Chris Lee & Partners Ltd

Market News 12 December                   *** MERRY CHRISTMAS ***

This will be my last newsletter for the year as we close the office on Friday for the Christmas break, thus it has become my review of 2016 and thoughts in preparation for 2017.

Having a rest from the keyboard will be nice but evidence would suggest that after nine years with Chris and approximately 425 newsletters there is little doubt that I will have opinions to share well into the future.

2016

Looking back on 2016 it took quite some time to research all that happened such is the weakness of my memory combined with the very high volume of information and new investment offers that occurred during the year.

New offer investment activity was very high during 2016.

Whilst there were only three new equity offers (IPO) I lost count at 24 for new bond offers for the year, which provided investors with plenty of opportunity to populate any strategic gaps in their portfolio (measured against their personal investment policies).

The Financial Markets Conduct Act has made a huge improvement to the ease with which NZX listed companies can issue new bonds and they were quick to embrace this and we believe they will continue this behaviour well into the future.

The share market tried to retreat in price several times but ultimately my preference for lower share pricing failed to emerge and the capital value of shares is up approximately 9% for the year (NZX50 Capital).

There have been some failed and failing businesses on the market, as there always will be in an economy. I’d rather not dwell on them other than to chastise Wynyard for their inept performance and to remind investors of the need to review portfolios to keep an eye out for struggling businesses.

Wynyard failed so quickly that it almost happened ‘between reviews’ providing very limited time to exit such an exposure based on research. This situation reminds me of the merit in trusting one’s instincts just as much as the public releases made by companies.

Interest rates fell further during 2016, which we expected, but they began to show some signs of increasing late in the year. I have covered this point later as I review the predictions we made for the past year.

The standout information though from 2016 was political change, which surprised some and shocked others but on reflection maybe the changes should have received a higher probability rating because voting is a reflection of what ‘we’ (the public) have been saying in continuously increasing numbers.

Based on today’s outcomes no political change in 2017 and 2018 should be discounted as impossible.

Dissatisfaction with political leadership has been rising as an ever-widening group of the population feel that their situation has been compressed to an unacceptable point.

This dissatisfaction was made clear to me recently during a class project by14 year olds; they decided to use their Social Studies project as an opportunity to mock politicians. Politics was more than just typical fodder for satire; the presentation reflected their lack of respect for the quality of global leadership, where I use the term ‘leadership’ very loosely.

The benefits of cheap money from the past eight years have not helped enough people.

Too many of the repressed folk were not in a position to borrow money and enjoy its low cost and they are declaring that cheap money is not leading to sufficient improvement in their employment outcomes (first derivative of cheap money) and is not resulting in stronger economies through debt repayment (second derivative of cheap money).

The repressed can see the problem clearly and they have given up waiting for the rest of us to recognise it.

It now appears that many governments will be forced by their electorate to spend more money to satisfy these people. Increasing tax collection is one option for increasing spending but for many nations’ urgent increases to spending means immediate increases to national debt levels from ratios that are already being described as high, or intolerable.

The increased debt strategy is ‘kicking the can down the road’ and you all know that it is impossible to perpetually spend more than you earn.

Something’s got to give, but I doubt the pressure release valve will be heard during 2017 given the energy for change (toward more spending).

BREXIT – This development seems a long time ago, yet its legal status is ‘yet to launch’. It stood a chance of being the biggest news of 2016, until the US Presidential elections came along.

The British High Court has determined that BREXIT can only progress following a parliamentary vote. The ‘Remainiacs’ will likely see this as an opportunity to try and block BREXIT but I cannot think of anything more stupid for the British government than not following the will of the majority of its people.

BREXIT still has plenty of potential to be disruptive to global economics and thus investment decisions.

BREXIT is a symptom and to some extent the European Union is still grappling to understand the cause, a cause which poses a very serious threat to the EU that was intended by its designers.

As European President for 60 seconds I suggest that the European Council look back at the simplest objectives that were proposed for the EU back in 1949 by its conceptual instigator, Frenchman Robert Schuman; to avoid war and have countries reconcile within a supranational association.

Many of the demands set by the EU seem to extend well beyond these core principles.

Ironically the post-war ‘EU’ olive branch was offered to Germany to join this new organisation, but Germany is now the nation that is doing the most to hold the EU together.

