Chris Lee & Partners Ltd

Market News 18 December                

 

*** MERRY CHRISTMAS ***

This is my last newsletter for 2017 and is a look back at the past year and a little speculation about what 2018 may have in store for us.

We close the office this Wednesday at 5pm for the Christmas break.

2017

Plenty of opinion has been offered in recent years about market prices moving too high, too fast and an ever-increasing cohort of commentators are making predictions that pricing must soon slow down, or retreat.

That’s the ‘tell me’ part.

The ‘show me’ part is that many people are still applying more money to buying assets and applying money is the ultimate opinion about what one believes happens next.

However, a rising proportion of the decision-making is not done by people, it is done by machines that are programmed to follow trends and momentum with higher priority than the real value of an asset.

Ultimately real value still matters because it is how real returns will be measured.

Many headline grabbers prefer to predict that the turning point will be another crisis, without knowing what the trigger will be, but I only place a very small chance on a dramatic market failure.

I find myself nodding my head as I read articles from people that I have developed a longer-term respect for when they warn us of lower returns ahead (fixed interest and shares), but they are referring to a period of multiple years ahead of us, not trying to spot a turning point.

As I reach for the keyboard to inform you of our views it is no easier to tell you what to buy or sell with any certainty, regardless of this swirling universe of opinions.

I don’t have a statistic for you of the ratio between bullish and bearish commentary as we entered 2017 but I’ll guess at least half of what I read was bearish (prices expected to fall), yet markets this year (especially shares) charged higher in price.

This is a classic difficulty for decision making by investors; getting timing right.

Even if, on the balance of probabilities, I, or any other analyst, are correct about market pricing it is still no better than the toss of a coin when addressing timing for a change in the market’s pricing behaviour from optimistic to pessimistic.

I’ll tackle how to tip the scales in your favour below, under portfolio review.

Looking back at my meek attempt to make predictions for you for 2017 I see that I did think there was a high probability that share markets would rise in value this year.

I am as relieved as I am pleased that this guess has played out nicely; relieved that the market aligned with my guess and pleased that you have all enjoyed a profitable year from investing.

While I am on the subject of rising shares particularly, here is the table I used last year displaying annual performance of a few major indices (at the time of writing):

Index                     2015            2016            2017            Change

NZX50                          6,042               6,888               8146                +18.2%

NZX50 Capital             3,006               3,291               3,744               +13.7%

ASX200                        4,938               5,438               5,980               +10.0%

Dow Jones (US)           17,375             19,216             24,140             +25.6%

Nikkei (Japan)             18,712             18,350             22,457             +22.4%

Shanghai (China)         3523                3,208               3,277               +2.1%

FTSE (UK)                     5,946               6,746               7,348               +8.9%

EuroStoxx                    3,186               3,052               3,561               +16.7%

Plenty of people thought 2016 was too strong, especially on the back of five strong years for share pricing. They’ll be perplexed by the strength of 2017.

Some of these performance numbers would be extraordinary from the turning point of a weakened market (such as 2009), but they look quite unbelievable in the context of being the eighth sequential year of share market rises and what looks likely to be 12 sequential months of rising prices.

Is it a starburst moment?

I hope not, and I don’t think so. I’d rather not see your enlarged portfolios being sucked into a Black Hole or similar disruptive vortex.  (The markets were calm on the news that astrologists had discovered the largest Black Hole ever, and it wasn’t on Wall Street – Ed).

I paused for a while to reflect on the Chinese market having the weakest annual movement, yet they have the fastest growing economy. The simple strategy of tightening access to credit in China may well be the major ‘coolant’ for that market and if so, we would all be wise to monitor if the Western central banks achieve their stated goal(s) of tightening credit across the US, Europe and UK.

Tightening monetary policy will not be easy to achieve smoothly but with hints of stronger inflation, an obvious excess of debt use at present, and Trump’s tax cuts in the US it is appropriate that the central banks try to tighten monetary policy, in my view.

Maybe ‘smoothly’ is the key word above; central banks will try but the path will not be smooth?

However, for all the intent I do not think central banks will make large strides with the strategy of tightening monetary policy, so I don’t see this as a ‘trigger’ for weaker markets in 2018.

In a repeat of recent years’ comments, please do not get used to these hugely outsized returns from the share market.

