Chris Lee & Partners Ltd

Market News – 26 August 2019

Get financial advice from qualified people.

Having National Radio leave people feeling a crisis was imminent last week and that banks weren’t to be trusted was unhelpful to all concerned.

INVESTMENT OPINION

Market Study – The A2 Milk (ATM) share price was an interesting case study for investors last week.

The company’s latest profit result presented revenue now up above $1 billion, profit margins of about 28% (Steel & Tube recently reported 2% and declining) and profit for the year of $287 million (+47% increase year on year) but the share price fell.

The abbreviated explanation is that the collective shareholders (marketplace) expected the result to be even better.

This is what markets do; they trade off all possible and probable information about financial performance until the facts are reported.

Surely the central bank will cut interest rates by 0.25%?

Until they announce a 0.50% interest rate cut.

Surely A2 Milk will report a profit of $325 million?

OK, not quite.

Sometimes a market will get a bit ahead of itself and allow optimism to become optimism squared (or temporarily cubed – Ed) and financial reports return some sanity to the situation.

I put A2 Milk into this category; a brand-based business story, that almost has less staff than our little business, generating >$1 billion in revenue, from profitable sales.

A2 Milk is something for NZ to be very excited about and for Fonterra directors to envy. With a staff of 128 A2’s market value is now twice that of Fonterra who have 22,000 on their payroll!

I don’t like looking backward, because it is pointless from the perspective of investment returns, but ‘what if’ Fonterra had simply hedged its bets with respect to potential sales of A2 versus A1 gene milk supply and invested in A2 Milk Company when the minnow required start up capital?

The capital call by ATM back then would have been less than the value of ten Fonterra trucks.

Actually, the Greens, or more likely the new Sustainable Party, should be very keen on the emerging demand growth and price premium for A2 milk supply, because if demand continues to grow it might enable NZ to generate greater returns from less cows (environmental relief).

The dairy farmers I stayed with a couple of years ago would be happy to migrate to A2 gene but only by gradual breeding and not wholesale culling of a herd. If ‘we’ haven’t started this strategic evolution of the national herd, we should do so, soon.

Transitioning a herd to pure A2 takes between 5 – 10 years.

However, I don’t run A2 Milk, nor Fonterra, nor manage herd breeding programmes  or run a dairy farm and have no interest in joining politics, so I’ll just hang on to a handful of shares and leave the difficult thinking to others.

Japan vs Korea – A couple of clients in Japan, plus an interested local, made contact on the subject of the minor trade spat between Japan and Korea.

It turns out that it may be related to their own little trade war, and the constant revisiting of old war crimes demands.

The trade item was described as the Japanese withholding exports of fluorinated polyimide, and hydrogen fluoride, needed for semi-conductors and Japan produces the purest forms in the world (so I am told).

Korea’s electronics manufacturers, and the country’s leadership, are not amused.

This was an example of an unintended consequence; if it’s OK for the US and China to change their terms of trade, then ‘we’ should do the same too.

We cannot view this as a good development.

Europe – Italy’s constant desire to change leadership has again seen the resignation of a Prime Minister Giuseppe Conte after only 18 months in the role.

I shouldn’t use the adjective ‘only’ because without looking it up 18 months is probably the average term of Italian Prime Ministers.

Along with the widening array of European countries with negative interest rates (see below) it’s hard to form a rosy outlook for European economics at present.

Infrastructure – Matt Whineray, CEO of the NZ Superannuation Fund, penned an article for the NZ Herald last week about New Zealand’s need to develop its infrastructure and a desire that government invite investors to participate in the process.

I’d encourage investors to read the article, which you can find on the Herald’s website (search Super Fund Hangs Out Its Shingle).

The amounts of money are enormous.

Our government’s financial position is robust so it has the potential to finance such projects but in my view those projects will enjoy better planning and better future performance if the governance of each project involves a portion of capital from private investors.

Local government, in most parts of NZ, is not in robust financial condition (over-indebted), which you can witness through your ever-increasing rates invoices, so regional infrastructure opportunities are probably more likely to become available than projects that are the responsibility of central government.

Regardless of what egotistical politicians think, private investors are far better at allocating capital than government entities (central and local). Governments make decisions with Other Peoples’ Money, which is easy, whereas for private investors the process is clearly very personal and therefore the decision making is much more careful.

