Market News – 12 August 2019

There was a headline last week that adopted the ‘embarrass by exposure’ stance but in my opinion, it was something to be proud of.

The article was taking a shot at the Financial Markets Authority.

The FMA was forced under the Official Information Act to release costs of legal cases against the badly behaved.

Rob Everett, and the board of the FMA, should adopt a new stance and publish these cases and their costs every time. They should be proud of their work in pursuing the ‘bad’ (my term) and then enthusiastic about publishing the outcomes, including costs, so that industry and the public see them demanding good behaviour under legislation.

For too long regulators have hidden behind a fear of cost when being asked to do their jobs properly, enforce regulations and standards, and this simply provides more room for bad behaviour.

The ‘badly behaved’ will take advantage of any weakness seen from the regulators. All parents know this.

So, Rob, after the FMA successfully concludes any case against the ‘bad’ may I suggest that you publish a summary of the circumstances, including costs, and the benefits to the community (public and financial) and distribute the report to the media, your Minister and place it on your website.

It should be a badge of honour.

INVESTMENT OPINION

Interest Rates – I thought I was throwing cold water around last week on this subject, yet this week interest rates have taken an even more stark move lower.

The US Federal Reserve and the Reserve Bank of NZ have done what markets expected and cut their respective overnight interest rates. (see OCR comments below)

However, sentiment linked to the trade war between the US and China and plus the escalating political tensions in various locations, but most heated in Hong Kong, are progressively removing almost all confidence that remaining optimists hung on to.

On July 31 (two weeks ago) the 10-year US Treasury bond offered a market yield of 2.00%. At the time of writing that yield is 1.74%. Note that the overnight cash rate in the US is around 2.25% at present.

In NZ our 5-year benchmark rate (swap rate) was around 1.50% only a month ago, yet today it is threatening to fall below 1.00%.

These are very large moves for long term interest rates, but of more concern is how fast these moves are happening.

For the sake of reference, the yield on a 5-year NZ government bond (default risk free) is about 0.82% and the 10-year bond yields about 1.10%.

Remember that NZ’s inflation target is +2.00% and expectations are currently about +1.80% so investors are accepting ‘default risk free’ with negative real yield expectations over the 5-10 year period ahead of us.

When lending to companies, with additional risks of default, investors deserve higher returns (credit margins). Yields on bonds issued by companies do indeed offer higher yields than government bonds, but I suspect you will be uninspired to hear that yields on all of these bonds are now below 3.00% and for the most part are within 0.25% - 0.50% of falling below 2.00% yields.

You’ll recall me discussing the new 5-year bond from Westpac last week, issued with a yield of 2.22%. This bond is now trading at a market yield of 1.75% and as an old financial market colleague points out to me, people who purchased this bond have enjoyed a +2.28% value gain in two weeks (59% per annum! – Ed).

This return won't perpetuate, but it is true that good value is still found in long term fixed interest investing (it temporarily protects you against declining interest rates).

If you are planning to arrange some new term deposits in the banks, please act sooner rather than later.

I expect that none of this continuous chatter from us about falling interest rates will be a surprise to you now. We’ve spoken about this probable future for interest rates for some time now; it no longer feels like a time warp.

The warnings remain real, to keep fully invested, because the ‘positive’ yields that remain on offer in NZ differ from the negative interest rate returns on US$12.5 Trillion bonds around the global markets.

I don’t want to believe that negative interest rates (yields) are probable in NZ. I know they are possible, as are most outcomes in financial markets, but probable?

Am I beginning to look a little naïve in thinking negative interest rates in NZ are improbable?

This subject is becoming one of consequential opposites; the lower interest rates go and the more commentary it inspires, the lower an investor’s returns (and level of interest – pun) become and the less they are interested in reading about it.

It is what it is, and we cannot simply close our eyes.

OCR – My first reaction is that the Reserve Bank overplayed its hand last week by cutting our Official Cash Rate by 0.50% (OCR now at 1.00%).

They used two bullets to kill the rabbit, which lay dead after the first shot.

The governor then reinforced the energy in the change by warning that further interest rate cuts are likely and negative interest rates will be used if necessary.

Take that.

It was far more than the market had forecast.

During the past 20 years OCR changes had settled into 0.25% increments when changes were announced with only two periods of exception; 2001 when the Twin Towers in NY were attacked, and in 2008 for the Global Financial Crisis.