While we are on tables of data, here are the movements in 10-year government bonds:

Dec 2014     Dec 2015     Dec 2016     Dec 2017     Country

2.25%             2.21%             2.39%              2.34%              – US (Market Leader)

1.89%              1.47%             1.63%              1.90%              - Canada

1.81%              1.73%             1.55%              1.41%              - Spain

1.03%              0.92%             0.79%              0.62%              - France

0.78%              0.57%             0.33%              0.32%              – Germany

1.94%              1.64%             1.98%              1.71%              - Italy

7.17%             8.62%             6.53%              5.45%              – Greece

0.30%              -0.20%             -0.15%             -0.16%             - Switzerland

2.01%             1.84%             1.40%              1.26%              - UK

0.40%              0.30%             0.04%              0.06%              - Japan

7.93%              7.82%             6.21%              7.07%              - India

1.81%              3.02%             1.52%              1.92%              - Hong Kong (China)

3.11%              2.82%             2.83%              2.51%              – Australia

3.87%              3.55%              3.25%              2.76%              - NZ

The main headline to take from this table is its stability, enforced by central banks, enforcement (manipulation – Ed) that will continue.

NZ has outperformed the others on interest rate movements (relative yield decline) without central bank intervention. (Greece was similar – Ed).

India has underperformed after they lost their highly respected central bank governor when it was obvious he would be undermined by political interference. Good governance matters.

I know the central banks are laying the groundwork with constant announcements about wishing to lift official cash rates and sell bonds off central bank balance sheets but it would lack credibility if I predicted for you that this will happen quickly.

These leopards (central bank governors) will be wearing the same cloaks come Christmas 2018.

I am placing myself in the camp that believes in rising long term interest rates, but the moves will not be fast.

The US 10 year government bonds (Treasuries) are not comfortable below 2.00% (1.50% low) and neither should they be as the central explains a strategy of lifting cash rates to at least that level.

The only risk of over-supplying the market with bonds, to pressure yields higher, is if central banks release their massive holdings too fast and you can be absolutely assured that this will not happen. Central banks have been so wimpish that they haven’t yet turned off the buying of bonds!

For all of the concerns about highly priced share markets there has been recurring evidence that maybe the decade of zero interest rates is beginning to result in some economic growth across the world’s major economies (US, Japan, Europe, UK) and China does seem to be successfully navigating its credit tightening cycle and move toward increased consumption.

If business profits do continue to increase, in these major economies, share markets are unlikely to respond by falling.

Other Stuff

News media, stirred up by content on social media, ensured that every morning we were led to believe something extraordinary was happening, even if it isn’t.

Politics claims space for many of those headlines.

Donald Trump is a perpetual attention seeker, North Korea wants some of that action too, the UK is struggling with its divorce from Europe but concluded its first step last week. Capitalists are struggling with the tidal move toward social preferences and power is shifting in the Middle East.

For all of the headlines, I don’t think I made a single investment decision during 2017 based on local or global politics.

Every day I am grateful for my NZ passport.

Whilst Bitcoin is not all that relevant to wide economic influence (at this stage – Ed) it did become one of the remarkable headline grabbers of 2017 with many looking at it daily.

By the time the price of Bitcoin reached US$13,000, one commentator, with tongue in cheek, said he expected Bitcoin to beat the Dow Jones (US share market) to reach the 25,000 level (the Dow Jones is currently at 24,000).

Two days later, at the time of writing this item, the Bitcoin price was US$17,000.

There is still a lot of water to go under the bridge with respect to crypto or alternative currencies. All I will say here is to be extremely careful and treat it like the speculative item that it is.

Tears are the likely outcome.

BlockChain is the important revelation that came from Bitcoin and will play a significant role in genuine economic improvement via technology upgrades. Look out for its wide use across the economy in the decade ahead.

Central banks are very influential to investment decision making and while NZ is a small economy what the Reserve Bank of NZ does is important from our local perspective.

Currently we are in a hiatus for the RBNZ, between governors and awaiting the review of the Policy Targets Agreement with the new government. These two items will be resolved during 2018 and will both be important, as will the conclusions be from the current review of acceptable definitions for equity capital on bank balance sheets.

One uncertainty has been resolved by the appointment of Adrian Orr as the next RB Governor, beginning March.

Portfolio Reviews – This is really important.

You don’t need my forecasts (50:50 chance at best – Ed) to decide how to invest, it is far more important that you rely on your investment rules in the first instance. If you have good investment rules (policies) you will be very likely to make good investment decisions and market speculation can be minimised.

Have you reviewed your portfolio relative to your investment rules after another strong year for shares?