EU membership expanded slowly over time and now two members have departed (Greenland, UK pending) without war being their motive. Perhaps movement in and out of membership should be a feature of the union for non core nations (The original six) with economic advantages increasing with tenure and removed completely upon departure?

Europe is still a very big subject and thus will provide us with new disruptive risk influences to consider for many years to come.

Trump - speaking of disruption, Donald Trump takes his seat in the Oval Office on January 20th 2017 and the world waits with more trepidation than excitement to learn what ‘show me’ will deliver from Trump after so many months of often bizarre ‘tell me’ content.

I think investors have an opportunity now to sit and be patient during the first quarter of 2017 before making any significant changes to their investment strategies.

The early shock moves for markets occurred in the hours after Trump’s election, such as the 0.50% increase to long-term (10 year) interest rates and the renewed bullish tone to the US share market. These primary trends are likely to continue in small doses over Christmas as the world waits for January 20th to pass.

Then, between January 21st and early May (first 100 days) investors should pay close attention to the actions taken by the excessively vocal President. Thereafter I suspect the next three months or so will be similarly energetic by Trump and the Republican House. It seems likely that there will be a lot to digest.

The actions they take may well be very influential for financial markets if Trump is half as active with the ‘pen’ as he has been with his ‘mouth’.

Trump has promised a lot, much of which is illogical or in direct conflict with some of his own promises, hence my view that patience is best.

The first few months should give us a steer for investment strategy for the following three years. The Trump scenario is not what we expected but investment risks are all about managing for the unexpected.

Most investors that we speak to are reasonably well positioned, even for this Trump environment, and thus I am happy to encourage patience whilst you head away to enjoy summer.

Europe – The Italians’ voted firmly (60%) against reforming the political structures of their country and in doing so confirm they are satisfied by their extraordinarily unsettled method of governance!

I find this vote to be consistent with the election of Trump, and of BREXIT, where voting reflects selfish preferences, unsurprisingly, and not good governance principles.

This voter trend will surely, in my view, present itself elsewhere in democratic locations around the globe over the next few years.

Greece then displayed a political willingness to dilute good governance values when they bowed to public pressure and paid out their hard-earned fiscal surplus in bonuses to retirees living on modest incomes.

They just don’t get it.

The generous creditors to Greece must have struggled to remove expletives from their communications of displeasure following the release of this news.

One cannot have their cake and eat it too. At some point people of influence will need to stop supplying new cakes to those who don’t understand this message, or do understand it but so far have learnt that people keep supplying new cakes.

John Key – This resignation was a surprise, but it is nonetheless refreshing for governance in NZ and I agree with one of his statements that there is a high risk of staleness and complacency when regulators get too long in the tooth.

I see no reason for concern relating to investment in NZ with respect to our current government, and the next government cycle.

Gareth Morgan and The Opportunities Party should provide our electorate with some fun, and some genuinely meaningful debate about NZ’s governance settings.

Financial markets have been very quick to try and distil the various significant political developments; one media article (Bloomberg) described how markets took three days to get over BREXIT, three hours to get over TRUMP and three minutes to move on from Italy’s referendum.

John Key’s resignation resulted in no market change at all, which is a good thing as it reflects the wider comfort with the NZ policy settings and balance of investment risks at present.

RBNZ – The central bank has been adding tension to banking regulations through its new macro prudential tools. The tools do seem to be having some impact on credit use (via reduced access), which is good, because this should free up more movement in the Official Cash rate (OCR) which needs to retain influence by price.

The OCR fell to an all time low of 1.75% during 2016. It might as well have been 0% for those with too much money in bank call accounts.

How many of you with investments in residential property thought the RBNZ was anti your investment strategy, but then read Gareth Morgan’s (The Opportunity Party) new tax policy which makes the RBNZ look like Santa!

I think the RBNZ will be quietly satisfied with its performance duing 2016.

Review my predictions for 2016

Prediction - I think returns from investing in fixed interest assets will remain low with 2.50% - 3.75% common from bank deposits, 3.50% - 4.75% from senior bonds and returns only exceeding 5.00% if additional default risk is accepted or complex terms are involved

This proved to be accurate throughout 2016 including after Donald Trump’s election as US President when longer term interest rates began to rise toward 4.75% again.

