Market News 13 July 2020

When I was a young(er) new entrant to financial markets investment bankers (Mike Milken in particular) used the description 'Highly Confident' relating to their belief in getting the deal done.

Today the US Federal Reserve prefers to use the description 'Highly Accommodative' given the need to support today's lack of confidence.

The Fed coined another contemporary description too, aimed at the banks: 'Inappropriately Optimistic'.

The irony here though is that because of the excessive flood of cash coming from central banks, investment bankers are probably still telling borrowers they are 'Highly Confident' of being able to issue bonds and borrow money for them!

INVESTMENT OPINION

Online Business – Field Days online?

Of all the online service replacements I have considered since March, pondering how the way we operate might change, this one seems the most challenging to me.

Being online is not like being in the field.

A variety of famers I know do indeed have a smart phone but they do not view the 'cloud' as the place where proper discovery and agreements are made.

Take a look at the offering if you're curious - https://www.fieldaysonline.co.nz/

I wish them well, but I hope they are back at Mystery Creek by 2021.

Price Manipulation? – Some of you will laugh at my use of a question mark, always suspecting that the largest players in a variety of sectors manipulate price outcomes.

There are plenty of cases in history that help to form your presumption.

Did Meridian Energy and Contact Energy manipulate the wholesale price of electricity in December last year for their own benefit and to undermine the electricity retailers who do not generate their own electricity?

The Electricity Authority has decided that they did, formally describing that an Undesirable Trading Situation (UTS) occurred.

I guess this industry regulator doesn't like using the more robust term of 'manipulation'.

You won't have witnessed the UTS event for NZ electricity pricing, but it broadly undermined the pricing you should be receiving for your electricity at home.

Small electricity retailers like Flick Electric and Electric Kiwi try to bring you better retail pricing by charging less relative to the wholesale electricity price, purchased from the market (not generated themselves).

If the wholesale price suddenly rises to be the same as the retail price paid by (in this case) Meridian Energy (MEL) customers there is no pricing margin to enable price competition.

MEL is indifferent to the margin between wholesale and retail pricing because it collects revenue from both generation and retailing, when one falls the other rises.

This is one reason the EA exists, to ensure the market is not manipulated and competition can occur.

If I was a member of the EA I would have been disappointed to witness the MEL and CEN share price increases following the publication of their findings.

Is the market determining that EA has no teeth, or that their findings validate the financial dominance held by the gentailers in the electricity sector? (a timely opportunity to refer you to Kevin Gloag's research item on the sector).

The EA may issue a punishment once a final determination is made, but this won’t bring back the competitive retailers who have been squeezed out of business in the meantime.

Politics – Covid-19 is constantly claiming all the major headline slots, and it is indeed very disruptive to economies, but longer-term problems are developing in global politics and its mix of long-term influence and undesirable outcomes will cause greater damage to the global population.

Vladimir Putin claiming the right to govern Russia until 2036 is one absurdity but given that China has a greater global impact at present Xi Jinping’s leadership will cause more damage.

China's behaviour with Hong Kong confirms its selfishness, and for me, it displays President Xi's lack of confidence in the wider Chinese population to make good decisions.

World history is littered with examples of greedy, egotistical people who thought they knew what was best for others but, ultimately, they did more damage than good for their nation, and thus their people.

Hong Kong was an economic powerhouse with very wide participation from international business. In my view that has changed, rapidly, and Hong Kong will fall fast with respect to its role in international business activity.

Other nations will copy the UK lead and offer residency to the best and brightest wishing to relocate out of Hong Kong.

In the past, such business relocations often took many years to agree to and conclude but I suspect the changes for Hong Kong will happen much faster than that.

Businesses that choose to relocate will, in my view, need to contemplate how they'll operate at a smaller scale so they are undeterred by the inevitable business threats that will be made by China in reaction.

This political disruptiveness makes global investment decisions more difficult to make.

Strange concepts – Tesla is now more 'valuable' than Toyota, according to financial markets.

What an interesting response given that the price of fossil fuel for 'old' vehicles has plummeted to deep lows, which should have extended the life of manufacturing such vehicles.

Green Bonds – Financial markets are always alert to changes that may have an impact on reward for risk.

One of those changes is rising political support for the environment and the detrimental impact commerce has on it.

Historically a small number of investors shifted their investment choices to try and display to capital users that they would not support businesses causing avoidable damage to the environment. However, the majority of investors continued to focus on pure commercial return relative to risk and the 'green' lobby was thus diluted.

Today the regulators are trying again to introduce financial costs for poor environmental behaviour, but more effectively some of the world's largest investment managers are beginning to dictate terms about directing capital to more environmentally sound businesses.

The vast increase to the scale of Exchange Traded Funds has given these fund managers an unusually strong position for setting policy for the environmental standards required to attract new investment.

It will be an ironic outcome if commerce enforces more effective policies for the environment than government has ever achieved.

In recent years we have seen a huge increase in the issuance of 'Green Bonds' that present themselves as being aligned with environmental improvement.

Green bonds are said to be certified, presumably by a group of new businesses who follow the emergence of new regulatory demands.