By way of example:

If you started the year with $500,000 invested, split as $325,000 in Fixed Interest assets, $75,000 in property assets and $100,000 in shares (non-property) how does it look now?

Are you still committed to your 65% / 15% / 20% rules for asset mix?

Under a flat earth scenario, using market indexed returns, the value of each asset allocation might now be:

Fixed Interest - $325,000 (62.9%);

Property - $78,000 (15.1%)

Shares - $113,700 (22%)

I am very pleased that this theoretical investor has ‘made’ $16,700 capital gain on top of the income received, but try not to let this new money be the cause for false confidence that your risk profile has increased.

Here’s what the portfolio might look like if untouched since 2014:

Fixed Interest - $325,000 (61%);

Property - $82,500 (15.5%)

Shares - $124,500 (23.5%)

Profits fuel greed, which feeds to the false confidence I refer to; this thinking must be kept out of risk tolerance assessments.

After eight strong years for share markets I have seen plenty of portfolios where the relative movements are far greater than the short-term examples above, yet the asset allocation ratios are not anchored to any targets.

An unchanged portfolio, such as the example I describe, has increased its volatility (risk) and will feel a greater weight of change during the next decline in market pricing (without me needing to guess when this will occur).

A portfolio review, based on your longer-term investment rules, should see people locking in some of their gains from the past eight years and holding the volatility (risk) of that portfolio closer to their preferences.

Have you made any strategic changes to your portfolio during the year or do you solely respond to maturities and spare cash when it emerges in your bank account?

I am not proposing a rush to review, but we strongly encourage reviews against your investment rules even if it is only to reduce the wasted energy of worrying about what financial markets might do next.

My predictions for 2017 from last Xmas newsletter

‘At the time of writing I think share markets have a high probability of rising during 2017’

As I stated above getting this ‘guess’ correct is a relief and a pleasure to witness for our clients.

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

As the sun was setting on 2017 President Trump looks likely to get his tax cuts through Congress and to thus supply even more cash to US consumers and the markets.

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

On this I was diametrically wrong. Volatility continued its decline to well below long term low points.

This feels unnatural; being in a ‘stretched rubber band’ market place but not being concerned about the potential energy becoming kinetic in a new direction.

Again I pause at the prospect of offering predictions for 2018, however, to leave a blank space would be to offer nil value on the matter of looking forward, so here are a few guesses.

Guesses for 2018

Share indices – I am going with higher pricing by the end of 2018, but not by a large percentage. As a subset opinion, I think the share markets of the major economies will outperform NZ.

The sugar effect of low interest rates followed by US tax cuts may be fully discounted into the market, which limits the impetus for higher markets from these major drivers, but I think we need to be patient during 2018 and watch to see if economic growth and real profits do increase further.

It feels odd telling you to expect 2018 to be an ‘up’ year for shares, so let me temper the opinion, and be very clear, that I also urge investors not to be over-invested in shares relative to their ‘normal’ risk tolerance (investment rules/ratios).

Frankly, I’d prefer that your weighting to shares was at the lower end of your target ratios because the rubber band of risk is, without question, stretched; making my guess a statistical improbability!

Official Cash Rates – I expect these to be higher by the end of 2018, but again only by modest amounts.

10 year bond yields – I think these will also be a little higher by late 2018 but not enough to discourage investors from continuing to hold an even mix of investments across the maturity date range (1-7 years in a NZ context).

Bitcoin – If you enter the water, don a thick wetsuit and best of luck to you. I won’t be.

Merry Christmas to you all.

Thank you for all of your business during 2017, we are grateful and pleased that we could assist and look forward to doing so again during 2018.

Michael Warrington, and all at Chris Lee & Partners.

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Market News 11 December 2017

This is my last Market News for 2017, save for next week’s 2017 review and 2018 ‘predictions’.

Thank you for ‘listening’.

I’ll be back in January, later over sooner.

Our offices close at 5pm on Wednesday 20 December after a brief chance to chat about Credit Agricole with those wishing to do so.

All else can wait until the New Year after you have enjoyed summer together.

Investment Opinion

Out of Jurisdiction? - An open question to the Treasury:

Has the election of the new Labour led government emboldened you to the extent that you feel it is appropriate to offer contributions on matters outside your brief?

According to the speech today, hosted by Treasury (delivered by a Professor from Auckland University) you seem to want the jobs of both the Minister of Finance and the Governor of the Reserve Bank.

