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Market News 16 July 2018

Anecdote I

There are plenty of reasons to point the critical rod at Russia, based on political behaviour, but the country deserves applause for its handling of the FIFA World Cup.

What a success.

It may well have cost them more to ‘gain’ the tournament than to run it, but, moral issues aside, they have run it very well from a viewer perspective.

Congratulations to France also for winning on merit.

Anecdote II

The value of the UK Pound fell on the resignation of Boris Johnson, presumably linking some of their potential economic success to his presence.

Given the contempt that most electorates hold for politicians one might have expected optimism to lift following political resignations.

INVESTMENT OPINION

Trade War – Donald Trump has already moved on to round two of his tariff war and amongst the headlines of disruption another thing stands out to me; the US share market has been drifting higher and the Chinese share market has been falling.

I think the aggressive trade stance being adopted by many countries is going to cause economic disruption on a significant scale, but the ‘weighing machine’, as legendary investor Ben Graham described the markets, is progressively delivering a verdict about the early impact of Trump’s war.

It is only first impressions, and even the markets have few clues about what Trump will do next, but very large sums of money are moved around in the US financial markets so the changes are worth observation by investors globally.

Valuable Women – Iceland has made it impossible (illegal) to pay women less than men for the same job.

I sincerely hope that Iceland’s economic growth now lifts in a way that is demonstrably linked to more women in the workplace, and in senior roles.

Then the rest of the world will be forced to move on from paying lip service to the unfair differences of treatment between male and female employees.

A greater proportion of women in the workplace, across the spectrum of seniority will unquestionably be good for outcomes.

Investors should look for more women at senior levels as part of their investment analysis and question its absence if that is the discovery.

Sky TV – Holders of Sky TV shares may be pleased by the recent lift in the share price to $2.75 from lows of $2.20 and an extended period below $2.50.

It appears to me that ‘new’ buyers of SKT shares have mopped up the shares that people wanted rid of, post the large reduction in last season’s earnings, and the share price is now settling into a new range as investors await news about this seasons earnings.

I have one little anecdote of progress by SKT for you; their new relationship with Spark (SPK) has secured me as a customer again where $30 per month was sufficiently well priced to choose ‘sport by internet’.

The history of my use included the original service, then MySky, until usage didn’t warrant the $100+ pricing. I returned as a customer when Sky introduced occasional purchasing of sport via FAN PASS ($15 per day), but again I dropped out when they insisted on $100 minimum per month.

They may now be positioning themselves well to compete by providing different service types to different customers and by doing so may stabilize, or increase, their cash flow.

I remain curious about the strategic ambitions of the new shareholders on the SKT share register (and of Murdoch’s push to take back control of private television in the UK with BSKYB)

Investment News

More deceit – Whose reporting can we reliably believe?

Nissan has conceded that they too ‘deviated from the prescribed testing environment’ for the exhaust emissions.

That looks like a quote from a sheepish, senior, male employee looking at his shoes with lawyers standing behind him.

Truckometer – I have always liked this index, right from the day Cameron Bagrie’s (era) team launched this data series for the ANZ.

I love the name and I like the usefulness of its data, especially the large truck series.

The latest results (June) show a slight softening, which is consistent with the circling economic expectations, but ANZ reminds us that over a wider window the ‘economic engine isn’t running out of fuel yet’.

It does seem that our GDP growth may now stay below 3.00% but ANZ wishes to argue that it won’t be far below.

Bank’s Stronger – occasionally investors’ will ask us to reassure them that the NZ banks are ‘safe’ to place deposits with, and own bonds from.

Some of the enquirers have been told by ‘the barman at the local’ that Open Bank Resolution law will raid some of their wealth one day. This can be quickly put back in the box with rational explanation.

However, another slither of additional strength (less risk) is appearing based on the Reserve Bank’s review of capital on bank balance sheets.

In the past the major banks were granted approval to internally assess their credit risks (chance of failure of each loan made) and then apply the regulated percentage of equity capital to the bank’s balance sheet to support that lending (as a rough reference let’s call that $10 equity for each $100 loan).