Prediction - Longer term interest rates for stronger bond selections will only exceed 5.00% if long term interest rates increase in the US

Our long term interest rates on senior bonds fell to just below 4.00% and have not yet threatened to go back above 5.00% and will only do so if Trump carries out some of his most disruptive and inflationary policies.

Prediction - I think the Official Cash Rate (OCR) in NZ will remain very low, either at 2.50% or perhaps as low as 2.00%. To hold at 2.50% will require the various macro prudential regulations such as lower Loan to Value Ratios (LVR) and higher bank capital demands to be proven effective for financial stability.

This was true and the OCR was ultimately cut to 1.75% which I hope is the low point. The lift in the US equivalent rate (Fed Funds Rate) is interesting but we need Australia to move higher from its current setting of 1.50% before NZ is likely to move much.

The new macro prudential tools are beginning to influence public behaviour (financially) and this is helpful as it should free up some potential to increase the OCR to further slow credit growth and hopefully increase savings rates (and bank deposits).

Prediction - I expect the US to begin increasing its equivalent of our OCR but the rate of change will be so slow as to allow ‘paint to dry between coats’.

The US did increase its Fed Funds rate by +0.25% last Christmas and after allowing 12 months between coats seem likely to increase by another +0.25% this Christmas. Making predictions in a Trump lead 2017 seems unwise to me but for the sake of a peg in the sand I do expect more interest rate increases but more than two increases would be a surprise to me.

Prediction - I will run with the same game plan as I did last year and invest with an expectation that share market indices will finish 2016 lower than their starting points.

Wrong, again. Low interest rates and populist belief that a nation can buy its way out of gloom (Trump et al) continues to fuel an overlay of optimism for market pricing (as opposed to value).

The following table displays the year to year performance of major equity indices:

Index                      Then             Now                Change

NZX50                       6,042               6,888          +14.00%

NZX50 Capital           3,006               3,291            +9.48%

ASX200                     4,938               5,438          +10.12%

Dow Jones (US)      17,375             19,216         +10.60%

Nikkei (Japan)         18,712             18,350            -2.00%

Shanghai (China)      3523                3,208             -8.94%

FTSE (UK)                5,946               6,746           +13.45%

EuroStoxx                 3,186               3,052              -4.20%

Bond Movements (10 year terms)

Dec 2014      Dec 2015      Dec 2016

2.25%            2.21%           2.39%  – US (Market Leader)

1.89%            1.47%           1.63%  - Canada

1.81%              1.73%         1.55%  - Spain

1.03%              0.92%         0.79%  - France

0.78%              0.57%         0.33%  – Germany

1.94%              1.64%         1.98%  - Italy

7.17%             8.62%          6.53%  – Greece

0.30%              -0.20%       -0.15% - Switzerland

2.01%             1.84%           1.40%  - UK

0.40%              0.30%          0.04%  - Japan

7.93%              7.82%          6.21%  - India

1.81%              3.02%         1.52%  - Hong Kong (China)

3.11%              2.82%          2.83%  – Australia

3.87%              3.55%          3.25% - NZ

2017

Investment Opportunities – Yes, there will be plenty of new investment opportunities during 2017, especially from the fixed interest market and rising interest rates should please all.

Banks are apparently finding it difficult to retain Core Funding Ratios at above the minimum of 75% from domestic deposits (weak) and long term international bond issuance (higher pricing) thus they are strategically reducing their willingness to lend (removal of unused committed lending facilities).

This situation has a direct link to New Zealand’s poor savings habit but retain an ongoing willingness to borrow money for consuming (new cars etc).

The changing bank behaviour has removed a ‘cheap funding option’ from many companies and the directors of those companies will wisely react by raising new capital (rights issues, hybrid securities) or issuing longer term bonds in their own names to achieve prudent funding outcomes for their businesses.

This means more investment opportunities for all of us.

Good News.

A little more product supply should also mean higher returns for all of us. One or two bond issues in late 2016 went very close to failing having set interest rates that were too low (on reflection). They would be unwise to sail too close to the wind with pricing in 2017.

More Good News.

The banks will need to respond with more competitive deposit rates, probably exceeding 4.00%.