About 10 years ago Lloyd Morrison established a Public Private Partnership fund and offered to invest in a variety of projects required by the NZ public. The fund was successful with modest amounts of investment (schools and prisons) but the process must have been too painful, and slow, because the majority of the funds money was subsequently invested in Australian projects.

Matt Whineray’s current call for access to invest in infrastructure reminds me of Lloyd’s ambitions, both for investors and for New Zealand. The NZ Super Fund has been an investor in a variety of funds managed by Morrison & Co.

There have also been articles recently criticising the Mixed Ownership Model (MOM) sales of shares in energy companies and Air NZ but again, I don’t like these backward looking, overly simplistic, analyses.

Each of these businesses may well have performed better under their MOM positioning. The government may well have extracted better returns from the money raised when it was used elsewhere; imagine if these funds were placed into the NZ Super Fund which has displayed very impressive returns over an extended period.

Savers are no longer going to be rewarded for lending money, so it would be nice if the government, and local government, provided a different incentive for the public to save money, being investment in infrastructure that is useful to the economy and would be priced to ‘probably’ deliver real returns (higher than inflation) to investors.

It is important that we continue to teach our population of the merit of savings.

The one missing subject from Matt’s article was that of liquidity to enable evolving ownership of each investment, but as ever I have a solution (an opinion – Ed); list each infrastructure entity (company or trust vehicle) on the NZX.

I can assure you that Mark Peterson (CEO of NZX) would be pleased to have the listings, as would we in the investment community, including Kiwisaver funds which have an ongoing need for such liquidity.

Imagine if we transferred infrastructure projects ‘go / no go’ away from the politicians and into the hands of professional analysts and private investors. Hon. David Parker says he wants to tackle, and reduce, red tape, which currently holds up some necessary progress. He will know he is succeeding if many more privately funded infrastructure projects proceed.

The broader the presence of NZX listed infrastructure investments became the more confident ‘we’ could become about getting projects underway and being able to invest in such projects.

Sometimes I revel in the simplicity of the problems that we solve here at Chris Lee & Partners and wonder aloud why politicians lack such clarity. (time to move on I think – Ed).

Travel & Trade – I see insurance companies are beginning to refuse to offer travel insurance to Hong Kong, and presumably other troubled parts of the globe.

This risk focused, rather risk sharing, trend from the insurance sector is visible in NZ post the Canterbury and Kaikoura earthquakes and will have quite significant effects on travel decisions and thus economics because tourism has become one of the world’s largest exports.

I may need to ask a few clients to better understand the insurance options for the prior generation when they set off abroad as young open minded people 40-50 years ago but I doubt insurance was an impost, and may not have been taken in many cases.

The rising costs of medicine mean travel without insurance is almost impossible, certainly unwise, so an inability to access travel insurance will be a big deal for the targeted economy.

I hope this means NZ will gain an increase in travellers based on our relatively safe location. We should promote the rising scale of our Police force, and perhaps the willingness of our military to provide support, in our ‘brand NZ’ marketing that Helen Clark spoke of recently.

Negative Interest Rates – Until recently we viewed negative interest rates as a strange language from ‘Far Far Away Land’ that wouldn’t appear at our shores, but it would now be an error to discount the potential.

Last week the German government issued a new 30-year bond, with a 0% coupon (interest rate) and asked the market what yield they would agree to (via auction); the answer was that investors were happy to buy the bonds with a return of -0.11%.

A negative return for 30 years.

Investors will pay $103 now and be happy to get $100 back in 30 years, receiving no interest payments during the life of the bond.

It sounds awful, doesn’t it?

According to one item I read 30% of the global tradable bond universe (US$16.7 Trillion) is now trading with a negative yield between now and maturity of those bonds.

Interest rates were not this weak (low) during, or in the aftermath of, the Global Financial Crisis. Are conditions really worse now?

Whatever the drivers, it is an ‘economic placard’ telling investors to make new plans (investment policy settings) for how to invest over the coming decade, and quite possibly 20-30 years.

There is no way to sugar coat this ‘statement’ from the market (accepting negative yields for 30 years for the protection of the German government); investors and investment managers are concerned about the long-term threat to capital retention.

Is this pricing cheap insurance for the protection of your asset or an absurd return on your money?

