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Market News 10 August 2020

The ACT proposal for an ACC like insurance facility for employment loss situations has merit and I hope it is explored further, as seems to be happening based on comments from Grant Robertson and Jacinda Ardern.

The idea was previously raised by the Productivity Commission as being a gap in New Zealand's social structure relative to many other nations.

We have experienced again how our government likes to step in financially regardless of the situation (political measure) so 'gathering acorns' (via a small levy on the employed) to temporarily support people immediately after loss of employment would help both with financial preparation (the insurance aspect) and with fair use (available to all).

By stepping in to help financially (wage subsidy) the government (unintentionally?) reduced the risk for insurance companies that provide income protection insurance. I'll guess that the 'constant lobby group' (insurance companies) are not refunding any premiums to customers.

Before such an idea proceeds, I'd like the banks to confirm they'll accept it as the income protection insurance they seek so young mortgage holders aren't forced to pay twice for this type of insurance.

If the scheme being discussed proceeds on its own merit it would imply that private sector income protection insurance is overpriced.

Whilst I'm on financial forward planning, maybe the government could introduce other reforms to incentivise good outcomes, such as:

Adopt ACT's proposal to cut personal tax rates for those on the average wage (up to $70,000); but

Introduce the employment insurance levy referred to above;

Make it compulsory to pay higher percentages of income into Kiwisaver;

Introduce an adjustable debt repayment levy – that rises when our government debt ratio exceeds say 50% of GDP and declines once debt falls below say 30% of GDP.

We are all ready for some policy change and it will be supported if it defines how we will ensure NZ is successful in the decade or two ahead.

Maybe ACT has more in common with a Labour led government than NZ First offered?

INVESTMENT OPINION

Unemployment – We New Zealanders are a very conservative bunch, aren't we.

When things are bad, we predict they will become worse.

When things are better than expected we declare that they are wrong.

When our June quarter unemployment rate fell 'we' declared it to be incorrect. It is a statistic, it's not incorrect. (shall we debate Statistics NZ frailties? – Ed)

The June quarter data is confirmation that 'we' succeeded in holding employment up whilst we navigated what Covid19 changes meant for our economy. You should have been highly unimpressed if we'd spent $13 billion on wage subsidies and we did not see employment maintained!

Wage subsidies were reduced, and will be removed, during the September quarter. It is logical to predict a rise in unemployment. There are no wage subsidies after 1 September and no autumn harvest, so it is also logical to predict another rise in unemployment during the December quarter.

However, starting in May (3 months ago) I expect that our best business minds started planning for how business can re-allocate human resources across our economy.

Yes, business people make employment decisions, not government ministers.

Productive businesses with financial risk as a focal length employ people, government ministers just talk about it.

I think six months (by November 2020) is sufficient time for business to define their employment needs for 2021, so I hope to see the pending rise in our unemployment rate begin to slow during 2021.

I expect to see a large increase in part time, or contracted, employment as we resolve the absence of our previously used international work force.

Average annual income levels will decline during 2021 and 2022 but this is a truth faced by our collective economy.

In return for only offering temporary work I'd expect the hourly rate to exceed the legal minimum. Ensuring harvest is completed is critical to a grower; they should share some of that reward as an offset for the flexibility of 'work only when required'. That's how contracting works.

Business must, and will, resolve use of our human resources and it will temper the unemployment fears that each new commentator broadcasts, yelling ever louder in an attempt to be heard over their peers.

What I'd like policy makers to do is improve the opportunity for business to succeed, and to remind you of a personal favourite, they should pursue a huge increase in our water storage and irrigation facilities.

Here's another idea for policy makers: I'd like to believe Work & Income NZ can improve its highly inefficient processes to ensure people can move seamlessly between employment income, and unemployment income settings to assist with the new flexibility our economy will require.

These most vulnerable employees should not be forced to confront incompetent administration as they battle to maintain some income. (bordering on President for a day again – Ed).

The tenuous link between this ramble and investment is weak consumption and yet another reminder that interest rates are not increasing within the aforementioned focal length.

Robots and Artificial Intelligence – Last month, as I headed South on my research tour, I was determined to read more than just the information that appeared on my mobile phone with its 'loud' and 'colourful' headlines clamoring for attention.

I wanted to learn something different, so I stopped outside the first book shop I saw in Picton and chose to purchase the 'New Scientist Essential Guide No.2 – Artificial Intelligence.'

It was so good to read about something with reasonable substance to it rather than the glib headlines and short, shallow, stories of mainstream media.

Yes, I chose the subject intentionally. I hoped to add some value to your investment process and my curiosity about artificial intelligence has been increasing since Covid19 altered human freedoms and thus our involvement in business operation and methods of consumption.

My curiosity actually began when the NZX introduced a Smart Share ETF (BOT) with a risk profile of 'Automation and Robotics'; the introduction implied market demand existed, driven by asset allocation experts.

Businesses always seek ways to increase automation of tasks and reduce the human element for several logical reasons, including; cost (lower employment costs), leverage (faster performance), accuracy (human error), revenue (more sales from faster production) and safety (no humans to be injured).

