first NZX listed bond issue.

The terms of the offer have not been announced yet, but we expect them to closely resemble bond issues by industry peers (senior, secured, long term).

Market yields on bonds issued by industry peers range from 2.60% - 2.85% currently.

If you would like to be added to our list of interested persons, please contact us.

TRAVEL

David Colman will be in Palmerston North on 26 February, New Plymouth on 27 February and in Kerikeri on 6 March.

Mike will be in Auckland on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 3 March and in Napier in April

Johnny will be in Christchurch on 25 March.

All the best,

Mike Warrington