There is one other outlier in March 2011 where Dr Bollard cut 0.50% in response to a very strong NZ dollar and the US government was threatening to not approve increased use of debt (we know how that ended – Ed).

So, 0.50% movements in the OCR have been linked to disturbing economic events and I don’t see today’s conditions being as disturbing as the GFC.

Maybe the situation in Hong Kong and the escalating trade war are parallel to the political stability concerns of the September 2011 attacks. Clearly Adrian Orr and his committee believe so.

Let’s take note of their concerns. They allocate a lot of skilled time to the permutations.

Adrian Orr quite rightly said that investors will need to pursue a higher proportion of productive investment assets, reducing their fixed interest asset allocations as interest rates track into negative real yield territory. We wholeheartedly agree.

The other thing that Adrian Orr would like from you is to spend more money please. Keep the economic wheel turning.

I’d be grateful if you didn’t share this last point from the governor with my wife; she has enough shoes (can you ever have enough? – Mrs Ed.)

Demographics – I read an excellent article summarising global demographic data last week. It reminded me of another book I had read years ago on the same subject and the cornerstone importance of global populations in economic outcomes.

The article reminds us that globally, outside India and Africa, the world’s fertility rates forecast declining population for many nations and given the rate of change between about 1970 (5 children per mother) and now (2cpm) there is a significant change developing between the age quartiles.

Global fertility rates are struggling to hold at 2 children per mother as the declining trend continues.

The number of young productive people present to assist the elderly is falling fast as a ratio and thus delivering rather serious financial consequences, especially to those nations that have already overspent for lifestyles that were not affordable.

Globally we have just crossed over the point where people 65+ years of age exceed people under 5 years of age.

Japan and Europe saw this crossover happen in 1978 and 1965 respectively. China reached the crossover in 2002 and this demographic data is affecting economic performance for all of them.

Interestingly the demographics in the US are more balanced.

It has taken about 50 years for the world’s progressive change in the shape and scale of a family to put us in the position of demographic mismatch, and the disruptive forces that will result, so it’s entirely reasonable to believe that it will take another 50 years (two generations) for a more balanced position to be reached.

The irony is that many of the world’s older population view children as replacing them as producers and as supporters for them in old age yet from what I see it will be the retired who are supporting grandchildren financially over the next 25 years.

That financial support from grandparents will not come from the attractive returns on savings, which we all now know are shrinking fast, but from the passing of equity from one generation to another (possibly leap frogging one in the process).

Think of it as re-opening the pocket money routines for your grandchildren, but make sure they mow your lawns and help you with technology and the modern methods of interaction with the world.

Guardians of NZ Super is good for NZ and we should continue contributing to this fund. Kiwisaver is a good vehicle for NZ, and for teaching the young about the lost art of saving.

I happen to agree with those in politics who are calling for an increase to the age of entitlement for National Super. If enough lead time is given savings can be accumulated. Peter Dunne’s proposal for discounted early access made sense for those with compromised life expectancy.

Last week Mainfreight reminded us all that it tries to work to a 100-year strategy; retirement villages should be doing the same thing with their property portfolios because it is entirely possible that by the year 2070 the residents of my Dad’s retirement village will be 25-40 years of age.

The demographic trends are a clear contributor to today’s economic circumstances and because the demographics are not changing fast it seems very likely that the economic situation won’t either.

Japan has a head start on most of us. Maybe a research trip is required.

Fed Now – The US Federal Reserve reminded us that crypto currencies remain a curiosity for them and not an embedded feature of future payment systems.

The Fed has announced the development of a real time payment system (named FEDNOW), finished by 2024 and accessible by all 10,000 US banks (this number was hard to comprehend!).

Current real time payment ‘Apps’ are dependent on the payer and payee both being on the same application, which very often they are not. It’s likely that the majority of the retired generation don’t even use an App for payment.

The Fed is correct that for real economic benefits all members of the population and all businesses need to be able to participate in a real time payments system. The marketing line is ‘ubiquitous, safe, efficient’.

The plan is to provide live (real time) banking every day of the year.

The initial payment limit will be US$25,000 until systems are tested and proved but this clearly covers the majority of transactions within an economy.

