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Market News 17 December 2018



This is my last newsletter for 2018 and as has become a habit it is a look back at the past year and a little speculation about what 2019 may have in store for us.

We close our offices this Wednesday, December 19th, for the Christmas break and a subset of staff will return on Monday January 7th.

It is daunting every time I pretend that I can make investment forecasts for the year ahead. Crystal ball gazing is no more effective than snake oil from the weekend markets.

First, I re-read the Xmas newsletter from 2017. It feels like I wrote it barely a month ago providing anecdotal (but not real – Ed) evidence that Einstein was right when he declared that time is not a constant.

I hope that the relative acceleration of time that I felt applied for 2018 does not disclose our proximity to a black hole (with time being warped on approach).


So much of the 2017 Xmas newsletter remains relevant today, so I have lazily cut and paste a few timeless paragraphs from 2017 (in italics) because they fit so neatly into a 2018 review section:

However, for all the intent I do not think central banks will make large strides with the strategy of tightening monetary policy, so I don’t see this as a ‘trigger’ for weaker markets in 2018.

The US started to tighten monetary policy and has delivered some interest rate changes, but they are already beginning to question the scope for this strategy to continue.

I know the central banks are laying the ground work with constant announcements about wishing to lift official cash rates and sell bonds off central bank balance sheets but it would lack credibility if I predicted for you that this will happen quickly.

It has been happening, and may deliver a little more yet, but it has not happened quickly and may be about to stop (interest rate increases).

These leopards (central bank governors) will be wearing the same cloaks come Christmas 2018.

They are, especially the Bank of Japan, the European Central Bank, the Reserve Bank of Australia and the Bank of England.

The US 10 year government bonds (Treasuries) are not comfortable below 2.00% and neither should they be as the central bank explains a strategy of lifting cash rates to at least that level.

US 10 year Treasuries lifted as high as 3.30% until markets recognised the inflation threat is not robust and this bond yield finishes the year at about 2.89% reflecting a view that the US Fed Funds rate may not be able to surpass 2.50%.

Donald Trump is a perpetual attention seeker, North Korea wants some of that action too, the UK is struggling with its divorce from Europe but concluded its first step last week. Capitalists are struggling with the tidal move toward social preferences and power is shifting in the Middle East.

Same, same, with the exception of Kim Jong Un being a little quieter. Political intolerance has escalated and will be a difficult storm for investors to navigate in 2019.

Upheavals in political configurations across the world. Among the emerging economies, Argentina, India, Indonesia, South Africa and Nigeria are headed for elections in 2019, as are Canada and Australia, among the developed economies. Argentina’s elections should be interesting, in light of its continuing economic crises and the recent emergence of strongman-politics in neighbouring Brazil.

At present the UK may temporarily make this colourful bunch look stable, but they are not, especially the emerging markets.

India has just seen its second Reserve Bank governor quit out of frustration at government meddling, which is not a good sign for this burgeoning economy.

To repeat; global politics will likely deliver elevated volatility in 2019 for investors to carefully navigate.

You don’t need my forecasts (50:50 chance at best – Ed) to decide how to invest, it is far more important that you rely on your investment rules in the first instance. If you have good investment rules (policies) you will be very likely to make good investment decisions and market specualtion can be minimised.

Have you reviewed your portfolio relative to your investment rules after another strong year for shares?

This will be true through all time for managing your investment portfolio. If you have not yet refined a broad set of investment rules please do so, then review actual investments against that plan. Recall that we can record these in our database so that you can measure your actual portfolio against your rules.

So, what of actual market performance during 2018?

Here is the table I use regularly for displaying annual performance of a few major share indices (at the time of writing):

Index                2015     2016     2017     2018  Change

NZX50               6,042    6,888    8,146    8,683   +6.60%

ASX200             4,938    5,438    5,980    5,565    -7.00%

DowJones (US)17,375  19,216  24,140  24,100   -0.20%

Nikkei (Japan)  18,712  18,350  22,457  21,190   -5.65%

Shanghai (Ch)   3,523    3,208    3,277    2,586  -21.08%

FTSE (UK)         5,946    6,746    7,348    6,778    -7.75%

EuroStoxx          3,186    3,052    3,561    3,058    -14.1%

The ‘all for one and one for all’ bullish share market appears to be over; share markets within each economy are reacting to local financial risks and specific company performance, which is a more logical behaviour than paddling in the collective tide experienced over recent years.