It is hard to be optimistic about the pan European economy. Four of the five central banks of the world with a negative interest rate setting for the overnight interest rate are in Europe (Switzerland, Denmark, Sweden and the ECB).

Japan is the other with a negative interest rate setting.

The negative interest rate movement appears to be a contagion.

The disincentive to lend will become greater as more global interest rates decline. RBNZ governor doesn’t mind this; he has urged savers to invest their capital more productively, which means to own more and to lend less.

Globally, investors, including superannuation schemes that have promised impossible returns to savers, will continue to buy bonds from trusted locations offering positive yields, further driving those interest rates lower as if one can arbitrage a Swiss interest rate against a New Zealand interest rate.

Maybe we can?

Is there all that much difference between the likelihood of repayment between Switzerland and New Zealand given our legislation for prudence with fiscal management?

I know what the credit rating agencies say, but they don’t manage real money.

Our interest rate market will continue to receive a lead indicator on potential lows for our interest rates from the returns on our ‘default risk free’ government bonds. These yields can go negative and I think I’ll stick my neck out and say I now expect them to do so based on current trends.

Very few of you own government bonds. Professional investors do, and as yields decline they are still adding value to bond funds (until the falling yields music stops – Ed).

However, if our risk free rate falls below 0%, interest rates offered by our next strongest borrowers will be uncomfortably close to 0%, let’s say 1% for short term deposits and 2.00% for long term deposits. Bonds from strong borrowers would be between 0.50% - 1.50% at that point.

I wanted to laugh at the absurdity of that paragraph as I was writing it, but I can’t because I sense it will become reality.

Banks in some international jurisdictions are beginning to present negative interest rates to borrowers, paying them to borrow money. I know this makes sense within the narrow confines of placing a profit spread between the price for borrowing and lending money, but paying people to borrow money is as absurd in reality as it sounds as a headline.

Save for some currency risks, why wouldn’t a person in such a country borrow 100% of their house value, be paid to live in that house and then invest their cash holdings in the most productive economies of the world (lending and owning shares)?

People with dual citizenship could arbitrage the finances of the two places they could live if it got a bit tricky in one or the other; be paid to borrow for their home in Switzerland but invest capital in NZ (buy citizenship! – Ed). Plus some in China and the US for diversity.

OK, too many facetious theories, but in the world of finance this is how risk comparison operates.

We may not want, or need, negative interest rates in our happy little economy, but their arrival may be beyond the control of our little market place.

Napier Port – is afloat.

After placement of the shares at $2.60 they spent the first week trading around $3.00.

Hawke’s Bay Regional Council and Napier Port should be proud of their decision to involve private investors in the development of their region, and be very pleased with the financial result of their share float.

They are an exact example of what Matt Whineray is calling out for, and we would be very pleased to see more of in NZ.

I hope the Hawke’s Bay economy sees the benefits that are intended from the Port’s expansion and that other regions, and the central government, feel the heat to do the same to assist more growth elsewhere.

Banks – APRA, part of the Australian bank regulatory tag team (alongside the RBA), has joined the NZ central bank (RBNZ) in applying more pressure to the banks to improve their behaviour, increase their capital and update their processes.

Until recently banks probably felt like a virtuous and integral part of our economy, whereas now they likely feely Ned Kelly on a poster nailed to a lamp post in the street.

EVER THE OPTIMIST

Rocket Lab continues its awesome journey, now up to its eighth launch, with four of them this calendar year and they have now placed 39 satellites into lower earth orbit.

It’s such a fabulous NZ success story.

ETO II

Good marketing helps.

Wellington On A Plate, and for the current fortnight Burger On A Plate has Wellington buzzing. Winter or not town is full and getting a booking to sample a nominated burger is difficult.

Wellingtonians are doing their bit to stave off the potential for a recession.

It’s great to see.

INVESTMENT OPPORTUNITIES

Infratil Bond – announced and launched its new bond on the same day (Tuesday last week).

On offer are two different terms:

7 years at a fixed rate at 3.35%; and

10 years at a floating rate, reset annually (3.50% for the first period).

The total sum being raised is $300 million and as large as this seems it really isn’t anymore so we don’t expect the offer to remain open all that long. Officially they say four weeks, but the rider is ‘unless filled sooner’.

