Market News 1 August 2022

Here's a sign that sanity is returning to commercial decision making.

Elon Musk and Tesla have sold their Bitcoin and now return to using regulated currencies to pay for cars.

INVESTMENT OPINION

US Federal Reserve (Fed) – The fifth meeting of the year for the Federal Open Market Committee to consider changes to the interest rate (Fed Funds) is complete and the Fed decided to increase the interest rate by 0.75% to 2.50%.

The Fed has now increased their overnight rate four times in five meetings and are forecast to do it again at their next meeting in late September, encouraging us to assess the potential for another +0.75% then, but they'll be realistic about data as it emerges.

The decisions made by the Fed have carried additional weight in the market both to confirm (again) how aggressive the US central bank wishes to become with tightening monetary policy and because it was the last review before the ''summer break'' timing for US markets (and workers).

This rate of increase was highly anticipated and thoroughly debated and so it brought only modest change to levels of long-term interest rates and the share market's pricing (index).

However, it is useful to highlight that long term interest declined a little after the announcement (10-year US Treasuries are well below 3.00%), approaching 2.70% yield following weak GDP data (-0.90% for the 2nd quarter).

Yes, long term interest rates can go down when short term interest rates are going up.

Also of interest to investors, the US share market indices rose after the FED meeting because the Fed Chair uttered a few soothing words; we are aware of the negative impact of the rate hikes on the economy.

The share market interpreted this as we won't suffocate the economy. So, the market now thinks that a lower cost of funds (nominal and real) is now locked in long term and the scale of the potential recession is modest (at this point in the available information).

As always, time will tell, and the story will keep evolving.

The views from the most credible analysts differ by virtue of their focal length, in my opinion.

Larry Summers, one time US Secretary of the Treasury, argues that the Fed is not tackling inflation with the force required.

Janet Yellen, one time Fed Chair and the current US Secretary of the Treasury, thinks settings are being handled well and doesn't see excessive economic risks in the forecasts.

Investors, responsible for making decisions with trillions of dollars are leaning slightly toward the Yellen conclusions (long bond yields are down a bit, share prices are up a bit); this may just be due to the natural optimism displayed by the human species.

I recently wrote a note about the high relativity between the price of oil and inflation data and that tentatively economic anecdotes implied that the price of oil should be stable or declining soon (by 2023). Oil producers don't benefit for long if they suffocate oil consumers.

The oil price has declined a little, which will be settling the nerves of the most inflation aware.

However, I do not think the central banks should ease off from this moment of monetary tightening in response to the oil price. There is so much more to the pricing of capital in an economy than a relativity to the price of oil and it is well past time that ''we'' remove the artificial settings for interest rates.

Consistent with this thinking, Europe is confronting a recession, driven by energy shortages (Russian supply behaviour) yet the European Central Bank (ECB) is increasing interest rates. To link these two things would perversely provide Vladimir Putin with a lever to influence ECB interest rates!

This is another link that needs to be kept distanced.

Financial markets have accepted the need for the changed monetary strategy, and it would be an error by central banks if they don't take advantage of this setting (acceptance) and continue to press forward with maneuvering interest rates back up to the point that they offer a positive real return/cost again.

I won't suggest that you now tilt the blinds, but markets may well enjoy a period of more calm (less volatility) as the Northern hemisphere summer breaks get underway.

The next meeting of the US Federal Reserve is due to be held on September 20-21.

NZ Dependence – We need to be careful with respect to our dependence on the world and always have local and personal strategies for reacting to undesirable risks and outcomes forced upon our economy.

In another anecdote of how small a country we are, and thus penalized by our lack of scale, Z Energy has confirmed that it will now close its biofuel production plant.

ZEL had been trialing its ability to produce biofuel to add to diesel and meet the upcoming government regulations for minimum bio content (from April 2023). However, they have discovered that it is uneconomic to produce their own relative to importing from the global market and access to supplies of tallow was unreliable (and volatile in pricing).