Observe the range of negative performances around the world this time. The US was hanging on to a positive result because of the day I chose to start typing but by the date of proof reading it was negative.

When sentiment turns against ‘us’ it is temporarily an unstoppable force.

And, here are the movements in 10 year government bonds:

Country Dec2014 Dec2015 Dec2016 Dec2017 Dec2018

US             2.25%     2.21%     2.39%     2.34%     2.85%

Canada     1.89%     1.47%     1.63%     1.90%     2.08%

Spain         1.81%     1.73%     1.55%     1.41%     1.47%

France       1.03%     0.92%     0.79%     0.62%     0.70%

Germany   0.78%     0.57%     0.33%     0.32%     0.25%

Italy           1.94%     1.64%     1.98%     1.71%     3.13%

Greece       7.17%     8.62%     6.53%     5.45%     4.23%

Swiss        -0.30%    -0.20%    -0.15%    -0.16%    -0.14%

UK             2.01%     1.84%     1.40%     1.26%     1.27%

Japan        0.40%     0.30%     0.04%     0.06%     0.04%

India          7.93%     7.82%     6.21%     7.07%     7.46%

Hong Kong1.81%     3.02%     1.52%     1.92%     1.98%

Australia    3.11%     2.82%     2.83%     2.51%     2.43%

NZ             3.87%     3.55%     3.25%     2.76%     2.41%

Observations – NZ and Australia are among the nations whose yields have declined whilst US (major market) yields have increased. Greece’s yield continues to settle as they work on fiscal management but Italy’s yield has increased markedly alongside elevated risk of economic failure.

Interest rates are a construct of inflation and default risk (additional reward for risk). Nominal interest rate movements have been modest reflecting the perception that inflation is not a current threat (outside of Venezuela and Zimbabwe) but the relative movements in yield offering commentary about changing relative default risks (Greece, Italy).

I think we are entitled to reconcile NZ yields being below US yields as a strong endorsement of our economic management and low risk to global interest rate investors. Let’s keep it that way.

It remains our view that interest rates will remain low this year (3-4% in NZ) and that these levels are likely to remain the truth over the next five years too.


Review 2018 specific predictions

Share indices – I am going with higher pricing by the end of 2018, but not by a large percentage. As a subset opinion, I think the share markets of the major economies will outperform NZ.

The sugar effect of low interest rates followed by US tax cuts may be fully discounted into the market, which limits the impetus for higher markets from these major drivers, but I think we need to be patient during 2018 and watch to see if economic growth and real profits do increase further.

It feels odd telling you to expect 2018 to be an ‘up’ year for shares, so let me temper the opinion, and be very clear, that I also urge investors not to be over invested in shares relative to their ‘normal’ risk tolerance (investment rules/ratios).

Frankly, I’d prefer that your weighting to shares was at the lower end of your target ratios because the rubber band of risk is, without question, stretched; making my guess a statistical improbabilty!

Wrong on two counts with this one. Most markets are lower. The NZ share market is up, not down relative to others, and you have most of your expsoures here so practically ‘share market up’ was correct, but the global tone has turned down.

Official Cash Rates – I expect these to be higher by the end of 2018, but again only by modest amounts.

Wrong for all but the US market. The rest of us did not follow the chart for increasing overnight interest rates, which contributes to why we do not expect meaningful interest rate increases during 2019.

10 year bond yields – I think these will also be a little higher by late 2018 but not enough to discourage investors from continuing to hold an even mix of investments across the maturity date range (1-7 years in a NZ context).

This was broadly correct outside NZ and Australia (and Greece – Ed), which are lower in yield, but the moves have not disrupted the importance of a diverse range of maturities in a fixed interest portfolio.

Bitcoin – If you enter the water, donn a thick wetsuit and best of luck to you. I won’t be.

Precise and correct. Sentiment has turned sharply against the likes of Bitcoin.

Central bankers continue to discuss the merits, or lack of, for crypto currency use in the economy but they are not in a hurry to adopt a collective position on the subject and they might not need to do so if they simply retain the current financial stability regulations and then leave developing overlaid payment methods to private enterprise.