The rising use of electronic accounting, and invoicing, should so easily link to a FEDNOW styled payment system and dramatically reduce waiting times for payment (unlike the behaviour of Fonterra and Fletchers in NZ who enforce delayed payments on small business – Ed).

Next, we need other central banks globally to follow up by establishing their own trusted live payment services, which could then allow far more efficient foreign exchange settlement services between countries.

If anything, it is a disappointment that our central banks have taken so long to deliver improved payment systems given the current age of technology development but if they want to describe crypto currencies as ‘investments not currencies’ they will need to improve payment systems for legal tender currencies.

Voting season – I have been invited to vote at annual meetings for a few of my investments.

Fortunately, I no longer need to take action as I have put in place a Standing Proxy (at both Computershare and Link Market Services) assigning my votes to the NZ Shareholders Association to act on my behalf.

I like that my vote is being applied, and applied well, increasing its leverage by consolidating it in the hands of the NZSA who by now surely are acting as proxy on millions of shares in various companies.

If you have applied your own Standing Proxy to the NZSA, well done.

If you have not, and would like to do so, let us know by email and we will email you the forms and a page describing the steps to take to put your Standing Proxy in place.

Vital Healthcare – The VHP managers have spent (wasted?) $4.3 million evaluating a deal that they did not do.

You don’t get many guesses as to who benefited from the spending.

To put this amount into perspective, VHP’s dividend could have been increased by 10% if they had not ‘wasted’ this money elsewhere.

EVER THE OPTIMIST

 

Unemployment falling to an 11-year low at 3.90% is surely good news, even if this is now old data.

However, someone cleverer than me will need to explain the simultaneous increase in benefit claims (11% year on year) whilst the economy says it is crying out for more employees?

ETO II – consistent with the above story on employment privately held company Datacom (partly owned by Guardians of NZ Super) added approximately 1,200 new employees in the year to March 2019!

INVESTMENT OPPORTUNITIES

Napier Port – Hawke’s Bay Regional Council must be very pleased with their recent share float.

Enormous demand led to a high share price of $2.60 presenting impressive funding to the Napier Port for its future development.

Investors outside the region, and the services of the lead managers, received few if any shares.

I hope the success of this Mixed Ownership Model share float is copied by other council’s around the country.

The NZX will welcome Napier Port to the market and invite other such businesses to follow.

New Bonds – we are told to expect some new bond offers in the weeks ahead.

Once details are known, you’ll read about them here. We will also broadcast them to those on our ‘all new issues’ list (which people are welcome to join).

TRAVEL

Kevin will be in Christchurch on 5 September.

Edward will be in Auckland on 4 September, in Wellington on 12 September, in Napier on 16 September.

 

 

Mike Warrington


Market News – 5 August 2019

Reports that China is moving troops South, closer to the border with Hong Kong are unsettling and if confirmed will undoubtedly lead to an escalation of protest behaviour.

The protests are large enough already, and becoming a little violent at the fringe, so the concept of Beijing poking them with a stick would be a mistake in my view.

Given China’s predictable approach (dictatorship, total control from a single point) this Hong Kong situation could become very messy indeed for what has been a thriving economic area for Asia.

New Zealand could do worse than to discuss the potential for inviting some of Hong Kong’s best, brightest and most productive people to emigrate to NZ and to bring any portable businesses with them (to domicile in NZ, pay tax in NZ and employ some locals).

Our freedoms must look very appealing to HK people right now.

INVESTMENT OPINION

US Trade – As prophesised once, here in Market News, I doubt that President Trump has any real interest in resolving the trade dispute with China so far out from the next election.

Last week one headline reported that the US and China would sit down to talk again.

24 hours later the President tweeted an attack about a China trade ‘rip-off’.

The art of the deal?

How to win friends and influence people?

Or, gathering votes 101?

At least in NZ Shane Jones is honest about ‘gathering votes 101’ as his foundation.

Interest Rates – For most readers the following will ‘sound’ like a scratched record, repetitively jumping back to the lyrics about falling interest rates but there is no harmony and the tune doesn’t change even if we shift the stylus.

Investors are continuously tasked with looking forward in time to make new investment decisions, a requirement each time money is returned to them or saved up anew.

Frustratingly the interest rate landscape continues to decline and appears to be on the move lower yet again.