Yet more good news.

We look forward to an environment that maintains stable inflation but where clients can again expect to see higher returns, between 4.00% - 5.00%, from deposits and senior bonds, with subordinated bond (or hybrid) offerings well above this range.

The share market has turned bullish (optimistic) again following Donald Trump’s election as President. The consensus view is, or wants to be, that low interest rates will be replaced as the economic sponsor by tax cuts and a ‘double up’ on fiscal spending by government which will flow into corporate profits.

Trump was named Time Magazine Person of The Year for 2016. He will undoubtedly be The Man of The Moment during 2017. By 2018 will we be saying ‘actually, he wasn’t so bad after all’, or, will Trump be impeached as one experienced commentator forecasts and go down as the disaster that many people fear today?

The binary risk of outcomes under the Trump presidency is the main reason to be very careful with your investment strategies during 2017.

Europe has many worrying structural issues to resolve both with its banking framework and the future for the European Union.

The majority of BREXIT needs to be negotiated, Italian banking failure needs to be navigated and in my view the EU needs to evict Greece.

These are huge changes for Europe to get through, a bit like a person experiencing a divorce, a house sale and a job loss within a month!

I don’t envy the people with decision making responsibilities in the EU.

Predictions

I am never all that keen to make predictions and in the populous political landscape that is developing, seeing the likes of Donald Trump elected as US President, I am even more wary of prophecising 2017 for investors.

As I write I am happy to retain the rough investment settings that I believed in for much of 2016 although I personally exited some speculative investments that had failed to perform. I finish the year holding predominantly robust investments that I believe can be held through various potential disruptions and I have very few speculative items.

Asset Allocation – The relatively disruptive political changes that are occurring does not inspire me to make significant changes to the broad asset allocation for a portfolio. I see no need for you to rush to large changes in response to the developing landscape.

Revolutionary political changes don’t, in my view, change investment portfolios from an evolutionary approach.

I am grateful to the ACC investment team for sharing their asset allocation data with Good Returns recently. ACC has beaten its investment benchmarks for the past 21 years, such is the quality of this management team.

I was interested in their settings for the past year, which continued to experience strong share market returns, where they held a reasonably conservative 62% in fixed interest assets, 5% in property and 33% in shares (local and global assets). Within the fixed interest portfolio they hold many inflation adjusted bonds, concerned about the potential for inflation to re-emerge. (the public hold various annual reset securities for this risk).

Privately I would be very interested in seeing their evolved settings for 2017.

We are always happy to review portfolio settings with clients and the first quarter of 2017 (once Trump has the pen in hand) will be a good time for doing so.

Shares – At the time of writing I think share markets have a high probability of rising during 2017 spurred on by increased government spending proposed in the US.

Increased government spending and lower taxes will replace cheap money in the US, although money (debt) will remain relatively cheap too.

Where the US markets go other developed markets will follow, although investors will need to be a little more selective as I do not expect this ‘rising tide’ to ‘lift all boats’.

If Trump’s policies do result in an escalation toward trade wars I would rather have investment exposures to the US than emerging markets. Trade wars are not desirable but being on the side of the biggest player(s) will be profitable.

Volatility will likely increase, so be careful with your share market investing.

Interest rates – We may finally have seen the low point for NZ’s Official Cash Rate and for long term interest rates, until that is the world’s excessive debts unravel.

Investors should not just sit on mountains of cash because ‘interest rates are going up’. Cash in call accounts and short term deposits will earn less than money invested for longer terms and I think this statement will be true for several years yet.

Also, regular readers should recall me saying that NZ fixed interest investments are not long at all. Most people struggle to invest beyond 12 months (90% cash in banks is deposited for 12 months or less), investors with financial advice usually have a good spread of maturities out to five year terms with a modest smattering beyond five years.

The average term for an advised investor remains very short at between two to three years. So, if interest rates rise further than seems likely at this point NZ investors will be quick to catch the lift in returns.

There is no need to sell any current bond holdings in my view. Investors are not traders. Commissions on trading are likely to remove all possible gains if any are actually achieved. (Please contact a financial adviser for your own specific advice).