It seems easy to predict that the use of automation will increase on a constant plane aligned with available investment capital (measured against risk adjusted returns and available savings).

Robotics has existed for many years, but increasingly artificial intelligence (AI) is the new overlay in a quest for machines that can make their own decisions and then learn from outcomes, which influence future decisions (are you personalising a robot via possessive pronoun? – Ed).

Is intelligence artificial if it is self-directed?

Machine intelligence is data driven (computers make decisions based on binary inputs, not via the variability of the brain) and the scale of data now being gathered (and stored by the likes of Infratil subsidiary CDC) is enormous and growing far faster than any virus numbers could!

In fact, I’d go so far as to say that the parabolic increase in data capture, and its analysis, will contribute to the medical suppression of Covid19 and other health threats in future; certainly faster than achieved in the past.

Side story: I think Infratil has wisely invested its capital in the storage of the data (CDC), not the growth of Artificial Intelligence businesses. CDC is a parallel for the person running the bar in the gold fields, rather than heading out with hope in your head and a pan in your hand.

Machines try to recognise patterns in data so that they can use this information to contribute to decision making, but it's for this reason that I don't think robots can replace humans; patterns often change based on human preference.

Where intelligence is 'artificial' it implies that 'real' intelligence will always be required. Robots will always need input from humans to be of greatest use, to humans.

It's beginning to sound a bit like Lincoln's description: government of the people, by the people, for the people.

Robots from the humans, by the humans, for the humans.

A robotic barman in the Central Otago gold fields might have opened a miner's preferred local Pinot Noir, to breath prior to his arrival in from the goldfields, only to discover he orders a new complex craft beer from Cromwell that he heard others talking about (new pattern).

Clearly robots will need to become adept at 'what if?'.

There was an interesting story in the magazine about teaching machines based on data and rules; in this case to play GO (you've probably already heard the story of machine beats Garry Kasparov at chess).

The first machine to play GO was 'AlphaGo'. It was taught all the rules of the game and then provided with data on methods for trying to win the game; it duly thrashed the world's best player of the day.

Developers then built AlphaZero and only taught it the legal moves of the game.

AlphaZero then played 5 million games against itself, discovering outcomes before taking on AlphaGo and winning that contest 100 games to nil.

We know there is a role for machines if we can teach them rules and preferred patterns, and I'd contend that the best robots, or automated processes, will be the ones that operate in conjunction with human contributions.

As you sit and ponder just how many machines are already embedded in our economy and society think also about their potential and then try to guess what may happen next; this is the frontier for new investment.

It was this thought that had me asking myself, 'how much of the trading that we see on financial markets is already machine driven'?

I convinced myself that machines applying as much artificial intelligence as humans can muster are already deeply involved in financial market behaviour.

These machines can analyse all available information (words and numbers) in the time it takes me to collect my morning coffee. Before I get back to my desk they have processed millions of calculations to compare current prices (implied returns) for a variety of risks and thus reached conclusions.

When the markets open they react to their conclusions and begin buying and selling different risk types automatically, without involving humans. No keyboard required; which is a good thing according to our technology support because apparently most errors occur between the chair and the keyboard.

Here's another thought for you regarding the unexpected strength of financial markets:

Maybe humans at central banks are making mistakes (approximating, estimating) and unemotional machines are extracting risk adjusted profits from the situation.

GO champion Lee Sedol (replace – central bank governor) thought he would beat AlphaGO (replace – AlphaINVEST), until he didn't. The contest wasn't even close.

Maybe there are some 'AlphaINVEST' machines out there extracting huge financial gains at the expense of taxpayers and less informed investors?

This thought made my brain hurt a little, but it did begin to help me understand the difficult to explain (using old theories) performance of financial markets and the speed of price change.

What can you and I do at a human level?

We should consider investment in businesses involved in data capture and analysis and possibly in businesses trying to provide AI and robots as a service.

As a minimum we should demand that businesses we own are trying to increase their use of intelligent machines. Those that are not earn a black mark and may have a limited future in a portfolio.

Speaking of which, can you tell if you have been served by a machine?

Alan Turing, computer and AI legend, defined a simple method to measure his own question of 'can machines think?': a human judge cannot distinguish whether they are being answered by a machine or a human.

I'd best draw this section to a close, but two more threads stayed with me:

The benefits to health:

1 in 10 medical diagnoses are wrong in the US and apparently 80,000 people die unnecessarily. If this could be corrected via machine-based data analysis, then two years of improved outcomes would equal the current US Covid19 related death toll.

Side story: Wellington based Volpara operates in this field of machine-based data analysis with breast screening data.

The importance of energy supply:

The more that artificial intelligence use expands, the more data that will be captured. The more data we capture, and use, the more energy we burn.

Nations with an energy surplus should win.

New Zealand is such a nation.

It's a fascinating subject and I'd encourage you all to read more about it when you can.

Track & Trace – This idea is not all that helpful to you as investors, other than a tenuous link to keeping our economy out of lock down.

It followed a discussion with a client about their bank statement. They asked why the wrong date was recorded against their transactions.

The answer lies in how slow our bank system processes payments.