Two weeks ago, Westpac NZ borrowed some money by issuing $900 million of senior bonds for a five-year term at an interest rate of 2.22% (a new high mark for volume of bank senior bonds issued).

The deal was reported as being well over-subscribed by investor demand even though nominal and marginal interest rates are lower than earlier this year. The amounts of money currently available for investment in bonds, or the willingness to buy longer term bonds rather than holding short term deposits, is increasing to the point where a lack of domestic supply is a problem.

Most of you are familiar with the decline in nominal interest rates, but credit margins are also declining again. The ‘credit margin’ that Westpac currently pays over the underlying benchmark rate has fallen by 45 pasis points this year (down from an additional 1.10% margin to about 0.65% now).

Before you become too shocked about the 2.22% interest rate, I’ll also point out that WBC NZ agreed to issue these bonds with a credit margin of +0.85%, being 0.20% more than they currently pay if borrowing the same money in Australia. So, the NZ bond rate could well have been issued even closer to 2.00% if they had chosen to borrow a smaller sum.

Term deposits at Westpac NZ rank parri passu (alongside) with these newly issued senior bonds meaning that if WBC was to fail as a business bank deposits and these senior bonds would rank equally for repayment.

Currently WBC NZ offers to pay 3.00% interest on a five-year term deposit; how long do you think such interest rates will be offered on term deposits if a bank can issue bonds to borrow money for the same term at 2.20%?

The regulator in Australia is applying pressure on banks there to increase equity settings on their balance sheets. They have taken a different approach to the central bank in NZ but one outcome is the same, being that the default risk of a bank will decline as the equity weightings on the banks’ balance sheets increase.

A lower risk of default should mean that a bank will reduce the real reward that it offers to those willing to lend them money (less risk = less return).

Borrowers have been told that higher equity obligations demanded by the central bank will mean that borrowers pay a relatively higher price (interest rate) when they borrow money (if they actually gain loan approval).

This will be true, but this development will take a while to play out and be seen by the borrowers. It will happen as loans are repriced or new debt arrangements are negotiated in the months and years ahead as the new equity settings are put in place (The RBNZ has proposed a 5 year introduction period).

However, investors are seeing an almost immediate impact from the central bank equity setting changes with interest rates being cut immediately, without reference to any change in inflation or underlying benchmark interest rates.

Default risk is a forward-looking situation. Lenders to banks already know what the regulators are demanding (higher equity, less risk), as do the banks, so the pricing (reward) for lending money to the bank is falling right now, based on the forward-looking information.

So, investors are the first to feel the ramifications of the push to strengthen the bank balance sheets, and not the borrowers, which is a shame given that savers display desirable behaviours within an economy. Borrowers feel like they are enjoying a winning outcome because nominal interest rates on debts are falling faster than the marginal increase in the cost of debt (measured relatively to inflation or returns on other assets).

The nominal declines are moving faster than the marginal increases.

Yet investors are experiencing pain from the nominal interest rate declines and not participating in the marginal increases that should be available from lending money.

Gaining 3.50% on a bank term deposit was available until June, shortly after the RBNZ announced its proposed higher equity demands from banks. The most common interest rate is now 3.00% and, in our view, these will be more like 2.75% soon and 3.00% will only be an occasional illusion to reach out to.

The banks are logically responding to both the ongoing decline in nominal interest rates globally, and thus locally, and they are responding to the pricing signals resulting from the reduced risks of future bank balance sheets.

During the first 20 years of my career interest rates were following a long-term trend of declining interest rates but there were interim cycles where interest rates increased to retest old theories about inflation and economics.

For the past 10 years interest rates have been in an almost constant state of decline, with the exception of a brief period in the US where the Federal Reserve tried to adopt 1990’s analysis to their improving economy. The US is about to re-join the tide, where once they held lunar rights.

What can I tell you?

There is no magic around the corner to provide investors with higher returns.

At a minimum, keep yourself fully invested because short term cash in the banks will be the worst performing asset class over the next five, and perhaps 10 years.

I guess that’s not saying all that much because Vanguard proved this statement correct across almost all-time frames back over 85 years.

I hope I am preaching to the converted, and thus the fully invested.

International Growth – As a generalisation NZ business aren’t very good at international expansion. Success seems to be the exception.

There are many examples to cite and most of us have been invested in one, or another.