If this offer fills, as we expect, it is unlikely that holders of the Infratil bond maturing this November (IFT200) will be approached with a reinvestment offer. If you are one of these investors, and you have spare cash, you may wish to consider reinvestment early into the current offer.

Transpower Bond – Transpower is issuing a new six year bond (matures 4 September 2025).

As a Crown owned entity with a AA- credit rating investors should view this bond in the ‘very strong’ category of risk.

Accordingly, the reward will be modest, estimated at 1.70% p.a. paid semi-annually.

This bond will be fast moving (firm demand by tomorrow please) with investors paying brokerage on the transactions.

Please contact us urgently if you wish to invest in these bonds.

TRAVEL

Edward will be in Auckland (Takapuna) on 4 September, in Wellington on 12 September, in Napier on 16 September and Taupo, 24 September.

Kevin and Johnny will be in Christchurch on 5 September.

Chris will be in Blenheim 13 September. He will be in Auckland on Monday 16 September (Albany), Tuesday 17 September (Mt Wellington), and in Christchurch Tuesday 24 September and Wednesday, 25 September.

 

David Colman will be in Lower Hutt on 11 September and New Plymouth on 19 September.

Mike Warrington

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Market News – 19 August 2019

Huawei.

There’s a very fine line between bold and stupid.

INVESTMENT OPINION

Fonterra - It’s hard to know where to start with this disappointment.

Fonterra has become the current poster child for reducing shareholder value.

Like the unprocessed logs leaving NZ via most of our ports, Fonterra’s result shows that we are no better at adding value to our milk supply.

Surely more than a few of you are pondering just what value CEO’s Andrew Ferrier and Theo Spierings truly added to Fonterra in return for their enormous salaries and exit bonuses.

Over a similar period of trying to add value Synlait Milk has more than quadrupled its market value whilst Fonterra has halved.

I guess the buck must stop at the board of directors, because the bucks never stopped flowing to the CEO office.

Fonterra is another of the great disappointments for the NZ economy, performing abysmally with its international expansion efforts, and is yet another warning to other businesses that interaction with China is not a simple solution to their trade dreams.

Hong Kong – The China situation, yes China, is worsening when it should be so simple to acknowledge the peoples’ concerns and settle the HK situation down.

Chinese leadership are throwing around terms such as ‘terrorism’ to justify their preferred actions, which are clearly physical enforcement and suppression.

It is the actions of the Chinese, and President Xi in particular because he is leading the current tone for China that are escalating the problem in HK, not those of the population living there.

It has been incredible to see the scale of the public protests, at very short notice. They make protests in NZ look like gatherings of the available.

The public’s use of social media and smart phones to coordinate their protests has been extraordinary to see. They are better organised than many military groups.

We’ll know that China has made another strategic error if they block cell phone transmission temporarily during periods of future disruption.

Hong Kong’s GDP will unquestionably drop for this period of local discontent. The time lost from production and the near-term slump in tourism must have an impact.

Much has been said in the headlines about China playing a long game in its trade war with the Trump led US but there is little point, nor value, in playing a long game when you don’t have appropriate cards in your hand.

Failing to take ‘your’ people along with you implies that politicians do not have the cards to play the current hand for a long period of time.

Settling the disruption in HK is a very important piece in stabilising the escalating political concerns around the globe.

Russia – More news from governments that prefer to manipulate the population (err, which ones don’t? – Ed), Russia has demanded that Google remove online video content that displays political protests.

These were ‘unsanctioned protests’. Good grief; ‘yes, you have permission to express a view in opposition on that matter, but not this one’.

Judging by the difficulty NZ faced in politely asking for assistance to remove online content, and the lengths that online businesses go to be legally unreachable, Russia and China will find it very difficult to dictate terms to these businesses.

The online information genie is out of the bottle and putting ‘her’ back isn’t an option.

To truly throttle access to online information is to hinder one’s own economy.

There’s also an irony with Russia demanding blocks to real information reaching the public after revelling in its hacking into other countries online channels to manipulate the information presented.

We appear to be continuing further along a path of more dangerous political disruption, witnessed by the usual failures of dictators to recognise their own weaknesses and a Western hemisphere that is more willing to push back.

Argentina – A democracy, but one that appears set to elect a more interventionist government again has seen the value of its share market listed companies fall by 30-50% in a day and its currency fall by 25% (-50% year to date) relative to the US dollar.