In a nod to developing the use of ‘old school’ payments, and to compete with services offered by Google, Apple, PayPal etc, the European Central Bank has launched a new ‘Instant Payments System’ for European banks to offer to customers which will process payments live (10 second processing time) on all 365 days of the year at a cost of only 0.2 cents per transaction.

Blockchain is impressive software with its shared ledger functions, and thus security of process, but it is currently criticised for lack of speed and cost of processing. HSBC recently proved it would be useful for cross border trade and payment activity (not time dependent in terms of immediacy) but maybe it’s a long way from being the platform to compete with standalone live payments?

Time will tell but it seems to me that plenty of time will pass before Blockchain based payment processes undermine central bank regulated payment processes.

Predict 2019

I am going to go with share markets lower by the close of 2019.

As I said near the opening of this newlsetter making precitions is hard and you should read them with three grains of salt and a squeeze of lemon.

However, my confidence in encouraging less risk and more care is surely aligned with the age of the bull market (9 years), the lack of scope for meaningful interest rate cuts, the currently stretched nature of consumers and the lack of capacity for governments to seriously use more tax payer money to sponsor higher asset prices.

Surely I’m the right side of these odds?

I am not suggesting an exit from your portfolio for shares, just carefully manage the holding against your investment rules, which are linked to your own investment risk profile. Observe that the recurring returns from many shares sit higher than current interest rates and we are not expecting a meaningful increase in interest rates.

Market volatility will be up and stay up. You’ve seen some of this behaviour recently with the Dow Jones being up and down 500-600 points every other day. Current political negotiations are having much larger effect on economics than recent years and this will drive a continuation of the high volatility, as might active investing in ETF and computerised trading.

The US and China are not even close to new trade agreements and I doubt they will be so by the end of 2019. The 2020 US Presidential elections loom ever larger in this context.

Investments with less certainty of success will underperform in such volatile markets.

Tidy up your portfolios – look very closely at your tentative ‘hopefuls’, test the appropriateness of their presence, and keep the boring robust and reliable investments.

Cash flow will be King.

When investors lose confidence they demand lower risk (better probabilities before taking risks). Businesses with highly reliable cash flows and hopefully the opportunity for reliable profit margins with retain investor attention.

Businesses without either characteristic will suffer discounts to market pricing. It doesn’t imply bad business, but it does represent more risk.

To some degree we all operate at the margin so a tidal shift can be very damaging. There’s a big difference to your ifestyle based on average income of 4.00% or 5.00%.

A business, or a country, with a lot of leverage (debt, or exposure to a necessary outcome) will be hurt quickly if the ‘wrong’ set of outcomes plays out given the thin margins required to achieve success.

If investors do lose confidence in 2019, probably linked to a declining share market and thus declining wealth, many ‘hopeful’ businesses with negative cash flow will fail or be sold very cheaply to competitors.

Avoid being in a position where the actions of others can put you under pressure to make decisions that you’d rather not make.

I think the interest rates you see today in NZ will be the interest rates you see come Xmas 2019.

The flattening US yield curve is an important signal. If short term interest rates are increasing in response to central bank action but long term interest rates respond by not moving, or declining, the market is telling us that it is not confident inflation exists, and that it expects current economic growth to wane.

Some active traders believe the best place to park money at present is in low yielding (2.00%) short term fixed interest investments.

You are not a trader.

Take their signals on board as you consider the forces upon your portfolio, but do not adopt an ultra aggressive portfolio position.

The current market does pay you more return to take more risk. Taking a thoughtful amount of such risk is appropriate for a portfolio and looks very likely to deliver higher portfolio returns than an aggressive move to short term cash only.

Bitcoin – crypto currencies will continue to suffer lost value in 2019.

Cyrpto currencies produce nothing and will not be an attractive asset type if investors lose confidence in the way that I expect.

In summary, our view is that investors should be setting a more conservative set of investment rules and following them by making progressive changes to their portfolio.

Follow a trend toward certainty of cash flow, profit margin and thus reward.

We will help, as we do every year.

On that note, have a very merry Christmas with your family and friends and enjoy some of the spoils of your investment successes to this point.

We’ll see you all in the New Year.

Kind regards from all at Chris Lee & Partners.

Michael Warrington

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