Interest rates (short and long terms) look likely to finish 2017 higher than now but I do not expect them to move so fast as to disrupt selections that best suit your own portfolio (if you need a four year term then do that deal, don’t wait and speculate).

In the past we supported over-investment in longer terms given the ongoing risk of falling interest rates; now we support long term investing but only with nuetral amounts of money relative to the overall portfolio.

So, there you have it; surprisingly I think share markets will move higher, interest rates will also move higher and investors would therefore be happier by Christmas 2017 than they are today, and today people seem pretty happy with their lot.

Have a relaxing and merry Christmas with family and friends and we look forward to assisting you all in the New Year.

Michael Warrington and all in the offices at Chris Lee & Partners.

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Market News 5 December 2016

I can tell we have hit the Christmas season because people are leaving meetings and wishing me all the best for the festive season.

December?

Really?

Forget electric cars and fossil fuel cars, I am going to be forced to return to walking to try and slow this ship down.

I know that some of you have already put your Christmas trees up during November, no matter what I believe, making you part of a club that my wife is a member of.

Yes, I like the lights and decorations, in December but November is a birthday month in our household and I think it is important not to confuse my birthday with that of the late JC, he can wait his turn.

Grinch she says.

No, not at all, I love Christmas, on Christmas Day.

What about the joy of shopping, she asks? (No she doesn’t, she’s given up asking you – Ed)

Only if I own shares in the store you are going to.

Grinch she says again. Give me that dividend cheque I am going without you.

There’s no point denying it though, we are here, December, and in two weeks it will be lights out for a while, although given the Presidential handover in the US none of us will be short of interesting and influential reading material.

Chris and I will, in upcoming newsletters, look back at a most interesting year and ponder what 2017 might bring for us all; could it possibly be any more interesting and influential than 2016?

The short answer is yes, yes it could be.

Investment Opinion

Returns – There is a nice array of returns developing again across NZ fixed interest investments after the ‘accordion’ of returns from this asset class had closed up a little tightly by mid-2016.

The last time I felt that the accordion was too compressed was 10 years ago, to the month, which I was reminded about by the recent repayment of the 10-year annual reset bonds issued by Sky TV. The issuance of that Sky TV bond was an all-time low both in credit margin (swap +0.65% for unrated bonds) and emotion around a deal (failure).

At one point recently the range of returns across most fixed interest risk types had narrowed to be inside 2.00% from top to bottom (with a few outliers). Today this range has widened out to almost 4.00% again, which feels more appropriate to us, and brings the high point of higher risk fixed interest products more in line with the returns from some shares with reasonably reliable dividends.

We can thank two things for the reversion to higher returns for higher risks and better definition between each grouping; a recent over-supply of bond issuance followed by the election of Donald Trump as President in the US.

Today the ‘bellows’ have widened to the following ranges:

Bank Deposits: 3.25% - 4.00% per annum (may need to rise a little to cope with an imbalance between borrowing and lending activity at the banks)

Corporate senior bonds: 3.50% - 4.75% per annum (I am not too concerned about higher inflation but do hope that Trump succeeds in scaring yields on our longer term bonds above 5.00%)

Subordinated Tier II bank bonds: 5.00% - 5.30% per annum

Subordinated Tier I bank bonds: 7.00% - 7.75% (using a recent issue by IAG Australia as a proxy for the higher end of the range).

There may be a little further room to move up here but I suspect the major change has already occurred now.

Long suffering fixed interest investors should be pleased after years of declining returns from short term, long term and higher risk investing to see increased returns from longer terms and from higher risk items.

Even though I currently doubt interest rates will move much higher from here we are being given reasons to believe that we may have witnessed the low point for medium to long term fixed interest investment returns.

Short-term interest rates are likely to remain unrewarding, relative to longer terms, for the foreseeable future so the incentive to invest in longer terms will remain.

Trump – We should soon get some insight in public opinion about how successful Donald Trump will be as President.

Donald Trump is to announce plans to remove himself from influence over his various businesses to avoid conflicts of interest with his role as US President.

If the stocks immediately rise in value with his departure the US citizens have much to worry about.

Loss of Focus – A row has broken out (probably in a trendy café in the Cotswolds) over why the Bank of England should have made the new five pound note vegan friendly, and not tolerated use of animal fat in the production of the synthetic notes.