No wonder, when I was over their last November, Argentine businesses preferred that our group pay them in US dollars.

The shop that sold me the flat white and donut for ARG 10, accepting USD 3 now has the equivalent of ARG 15 12 months later (50% returns).

The mighty USD; not about to be knocked off its perch by crypto currencies.

As my thoughts continue to extrapolate, a trip to Argentina should now be as much as 30% cheaper than when I visited in 2018. Perhaps we should go back and visit the North this time. Lovely people, lovely scenery, lovely food and Adrian Orr tells me it’s important that I keep spending money to help.. economies.

South Korea vs Japan – It hasn’t been hard to find news items about political disruption, but this one surprised me.

South Korea is removing Japan from its ‘most trusted’ list of trading partners following the escalation of a dispute about ‘the basic principles of international export control’.

That’s a rather generic statement and there is bound to be more political tension behind it.

It doesn’t bode well for the proponents of Blockchain technology which looked like it had strong credentials for improving international trade movement and payment and reducing the potential for genuine disputes.

I can’t think of two more civilised nations than Japan and South Korea.

What’s going on here?

Discounts – After that long stream of concerns from the international political arena I thought I had better discuss something financial; in this case, financial ironing.

Given the very low returns provided from interest rates extracting other efficiencies from your portfolio is now increasingly important. Efficiencies such as keeping fees down, because they are the biggest killer of average returns, but also taking up price discounts when they are offered.

Dividend Reinvestment Plans (DRP), where you agree to invest more equity into a business by purchasing new shares with your cash dividend, do sometimes offer a discounted purchase price ranging from 1-3% in my recent experience.

1-3% is now the after tax return on a fixed interest investment (deposit or bond).

These purchases also come without the impost of brokerage cost.

If I make a couple of naïve assumptions about a flat earth, and perfect market pricing all day every day, then in the current interest rate environment it should ‘pay’ to use any discounted DRP schemes offered and support spending from surplus cash held in the call account at the bank.

Money in call accounts is, and will be for years, the lowest earning investment within a portfolio.

Historically I was a fan of collecting the cash. Some need to spend it and for others I suggested accumulation to then add diversity to the portfolio by introducing a new constituent.

However, for a portfolio earning say $15,000 per annum from its dividends, a 2% discount for buying additional shares is a $300 saving (added value to the portfolio) and the equivalent of waiting another year with that $15,000 resting in a bank term deposit.

It now takes 12 months to earn $300 after tax on a $15,000 term deposit.

In the case of this example DRP you have collected the actual dividend(s) and the equivalent of 12 months interest on those dividends.

$300 is not going to make or break your budget, or financial success that year, but the philosophy of optimising your outcomes (fees down, discounts up) will unquestionably add value to the net performance of your investing.

You need to keep an eye on which of your share investments offer DRP, and if they are offered at a price discount, because directors can, and do, turn both of these features on and off.

The one that caught my attention last week was Summerset, being an investment that most hold for growth (not income) anyway. The dividends are modest, but today the 2% price discount for a few additional shares makes financial sense and saves a few cents (12c for SUM shares).

You can see my view on DRP has evolved with changing market conditions.

If you have more income than you are spending, then you have more capacity to look closely at using DRP, especially when price discounts are on offer.

There is one caveat that I need to throw in here; a DRP is more effective (has more leverage) in a falling share market because you get to buy ever more shares as the price declines.

However, for the purpose of this paragraph I do not want to speculate on the direction of the market (remember, flat earth society) and market movement does not change the correctness of the principle that you will win by keeping your costs down.

Bonus Bonds – This paragraph could sit under a new headline that may be required in Market News – The Law of Unintended Consequences.

A reasonably large proportion of ‘you’ have funds ‘placed’ with Bonus Bonds; ‘placed’ because it is a game rather than an investment, and I wonder if more of you will begin to withdraw from this fund as interest rates (prize values) decline.

The Bonus Bonds fund still offers three benefits, easy access to the cash (liquidity), high quality assets (bonds with very strong credit ratings) and a chance at winning something from the prize pool.

This last point is where problems may surface.

The prize pool is formed from interest earned on the bonds owned by the fund. The ANZ deducts its handsome fee and the remainder is randomly allocated in prizes.

What happens to that prize pool when interest rate returns reach zero for the fund? (in fact, when interest rates fall below 0.87% being the ANZ annual fee, which the bank stated in 2016 it has no intention of changing from the then 1.28%).