During the past seven years green bonds have reached a volume reported as now being US$500 billion in size.

It will take years, but I'd be very keen to see a chart that aligns increased issuance of green bonds with some measurable outcomes relating to environmental improvement (not holding my breath – Ed).

Long before environmental performance of green bond funding can be measured well, I think you will see yields on green bonds differ from the others.

Green bond yields should be lower than an alternative of identical default risk.

A green bond return (margin over risk free bonds) should reflect the 'true' probability of default for such a loan.

Theoretically the return on a non-green bond with the same default risk and terms should be higher, to reflect the lower demand to provide funding to such businesses, not willing to respect the environment to an acceptable level.

These differences will be hard to spot, doubly so in a very small market like New Zealand, but we will do our best to highlight different behaviours and returns to you.

New Zealand does have green bonds on issue, with Argosy Property's issues being the most recent ones that you'll be familiar with.

The NZX now presents such bond offers with a green colour scheme to differentiate them from the normal blue colouring on their website.

Post Script: If you agree with me that measuring 'greenness' will be difficult, just imagine the difficulty of then measuring political correctness and fair treatment of all when approaching investment decisions!

Asset Allocation – Another interesting article I read from the US recently concluded that 'no change' was required for asset allocation given the current set of financial market and economic circumstances.

To jump straight to the conclusion, the analyst still feels that a moderate investor should have a 50/45/5 portfolio, or more specifically 50% fixed interest assets, 45% shares (including property items) and 5% cash.

Our long-term readers will know that we have, in the past, preferred that retired investors (or approaching retirement) held a higher proportion of fixed interest assets with 75% being common and 100% being perfectly satisfactory if the investor preferred to avoid the share market altogether.

'Back then' real returns were available from fixed interest investing.

Asset allocation views are always evolving, tracking the evolving risk and reward scenarios but it was interesting to read one analyst conclude 'no change' following the Covid-19 disruption.

Having 45-50% invested in shares is common in the US, Australia seems to be higher, but this level tends to make Kiwi investors uncomfortable as they retain an acute focus on past volatility events.

It may be of interest for you to know ACC's asset allocation from the 2019 Annual Report:

Fixed Interest assets – 60%

Property and Shares risks – 34%

Cash – 6%

I doubt that these ratios have changed much by mid-2020 but the current journey into negative real returns from bonds must be having some influence.

I look forward to reading ACC's next asset allocation update.

We encourage clients to continue evolving their asset allocation rules with us.

Email Fraud – We all know this is a thing.

We often don't think it will reach us, but it does. We see some examples from clients each year.

The latest example was a person who started out emailing us correctly, but subsequent replies were being sent to the client by a person who hacked into the client's email.

The email address used to look like ours was subtly different.

The messages for you are:

Be very careful when assessing what is delivered to you in an email;

Test the content with common sense. If something seems odd it probably is and you should be doubly careful;

If odd, call us by telephone to discuss. This would immediately confirm whether or not our staff issued the email (and if still odd the person here can explain themselves!);

Save our bank accounts (trust account and company account) to your trusted bank customers list. We will never change our bank accounts. If a hacker pretends to be us and presents a different bank account to you for payment IT IS A SCAM (this appears to be the method that caught out Team NZ);

It is sad to say, but you must approach most email traffic from a sceptical perspective until confirmed as normal.

Tiwai Point - so, Rio Tinto has decided to stop riding the wave of subsidies provided by the tax payer (electricity price and Covid-19 employee support).

Good.

Now New Zealand can get on with reallocating this hydro-electricity resource widely across our economy.

Surely this will now accelerate Transpower from its lethargy with respect to increasing the capacity of the grid from Roxburgh to Benmore and thus on to the North Island.

We will comment further over coming weeks.

TRAVEL

Edward will be in Albany on July 28, The Wairarapa on 6 August and Napier 13 August

David will be in Palmerston North on 22 July.

Kevin will be in Christchurch on 6 August and Ashburton on 19 August.

Please let us know now if you would like an appointment in your town.

 

Planning for the seminars we will hold in ten cities is now taking shape, with some venues confirmed. We urge clients to contact us now if they plan to attend.

The current status is:

Kapiti – Southwards Car Museum – Tuesday, August 4at 11am

Wellington – Wilton Bowling Club – Wednesday, August 5 at 11.30am

Christchurch – Burnside Bowling Club – Monday, August 10at 11.30am

Timaru – Sopheze on the Bay, Caroline Bay – Wednesday, August 12 at 1.30pm

Albany – Albany Executive Motor Inn, Corinthian Way – Tuesday August 18at 11:30am (note change of date)

Auckland - August 17 or 19 - TBA

Tauranga – Hotel Armitage - Monday, August 24 at 11am

Palmerston North – Distinction Coachman – Monday, August 31 at 11.30am

Nelson - Beachcomber Motel, Tahunanui – Monday, September 7at 11.30am

Napier – Napier Sailing Club, Ahuriri - Tuesday, September 1 at 1.30pm (please note change of date).

 

 

Thank you.

 

 

Mike Warrington