So, it’s nice to read about those doing well.

Fisher & Paykel Healthcare is a long-term outperformer.

With a dose of bias, reading recent corporate reports, I like to read about the ongoing growth for the international parts of EROAD and Xero; technology is a near borderless product and should thus be easier to export (and compete with – Ed).

There are other private businesses developing software for the entertainment industries (gaming, movies etc) from NZ, and Wellington especially, and this silent export deserves wider applause.

Both EROAD and Xero have had to work hard and stick to their plan to reach their current states of cash flow surpluses and very good prospects for the future of their businesses.

A2 Milk has been a phenomenon, simply selling a brand.

Delegats has been a long-term success from our primary industry sector, compounding far more value annually than Fonterra does for our diary sector. In fact, Fonterra would do well to ask for input from A2 Milk and Delegats.

Mainfreight is demonstrating that a better strategy within a service sector can win abroad.

NZ so badly needs to increase it exports (type and volume). Our balance of trade has been negative (money out) for most of my working years and we need this to change if we are to improve ‘the lot’ of our population.

It is unrealistic of our politicians to make ever larger promises of financial support and better personal outcomes to the population if ‘we’ as a country do not achieve far greater sales of our products and services to the world.

As investors, confronted by the risk of interest rates declining very close to 0%, we also need more productive businesses available to us (publicly listed) to gain access to real returns on the capital that we invest.

All investors must be frustrated by the lack of choice on the stock market for investing in exporter businesses but we are grateful for those currently available. We enjoy reading about the results of those who appear to be winning and we applaud their directors and management for their successful and insightful leadership.

Mainfreight – A little more on MFT.

In their recent announcement to the market they included fresh displays of admirable management and governance behaviour.

For those investors joining the hunt for sustainable and environmentally friendly I would be more inclined to direct you toward companies that walk the talk with financial behaviour too.

MFT proudly explains that its tax payments have increased alongside rising profits and they have no intention of hiding their now international business in a tax haven for the benefit of shareholders but to the detriment of societies;

The company was honest enough to mark themselves as ‘could do better’ when reviewing the past quarter (even though it is a short snapshot within a 100 year plan);

They forecast that they will indeed do better over the balance of the year;

They confirmed their ongoing international successes reporting that international profits (56% of the mix) now exceed those of the NZ division;

Organic growth, improving and expanding their own businesses is using the company’s available capital and they see no need to ask for more capital simply to pay high prices to buy other businesses and deal with the bad habits of others; and

MFT explained the sensible logic behind its generous staff bonus pool (11% of profits) – each branch of the business must be profitable, and each sequential year must be more productive than the last (the very definitions of outperforming the norm).

The admirable governance and management has rewarded owners with sequential increases in dividend payments and thus ongoing rises to the share price. Increased profits and dividends will be seen ever more clearly in an investment landscape of declining returns.

To repeat my compliment, MFT has also delivered incremental increases in tax payments.

In fact, Chairman Bruce Plested was talking in such a socially responsible way it wouldn’t surprise me if he rode into parliament on a ‘horse’ alongside Christopher Luxon in the near future.

EVER THE OPTIMIST

 

Auckland building consents are again hitting records. This is real data that represents renewed confidence in the need to continue adding residential accommodation to the market for our largest city.

INVESTMENT OPPORTUNITIES

Napier Port – All bids are in requesting allocations of shares in the Napier Port float.

There is clearly a huge excess of demand for the shares. With a regional population of about 165,000 being offered priority access the share float would be full if only half of this group purchased the minimum number of shares offered!

Hawke’s Bay Regional Council should be very pleased with their decision to invite external investors, especially locals, and the timing of their share float is beginning to look very good indeed.

We hope to see the Port development deliver an economic boost to the region. I’d like to believe they could get their irrigation dam back to the start line too.

No doubt the NZX will be pleased to have another member on the bourse.

We hope this inspires other central and local government organisations to consider partial floats of shares in other businesses in NZ.

New Bonds – we are told to expect some new bond offers in the weeks ahead.

Once details are known, you’ll read about them here. We will also broadcast them to those on our ‘all new issues’ list (which people are welcome to join).

TRAVEL

Kevin will be in Queenstown on 23 August and in Christchurch on 5 September.

 

Mike Warrington


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