However, do you recall the criticism of Westpac in 2017 where they had breached the terms of their risk agreement with the Reserve Bank?

This behaviour, and other concerns about vagueness across the major banks approach to risk assessment, may result in the central bank insisting on a homogenous approach to risk assessment on loans.

The poor behaviour of the major banks’ parents in Australia will have left our big banks with very little negotiating strength.

If the central bank sets risk measurement rules across the industry you can be sure they will not set them at the sensitive, or stretched, end of the risk spectrum.

The result would be similar to insisting that banks hold a little more equity in support of their lending; call it $11 per $100 of loans, and the impact would be a slight reduction in the default risk of our banking sector (and an increase in the real cost of debt to borrowers, which is no bad thing).

Depositors and bondholders rejoice.

Recession Anecdote –The ongoing flattening of the US yield curve (a yield curve is a plot of interest rates measured across maturity dates out to 30 years), with barely 0.25% additional yield between a 2 and 30-year term, is sponsoring plenty of ‘Recession Pending’ headlines and story lines.

It’s never wise in financial markets to say ‘it will definitely happen again, because it happened last time’ but adopting a concerned footing is an appropriate starting point for monitoring the horizon, in my opinion.

Once one forms a firm perspective they typically only see the factual and anecdotal evidence that suits their expectation; for now I am scanning for information that reinforces the probability of a US recession.

Plenty of data declares that the US economy is doing rather well at present, but I side with those who are concerned about the US economy based on the short term ‘sugar-like’ effect of recent tax cuts and the long-term distortion resulting from excessive debt as both are unsustainable supports for the economy.

And it’s not just the US economy; Auckland is showing signs of excessive public debt.

Their cheeky proposal to isolate part of the sewerage system and then apply a ‘toilet tax’ to each user was a crass attempt to increase the community debt levels and increase the money collected from the community.

It’s not clear to me whether they intended to attach the new ‘toilet tax’ to the new debt being raised (security for the lenders) or whether the lenders would have simply demanded (as I suspect) the normal local government security against rates (special rate) but either way the outcome is the same; more debt and more servicing costs to the community.

I certainly smell an investment bank in behind offering Phil Goff clever ideas to increase council debts and increase their investment banking fees.

New Zealand should not be feeling all high and mighty about the world’s problem of too much debt because our private debts and many of our councils’ debts are uncomfortably high (our government debt is fine, but it needs to be as an offset).

I’m no economist, it is just common sense that too much debt will be suffocating, or I hope it is because it makes sense to me.

Another anecdote that is consistent with being careful with investment decisions is the rising credit margins on bonds (the additional interest rate paid for additional risk).

A rising credit margin is the market concluding that the chance of default (non-repayment of loans) is increasing, and in return the market logically wishes to earn more if the risk is higher.

When looking back at the historical (1985 – now) credit margin for a BBB Investment Grade bond in the US the margin spends a lot of time around 2.00% over US government bond yields. It drops lower in times of confidence about loan servicing and rises higher in times of duress.

If you remove the +6.00% credit margin from the heated period of the Global Financial Crisis, the typical high point for this measure is around +3.00% credit margin.

This month the credit margin is again rising slowly and may soon breach +2.00%, and heading higher.

The theme of the Bloomberg article I was reading was the prevalence of recessions that follow each movement of this credit margin back above +2.00%.

Other than in the event of a crisis these indicators do not move sharply, so we have more time to monitor developments but some alertness would be wise if it continues toward +2.50% or more.

The jigsaw puzzle that reveals what happens next in financial markets is never completed, there are always pieces missing (in the vacuum, eaten by babies, coloured in by pen) so you’ll never see a clear picture.

I have only offered you two pieces above, but I happen to view them as centrepieces that you build your image around, like the key in St Peter’s hand in the Vatican City.

Cash– Not everyone is convinced about the theory that crypto currencies will replace cash within a short time frame.