According to the headlines some café has stated they will refuse to accept payment in five pound notes.

This is loopy behaviour in a world that is increasingly requiring clarity and focus on issues that matter.

The Bank of England has foolishly responded openly and explained they are looking into the problem further.

Great, the institution tasked with financial stability and management of monetary policy has distracted itself with a belief that they should have a role in assessing suitable chemical compounds in a manufacturing process.

It’s good to see the British have moved on from BREXIT.

Investment News

 

John Key resigns – I thought the resignation of the Italian Prime Minister (now confirmed) would be this week’s news, but straight after Ernie Merrick (Phoenix coach) resigned John Key also lined up to join the party. (Perhaps Key wishes to be coach? – Ed)

Surprised? Yes.

I hope his health is good.

Let’s see where this goes, but I don’t view political change in NZ as being disruptive to the economy.

 

Austria – It’s healthy to have a laugh and whilst we shouldn’t usually do so at another person’s expense Austria is a country, not a natural person, so I think it’s OK on this occasion.

Austria was trying to rerun its Presidential election after complaints about the counting process from the previous attempt.

They were all set to go…. until a member of the public reported that the glue on the envelopes for the voting papers was failing to hold, which ‘opens’ (sorry) the way to allegations of more corruption with counting.

Apparently Austrians don’t have glue, tape or common sense to use a backup method for sealing an envelope.

Austrians’ really are becoming ‘detached’ from good leadership.

The election was then held on Sunday (last night) and I suspect Europe will be more than a little relieved that the ‘hard right’ party has conceded defeat.

 

Italian referendum – The Italian people are voting ‘No’ to the referendum calling for major reform to the country’s notoriously slow and costly government. (Italy has a “perfect” bicameral system – meaning its two chambers have the same powers as each other, leading to political gridlocks).

Exit polls, at the time of writing this, were settling with ‘Vota No’ at 55-59% and ‘Vota Si’ at 41-45%.

The early counting implies that the Italian Prime Minister (Renzi) will resign and the immediate regulatory future will be unclear for a while.

There will be plenty of market reaction and analytical forecasting in the news tonight, and tomorrow, and next week, next month, next year, for us all to digest.

Here is a website link to the count if you are interested.

http://elezioni.interno.it/referendum/scrutini/20161204/FX01000.htm

Hellaby  - After all the complaining and poor corporate behaviour Bapcor has increased its takeover offer to $3.60 per share, the bare minimum of the fair value range described by Grant Samuel recently ($3.60 - $4.12).

The higher bid confirms what we expected and what Grant Samuel felt was appropriate and it discloses that the decision makers behind Hugh Green’s investment vehicle (who encouraged people to accept the $3.30 offer) don’t have half of the skill that Hugh Green himself had.

Hellaby’s directors will now be obliged to describe the offer as ‘fair’, which is the strategy Bapcor is seeking with the new price, but I doubt they will be effusive in their next communication.

Profits – Unlike Wynyard in NZ, GoPro has recognised the importance of actually making a profit and knowing when you are heading in the wrong direction.

GoPro has cut 15% of its staff and eliminated its entertainment division in an effort to return to profitability next year by focusing on its core strength of selling cameras and their accessories and not getting into data (image) management.

Clarity and focus always help with business success and are coincidentally a noun and a verb with appropriate connection to GoPro.

Downer EDI – Where once the exposure to trains caused investor concern about Downer today they are again adding value as the company wins a new A$1.7 billion supply and maintenance contract in Sydney.

This contract followed close on the heels of another won in the state of Victoria.

Downer’s shares are now sitting at a post GFC high reflecting the markets confidence in the current financial success of the business.

The lift in capital risks for the business seem to reduce the potential for repayment of the perpetual securities in NZ, although the market price (close to $100) implies that some still view repayment as a chance.

House Pricing - The number of homes with an estimated value of more than $1 million increased from 59,000 in 2013 to 235,000 properties in 2016, a move from 3.25% of all private dwellings to 15% of them.

Really? Wow.

It is not credible that the incomes of this volume of people increased substantially enough to justify such price changes.

I know that much of it relates to a shortage of supply (Resource Management Act etc.) at a time of increased demand (immigration etc.) but at some point the sniff test needs to apply and current pricing ‘statistics’ don’t add up.