The fee was cut from 1.28% to 1.15% and then 0.87%. It will need to be cut again for credibility.

The heat will become more serious when interest rates become negative in New Zealand (when?? – Ed). Although, as noted above, returns become negative for the Bonus Bond Fund once they fall below 0.87% for the assets selected by the fund.

If interest rate returns to the fund become negative will ANZ collect its fee by cancelling some of ‘your’ bonus bonds?

Just before you shred this paragraph thinking you can worry about this later once interest rates actually reach that point, I’ll point out to you that yields on almost all bonds that the fund invest in (strong credit ratings) now yield well below 2.00% for all terms.

I can be more specific; the average yield across all these bonds (courtesy of a BNZ market yields sheet, thank you) was 1.49% as at 13 August 2019, implying positive returns to the fund of just 0.62%.

The balance of money in the fund is about $3.1 billion (and declining finally), which implies a potential prize pool of $19 million (pre-tax).

Maybe the monthly draws will become quarterly, then semi-annual, then…. Not at all?

Maybe I shouldn’t extrapolate too far ahead. I usually criticise headlines and analysts who make sweeping assumptions including unchanged conditions for their multi-year forecasts.

You get the point though.

Reading about the history of Bonus Bonds, it was launched by the government, under NZ Post control, to try and encourage savings. At one point apparently one third of New Zealanders held some Bonus Bonds.

The fund switched to a commercial imperative when ANZ purchased Post Bank.

The government has a new, more logical, savings policy now called Kiwisaver.

Will the journey toward 0.00% interest rates kill off the Bonus Bonds fund?

It’s easy, and biased, for me to say that investors will be better off by accessing financial advice and maintaining a well-considered portfolio.

Adrian Orr, governor of the central bank, wisely told the public that one response to very low interest rates is to get financial advice and invest more productively. Clearly this same thought overlays for holders of Bonus Bonds.

EVER THE OPTIMIST

Owner occupier debt ratios are easing according to the Reserve Bank. The percentage with debt to income exceeding a factor of 5x has fallen from 37% to 31%.

Some of this improvement will relate to pay increases (also a good thing) and some, hopefully, to debt reduction, which I hope is a function of people maintaining their weekly payment amounts while interest rates decline.

It is a glimmer of hope for a nation where private debts are far too high. (with the majority of high ratio debts being first home buyers in Auckland, as you’d expect).

The central bank must also be pleased to see that a high proportion (73%) of bank supplied mortgages are to owner occupiers, with the declining risk ratio. (an inconvenient truth for increased equity on bank balance sheets? – Ed).

As a supplementary thought, the Reserve Bank noted that the data is only for owner-occupiers as data is harder to get for property investors.

I could even issue a Brick Bat under ETO, to the RBNZ, because surely the greatest risk to financial stability comes from the investors across this asset class.

It shouldn’t be that hard to establish income ranges (rent!) to measure against debt data (nominal and as a percentage of property value) to begin analysing averages, upper and lower quartiles and potential financial risks based on various market scenarios.

ETO II

JB Hi-Fi enjoyed a 2% increase in sales over the past year, so consumers are still active. (The Warehouse also reported increases year on year).

Of more interest to me was the statistic about online sales: ‘up 38%’, which seems substantial until you read that online sales were $13 million of the $236 million in total sales.

If you must store product for consumers to buy, surely you will always have some of it in ‘a shed’ on main street where people can see it.

Replacement volumes will be kept at cheaper property sites (lease costs) to feed online sales and restocking the front-line stores, which is sounding much the same as the traditional retail distribution model, with online as an additional channel.

INVESTMENT OPPORTUNITIES

Napier Port – The NPH share float is complete.

The Regional Council should be very pleased about the successful process and price achieved for its shares ($2.60).

Hawke’s Bay residents must be pleased with their priority access as investors.

The NZX is pleased to have them join the bourse.

Investors who missed out on the initial float will soon be able to reconsider investing through share purchases on the market.

A pretty good result all around.

New Bonds – pending, we are told.

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

Edward will be in Auckland on 4 September, in Wellington on 12 September, in Napier on 16 September and in Taupo on 24 September

Kevin will be in Christchurch on 5 September.

 

 

Mike Warrington

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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

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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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