The Reserve Bank, on behalf of government, could ask all banks to present the actual date and time of a transaction on a client bank statement, not the 'when processed' date currently displayed.

Then the government could make displaying its QR code compulsory for all businesses at physical addresses.

New Zealanders are proving to be disengaged with the track and trace concept. If our bank statement helped trace some of our locations and we can scan a QR code in most places NZ will have far better track and trace data to work from.

That should help us reduce lock down restrictions in future when incidents of Covid19 inevitably reappear.

If my bank statement activity was live and I switched on Google tracking (as I do) then I would have a very good idea of where I was and when with very little inconvenience.

Case Study – Often market participants will allow oversized assumptions to drive excessive volatility into the pricing of a share. Recently Metlifecare (MET) shareholders experienced such behaviour.

MET investors applied a very short-term focus and thus jumped to aggressive conclusions forgetting that it is a simple business owning real estate and providing residential and care services to its customers (tenants).

The share price movements were massively more volatile than the underlying business type and customer behaviour.

Share price prior to initial takeover offer - $4.50 (Net Tangible Assets $6.97);

Takeover offer negotiated to $7.00 to align with NTA. Share price lifts to $6.85;

Covid19, takeover withdrawn, share price slumps to $5.00;

Legal challenge introduced, and disputed, share price falls to $3.30 (47% of NTA);

Post Covid19 reporting displays relatively normal performance by MET, share price rises to $4.50;

Replacement takeover at $6.00, agreeable to major investors, share price rises to $5.85.

MET business experienced only modest change throughout this period, its NTA unchanged at $6.97, but its share price danced around in a 50% price range.

Looking back the only real change in share pricing is, or should have been, the difference between the two takeover offers, being $1.00 or about 15%.

The thoughtful investor (not trader), operating to a well-reasoned investment strategy, would have sat still and is still ahead financially.

An active investor willing to trade shares might have reduced their holding when the market price sat very close to the prior takeover offer ($6.85 versus $7.00) but this decision wasn’t an easy one to make.

I have stated previously that traders love volatility and they typically profit from it at investors expense, so isolating yourself from too much trading is usually a rewarding decision.

NZSIF Update – Investors love infrastructure and well defined future cash flows, as they should, and this led many of you to invest in the Social Infrastructure Fund a few years ago.

This fund was developed by HRL Morrison & Co (Infratil managers) and distributed with the assistance of Craigs Investment Partners. We liked the fund for its diversity and opportunity and participated.

NZSIF offered access to public private partnership investments, which involved projects from both the Australian and New Zealand governments.

The good news, which NZSIF investors may have read in the recent Directors report is that a new investor likes our investments even more now that 'we' have completed their development and removed this risk from the process.

It sounds as if these investors intend to make us an attractive offer to sell our investments to them.

The combination of our fully developed service contracts with reliable long term cash flows in a world of collapsing interest rates is driving up the value of our investment.

More will be revealed by our directors soon but you should read this as a 'do not sell' notice for the NZSIF investment.

EVER THE OPTIMIST

Another young New Zealand business reaches the stage of achieving public success; Aroa Biosurgery has listed on the ASX and quickly gained a market valuation of $400 million.

https://aroabio.com/

We'll leave the debate about 'why not list on the NZX' for another day, and celebrate the NZ business success first.

Investment Opportunities

Investore Property – Investore has announced that they are considering issuing a seven-year senior, secured bond with more details to be announced next week. We would anticipate a yield of around 2.50%.

If you would like to go on the list for this bond please email Penelope.

Wellington Airport – WIAL successfully issued $100 million of new bonds last week for a six-year term at 2.50%.

It was nice to see a new bond from a corporate after months of only government and local government bond issues (because that's all the Reserve Bank would buy – Ed).

WIAL took advantage of the more settle market to pre-arrange funding requirements well into 2021, which seems very wise to us and we hope other companies follow their lead and bring more bonds to market.

TRAVEL

Kevin will be in Ashburton on 19 August.

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

 

SEMINARS

Our seminars for clients and investors are now underway.

The 30 pages of statistics are available on the client pages of our website, under ''Research''.

At the conclusion of the six-week programme, a video of the seminar will be available to clients.

The title for the Seminar – No Hiding from Risk- will be explained with some thoughts offered on how one can deal with the contrasting risks facing investors, requiring opposite solutions.

Registrations at our remaining meetings in Timaru, Takapuna, Mt Wellington, Tauranga, Palmerston North, Napier, and Nelson are still open.

Clients wanting to meet with advisors after each seminar would need to arrange this as soon as possible.

Venues and times are:

Timaru - Sopheze, Caroline Bay

12 August at 1.30pm

Takapuna - Fairways Conventions

18 August at 11.30am

Mt Wellington - Mt Richmond Hotel

19August at 11.30am

Tauranga - Armitage Hotel

24 August at 11.30am

Palmerston North - Coachman Hotel

31 August at 11.30

Napier - Port Ahuriri Yacht Club

1 September at 1.30pm

Nelson - Beachcomber Motel

7 September at 10.30am and 2.00pm (Please specify which session)

Thank you.

Mike Warrington

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