A $1m home is more than 20x the average after tax wage in NZ (full time worker), 10x if you convince a nice person to join you and help pay the bill.

I know, I am just stating the obvious.

On the same subject the Reserve Bank has said that it has prepared for banking regulations to restrict debt to income ratios but will not be rolling them out unless it saw house price inflation driven by credit. Rising credit from banks is looking less likely though as banks’ are strategically looking to reduce credit availability at present.

The decline in deposits from the public at a time when lending was increasing has made it difficult for banks to meet their Core Funding Ratio (CFR) obligations, so, lending will be reduced. The RBNZ will be pleased to see this regulatory force (CFR) having the desired impact.

I don’t expect much of a retreat in the average house price but I suspect the relentless march higher will now stop. If it doesn’t the RBNZ has warned that it will use its dry gunpowder (Debt to Income restrictions, and in my view higher mortgage rates via increased capital restrictions on banks).

If a residential property investor cannot gain an income level (rental) at, or greater than, an interest rate measured against the total value of the property then they are dependent on capital gain only for their rewards. The statistical likelihood of this outcome is declining fast.

Oil – For the first time in a very long time OPEC members have agreed to a modest cut to production, surprising markets and resulting in a 10% lift in the price of oil.

I wonder how long OPEC members will be able to hold the line given the increased oil supplies from the US (largest new finds ever in North West Texas, which would be profitable with an oil price at US$65) and the potential for Russia to increase supply one day.

Within the US President Barrack Obama also passed into law the maximum application of biofuels mixed into fossil fuels (ethanol mixed with petrol and biodiesel mixed with diesel).

This Renewable Fuel Standard was passed into law by George W Bush but Obama is increasing the ratios. Unsurprisingly this sets off a vigorous round of lobbying between the oil industry and the agriculture industry but Trump will find it hard to repeal given the wide support that he received from the agriculture focused states.

Saudi Arabia seems to know not to expect increased demand from the US and is considering an extra-ordinary new strategy to increase car use; allowing women to drive. (Sorry – Ed)

The self-sufficient oil status of the US will surely result in changes to the political behaviour of the US in the Middle East.

Side Note: Slow uptake of electric cars by the US, given this expanded move toward oil based fuels, doesn’t bode all that well for a rapid increase in the production volumes of electric cars.

Coastal Shipping – Kiwirail has moved quickly to negotiate access to coastal shipping space, especially between Christchurch and Auckland to replace its inability to move stock by rail up to Picton and on through the North Island.

This development clearly doesn’t help Centre Port in Wellington which has suffered the expense of earthquake damage and appears likely to lose some of the freight movement income that it enjoyed in the past. Ironically Lyttleton Port, which was so badly impacted by Canterbury’s earthquake, looks likely to gain traffic and revenue from this latest earthquake.

I hope Kiwirail’s drivers from the Christchurch to Picton run are successfully relocated to other regions because as I understand it there has generally been a shortage of drivers in NZ, or that was the case until the Australian economy cooled off.

These are all good examples of unexpected business risks that investors should always be contemplating when making new decisions; ‘what could go wrong and how would it impact me’?

Investors also like to think about what could go right but minimising downside risks (losses) takes up more thought time. For example Centre Port in Wellington should have been thinking about the many ‘what if’ risks to their business but Lyttleton Port will not have been contemplating the loss of the main trunk line between Christchurch and Picton as a potential business upside for them.

From a NZ perspective I am impressed that we have many options (transport) and are moving quickly to ensure that the recent earthquake damage doesn’t unnecessarily hamper our ability to get produce to market.

Finance Vacuum – The vacuum that was left in the NZ finance sector, after the wide-ranging failure of the non-bank deposit takers (finance companies) between 2007 and 2010, is progressively being filled by new and reformed institutions.

Two visible examples are Heartland Bank (born out of Marac, Ashburton & Southern Cross building societies) and Turners (born out of Dorchester Finance) who have claimed significant growth in the opening left by others.

Mortgage securitisation (bundling of housing loans for collective sale) has been trying to make a come-back and this enables non-bank mortgage lenders to expand and work around some of the Reserve Bank’s new lending regulations.