For your interest, the international price of tallow has increased from 20 cents per pound in 2020 to 80 cents/Lb now. A political cynic would be unsurprised by the price rise following governments regulating for compulsory use in fuels!

I'll re-word ZEL's announcement: It is too expensive to build our own plant and equipment to the necessary scale for supplying a small market like New Zealand and the input pricing brings too much risk for the capital being invested.

It won't be because the 'returns' are too low; it will be due to the high probability of losses now and for the foreseeable future.

Fuel regulations will allow the likes of ZEL to factor into fuel pricing the proportionate costs of imported biofuel and to do so at the international pricing level, and thus not involve the use of any ZEL capital placed at unnecessary pricing risk.

Remember too, that anything that is now ''Mike Bennetts said'' should also be interpreted as ''AMPOL insists'' and in the face of rising costs, and declining sales, now is not a time for the ''nice to have'' business strategies.

Part of the spike in local inflation relates to our trade and finance links to the rest of the world. The price of oil is the clearest example to all New Zealanders.

Those who read a little more deeply into financial matters may also have observed the global rush to hold US Dollars relative to all others, when financial and economic risks increase. The suppressed value of, in our case, the NZ dollar further increases the price we pay for imported goods and services. (Witness NZ's widening trade deficit)

These views from me, by oblique but relevant connection, are reinforced by a view expressed by Dr Bryce Wilkinson and Leonard Hong for the NZ Initiative in their report 'Walking the path to the next global financial crisis' (an excellent read for the economically curious who seek expert opinion).

Bryce and Leonard are very concerned (as the title alludes) about the excessive level of financial risk being carried in the major economies and the flow through risks this represents to New Zealand.

The anecdote in China where property owners are refusing to meet their debt servicing obligations, fearing that the value of their property is about to fall below the scale of their debt, is a real-life example of what Bryce and Leonard are concerned about.

Chinese property developers are already being bankrupted, but more money is going to be lost and the property owners are yelling that they don't want it to be them alone. Bankers and taxpayers are the only other two who can contribute, but if the banks share in the losses it places the Chinese banking system at greater risk and is a very similar scenario to the US triggered Global Financial Crisis.

Given that it is election time and wannabe demigod Xi Jinping wants to stay in the job I am betting that the taxpayers are going to support the communal good.

Bryce and Leonard conclude:

For small economies, prudent defensive measures are the only option. The New Zealand government should plan to restore Crown net worth and public net debt to prudent levels before the next crisis hits.

You'll note that the expectation of a next crisis isn't a probability, but a certainty for them.

If NZ does not pursue such a careful economic strategy, their subsequent recommendation to you is:

The less prudent the government, the more prudent individual New Zealanders will need to be. Borrowing heavily to buy property or shares at current prices is like playing Russian roulette with one's financial future. Portfolios should be diversified. There are risks of both deflation and inflation.

Regular readers will know I occasionally point out that hope is not a good investment strategy.

A strategy of hope today involves believing the world's largest economies will successfully navigate their way back from the point of excessive debt, and that the NZ government will follow a strategy to insulate us from global failure to perform.

There are some clever minds at work globally, but in my observation the political preferences overrule the analytical tilting outcomes toward risk, not reward.

So, at the risk of sounding a little biased; control what you can, make financial decisions according to a strategy linked to your personal situation and get some financial advice.

Green – Regardless of your perspective about climate influences it is important that ''we'' keep walking forward with the improvements (as investors and consumers) because reading global data generously provided by BP we have a long way to go.

Some interesting global statistics:

Renewable energy (ex hydro and nuclear) has increased to … (only) 13% of global generation, rising at about 0.8% per annum;

Wind and solar are the fastest rising (subsidised) now at 10% of generation, but are not reliable as base load generators;

Coal is drifting lower, but still contributes 36%;

Gas was increasing as a percentage (23%) although Russia's behaviour may impact this trend;

Without a reduction in energy consumption (Europe's next winter will be interesting) the world needs to increase nuclear energy again (currently about 10% of generation) if we are to reduce coal and gas use;

Given the importance of irrigation in food production, I'd like to believe the world will take more steps to increase water retention (dams, with generators) and thus increase the input of hydro;

Data like this will help Infratil investors to understand the director's investment focus in renewable energy supply.