According to our central bank the New Zealand public and other economies are very happy to continue using NZ cash for transactions; so much so that the volume of cash outstanding in the economy is rising.

Adrian Orr reported this news by disclosing that the old series 6 bank notes were taking a long time to be returned to the central bank, replaced by the new series 7 notes.

NZ is a large user of EFTPOS methods of payment so this may contribute to slightly slower movement of notes, but the volume outstanding has been continuing to increase also, so plenty of us are happy to view notes as a reliable source of value.

And, it’s not just ‘us’ in NZ, apparently one third of NZ notes are used outside NZ and thus respected as a reliable store of value much more widely than on our shores.

That is a good anecdote for the respect with which NZ is governed and the way our financial markets are regulated.

It’s also a settling thought for the way external perspectives of NZ will be formed in the event of a future financial disturbance, specifically, ‘we’ shouldn’t have too much trouble sourcing funding for our government, our banks and our most reliable businesses even during periods of duress.

Tax Monitoring – I don’t recall if I passed on to you another development in the evolving space of tax monitoring.

Come the year 2020 if a person does not provide an IRD number when sought by a registry (or deposit taker such as a bank) the withholding tax rate will be set at 45%.

Further, if an investor fails to provide an IRD number to a PIE managed fund requiring a Prescribed Investor Rate (PIR), that fund will force repayment of the investor’s money from the fund.

Common Reporting Standards (CRS) and the Foreign Account Tax Compliance Act (FATCA) are leading a global clamp down on tax evasion.

97 countries have signed up to the global Multilateral Competent Authority Agreement (MCAA), to automatically exchange information based on Article 6 of the Convention on Mutual Administrative Assistance in Tax Matters.

These developments will cause no concern for investors who are well organised administratively but there will be no room for negotiation.

Ever The Optimist– Tractor sales are up 25% year on year;how can that not be great news?

I also learnt from the story that we have a Tractor and Machinery Association.

This sounds like a real person’s association where I expect the uniform involves Red Bands, the car park has extremely large spaces and there are dog kennels at the front of the clubrooms.

ETO II – For NZ, but more specifically Wellington, Shopify has selected Wellington for a regional customer service hub, employing up to 100 people who can operate remotely (home if suitable).

The launch is targeted for 13 August, so straight into it.

ETO III – During the shoulder season between summer and winter you might expect a dip in NZ tourism numbers, however, Statistics NZ reports that May 2018 was a record level for May.

‘Total guest nights in May rose 1.6 percent to 2.54 million from May last year when they grew 7.3 percent’

President Trump’s tariff war and the US Federal Reserve lifting interest rates is placing downward pressure on the NZ dollar, so, we now look a little cheaper to the international tourists.

Maybe we will be a beneficiary of Trump’s antics?

He can’t place a tariff on our landscape exports.

ETO IV – Retail sales are up, although some might claim this isn’t great news in a country with a poor savings record.

Seasonally adjusted retail spending on credit and debit cards rose 0.8 percent in June following a 0.6 percent lift in May, Statistics New Zealand said. Core retail spending, which excludes vehicle-related industries, rose 0.6 percent in June, matching the increase in May.

This data will satisfy one sector of our economy but I rather hope the weaker NZ dollar will result in slightly weaker spending numbers (other than the forced purchase of fuels at higher prices).

Investment Opportunities

WEL Networks – Waikato Electricity Network’s offer of a 5-year subordinated bond (WEL010) was successfully launched last week, with very high demand.

The interest rate was set at 4.90%.

If you received a firm allocation from us please urgently deliver your application form to us. Interest begins at 4.90% from the day your application form is processed, so there are few reasons to wait.

We have a waiting list that people are welcome to join, if they missed the opportunity to join us prior to bidding for our allocation.

More bonds – We have been told to expect more bond issues in the weeks ahead, giving fixed interest investors the opportunity to be fully invested before spring!

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.

Travel

Edward is in Queenstown 26 July.

David will be in Palmerston North and Wanganui on 17 July and New Plymouth on 18 July.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a free meeting.

Michael Warrington

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