One such lender, adding more use of home loan lending, is Avanti Finance who recently received a BB credit rating from Standard & Poor’s including some compliments about their equity and business management quality but consistent with the subject of my note they included the following sentence:

S&P says there is ‘a lack of meaningful competition in the non-bank sector’.

Several new lender brands have been advertising on television and peer to peer lenders are popping up too, across different lending risk types. Sadly I suspect some of the loan shark type lenders are succeeding too.

More recently the banks’ have been reducing their willingness to lend, all of which plays further into the hands of the most successful of the smaller lenders.

Little wonder then that the two listed entities, Heartland Bank and Turners, are reporting robust financial performance at present and gaining analyst attention as likely to outperform in the year ahead too.

Patient Dorchester (DPC) investors should be pleased with the performance of the business that has evolved from the starting point of the 2010 restructure. Turners shares, at the point of exit from the DPC restructure, traded at the equivalent of about $1.25 per share (12.5 cents then, prior to consolidation). Turners shares are now trading around $3.50 each (35 cents by the old measure).

Accessing loans for some risk types (investment properties, apartments) is becoming more difficult but the fact that NZ private sector credit numbers are rising again proves that the non-bank finance sector is expanding once again (sadly – Ed).

This expansion of credit use benefits those who have populated the finance space left ‘cleared out’ by the multiple failures from the period around the Global Financial Crisis.

Commercial Property – The market prices of all listed property entities fell by unusually large proportions over the last six to eight weeks, partly in response to weaker markets, partly rising interest rates as Donald Trump was elected President.

The impact of the recent earthquakes on Wellington property stock did not help some of the assumptions being made by investors.

I suspect that all of the property companies’ executives will have been a little surprised by the share price moves as they were in the midst of gathering their latest data for reporting performance to the NZX (and owners).

They have all now reported and without meaningful exception they all reported increased asset values, higher profits, longer tenancies and continued quality improvements within portfolios. (Kiwi Property for example just re-signed a tenancy agreement for a 12 year term).

Did we witness a market disconnect?

In short, yes.

Influences that investors felt may be tidal in nature, and thus longer lasting, must have left some investors with cause for pause, or exit.

Over the past week the prices of the various shares/units have increased a little and in many cases with nerves settled by disclosure of the facts surrounding the performance of the assets and their managers buyers have been returning to the market.

Performance reports won’t always be rosy but at present the property managers have a lot to be proud of.

By the way, the return of Dividend Reinvestment Plans (DRP) from the listed property companies caught my attention too, especially given the relatively low and inexpensive debt levels of the various entities and share prices very close to the Net Tangible Asset levels for the business.

We pondered if it heralded a desire to buy or build more properties but given the breadth of the DRP offerings we think it is far more likely evidence to confirm evidence of banks reducing their willingness to lend as freely as they have in the past.

Property companies have wisely responded to this industry change by allowing equity ratios to drift higher and perhaps even to use any surplus cash to reduce actual debt levels (as opposed to ratios) to ensure a barrel of dry gun powder is retained for the rainy days or good value opportunities that emerge from time to time (often from others who are less well prepared).

If indeed the banks are applying more tension to the financing they will offer to the property market then a few forced sellers may emerge and the conservative investor will benefit as a result of their conservative positioning.

Ever The Optimist – When a Grinch mails off a note that begins ‘Dear Santa…’

ETO II – Hon. Todd McLay is leading a trade delegation to Iran and 18 businesses and educational institutions have agreed to travel with him.

The article I read defined Iran as our fifth largest trading partner in 1980. It would be fantastic if we could rebuild our trading with nations in and around the Middle East.

Investment Opportunities

Quantum – The Wellington Company offer of another property for sale via a syndicated structure is open - ‘TWC Quantum Dixon Street’.

The pdf version of the offer document is available under the Current Investments page of our website and we have hard copies available in our office.

If you wish to invest in this offer please contact us urgently to discuss access to a firm allocation.

Travel

We will close our offices on 16 December 2016 and re-open on Monday 9 January 2017.

We can be contacted on mobile phone and email if urgent matters arise, such as transactions. We will note our contact details in our final newsletters for the year.

‘Merry Christmas’ to all our readers. Be safe and be happy and we look forward to seeing you in the New Year.

Michael Warrington

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