Argentina – is not a 'Sri Lanka', but they are struggling financially all the same.

The Argentinian peso (ARS) continues to decline, as the desired US dollar simultaneously strengthens.

When you look at pricing charts it has been an almost one-way track from 5 ARS per USD 10 years ago, to 15 ARS 5 years ago, to now being ARS130 (officially).

The black market confirms the difficulty in actually accessing USD (paper notes) because the reported price in the black market (not via US banking system) is ARS350.

No wonder the retailers always preferred to receive USD cash from us when we were travelling there 5 years ago. Even with an expensive airfare it would be much cheaper to travel to Argentina again now.

Currency movement, and sustained price trends relative to the USD, are very important signals that governments of the day should reflect upon as they make decisions that influence the economic performance and potential of the country.

The market thinks that Argentina has been making poor decisions for the past decade.

Argentinian government bonds now trade at yields of 40% and are signaling a high probability of default (again) and they are not yet showing signs of fighting inflation.

The neighbouring Chilean peso has also lost value over time, but at a far slower rate (minus 40% over the decade).

Chilean government bond yields are about 6.80% and they are engaging in tighter monetary policy to take the fight to inflation.

The New Zealand dollar has lost about 33% over the same time frame.

Some of this currency weakness for the NZD relates to interest rate differentials, but some is also due to weaker economic performance and frankly I'd quite like to see NZ focus on improving this latter issue and not ignore the financial signal.

Ever The Optimist

Samsung reports up to 45% reduction in energy consumption for its latest semiconductor chip design, reported as being a nearly invisible 3 nanometers in size.

I looked up a relativity reference – human hair is 60,000 nanometers.

Infratil – Continues to 'show' investors good form, in a market that drags its heels with acknowledging their investment performance (by discounting the share price).

The recent capital raise for Longroad Energy (part of the portfolio) was completed at a valuation at 3.6x that offered by independent valuers for 31 March 2022, and 1.16x the 30 June 2022 value (in the midst of negotiations).

I don't blame investors for placing reliance on third party valuations, but those valuers should be taking a good look at their processes and investors should contemplate the relativity between building future value and the immediacy of their demands for value to be delivered before accepting it as a truth.

Infratil CEO, Jason Boyes, rightly too the opportunity to say:

This transaction, alongside the sale of Vodafone New Zealand's passive mobile towers announced in July, continues the trend of private market valuations of infrastructure assets for like-minded, long-term investors exceeding listed market consensus.

On behalf of our clients, I'll take the opportunity to thank Paul Gaynor (Longroad CEO) and the Infratil (Morrison & Co) team for the recurrence of their outstanding performance.

ETO II

A Finnish business (Vatajankoski) has developed a ''battery'' of sand to store heat (from renewable generation) for redistribution over periods as long as months.

The stored heat can be used for both home heating and electricity generation (no description about energy loss during storage or conversion).

Ultimately the scientists will rescue us.

Investment Opportunities

Nothing has yet been announced but businesses are always planning for new debt and capital activity, so keep your eyes on our newsletters, or emails to All New Issues group (all are welcome to join this group via our website).

The secondary markets are always available for arranging new investments.

Travel

Johnny Lee will be in Christchurch on Wednesday 24 August (Russley Golf Club).

Edward will be in Wellington on Thursday 25 August (Featherston Street); and in Auckland again on 31 August (Ellerslie), 1 September (North Shore) and 2 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on Thursday 22.

Chris will be in Christchurch on September 5 and 6 (morning), in Ashburton on September 6 (pm) and in Timaru on September 7, keen to meet clients to discuss investment portfolios. 

David Colman will be in Lower Hutt on Friday 26 August and is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Michael Warrington


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