Resilience and Reform – Towards a Financial Stability Framework for New Zealand

The promotional abstract:

The Memorandum of Understanding on Macro-Prudential Policy between the Governor of the Reserve Bank and the Minister of Finance is due to be reviewed in 2018.  But what should a decent institutional architecture for financial stability policy look like?  In this lecture, I consider the political economy of financial stability and examine some issues confronting the design and governance of “macro-prudential” policy.  I argue that the MOU review is an opportunity for a fundamental reappraisal of the financial stability framework in the light of developments in academic thinking, policy debates, and experience

Let’s leave the role of financial stability to the RBNZ and its experienced folk and keep bureaucrats’ academic thinking and policy debate teams out of it.

It’s true that we express plenty of opinions about the banks, and the central bank, from a perspective of how they may impact our clients, but we do not tell the public how to pursue insurance (outside our brief) even though we have an opinion on the subject (several actually, including one that has reached the District Court).

Subordinated Bonds – last week I spied a subordinated bond with an appropriate reward for a subordinated bond risk, unlike a few others on issue;

Accident Compensation Corporation has made shareholder loans to its partnership investment in Wiri Prison for 25 years at a return of 10.50% per annum (alongside its equity investment).

I’ll guess in the terms of agreement that there are repayment risks on these shareholder loans, but with the government as the client and a 25 year agreed term it seems unlikely that the loans will be defaulted on by the prison entity.

All it takes to ensure payment of the interest, plus a probable dividend, is to manage the clients of the business well, because as a country we clearly have plenty of clients.

Crypto Gold – Regardless of your opinion about crypto, digital, or alternative currencies in our financial future you really must take heed of the US Federal Reserve’s current opinion, which concluded by issuing a warning:

‘More serious financial stability issues may result if they achieve wide-scale usage. (Digital currencies are a) niche product that sometimes garners large headlines. (It) has no intrinsic value, is not the liability of a regulated banking institution, and in leading cases, is not the liability of any institution. Indeed, how to treat and define this new asset is complicated.’

The journalist, who is a believer and presumably owns a few Bitcoin, accused the central bank of arrogance and ignorance. He clearly believes in the world domination theory.

He seems to have forgotten that the excitement he proportionately aligns with his profit is measured in US dollars, not in consumer products that he has access to. Further, the financial markets that are embracing trading in Bitcoin are doing so to earn commission and the new Bitcoin derivatives (futures contracts) settle in US dollars (real money).

The value attraction for Bitcoin, that I see, is limited supply and decentralisation, plus a dose of anonymity.

Regular readers won’t be surprised to hear that I have the solution for central bankers to compete;

Central banks of the world should issue their own digital currencies, built on BlockChain technology and linked to gold as its limited supply tangible asset.

Gold will help arbitrage out global disagreement about the value of government guarantees that might otherwise have been offered, which have proven unreliable (Greece, Argentina, Zimbabwe, etc).

If the world is indeed seeking a more efficient (online, low cost), borderless, reliable, live payment method then armed with the confidence of good regulation (and crime monitoring) ‘my’ new digital currencies should more confidently find its place alongside FIAT currencies.

A crypto currency called Tether offers a similar theory by linking their currency unit to US Dollars held as real collateral, but this item isn’t as truly borderless and apolitical as gold would be.

Because central banks find it hard to agree internally, let alone with each other, I’ll leave the Bank of International Settlements to knock some heads and coordinate the finer details of my proposal.

Post Script: I already have two supporters for my proposal, ECB director Yves Mersch and Jens Wiedmann of Germany’s Bundesbank, who urge banks to move quickly toward live payment systems (Real Time Gross Settlement for everyone) if they wish to compete with current crypto currencies.

Yves and Jens haven’t yet solved the next step, which will happen when they read Market News tonight in France and Germany.

Irrigation - The past four months of weather should be a sharp jab in the ribs for the likes of Hawke’s Bay Regional Council and their failure with the proposed Ruataniwha dam and irrigation scheme.

In the Wellington region, at least, between May and September we received an unusually high rainfall.

I remember thinking, ‘a few days break would be nice, but this rain is a natural competitive advantage for NZ’.

One month later (now) and the Wellington City Council has started water use bans (as has Napier ironically for this opinion).

I do like the forward planning aspect but if the Wellington Regional Council did not fill the reservoirs to the brim for summer’s known usage patterns I would question the competence of that forward planning.

If the likes of Hawke’s Bay primary industries now struggle for good ‘production’ rates, or worse they suffer a retreat in the value of their ‘stock’ I’d share the intensity of their disappointment.

We have it easily within our control to avoid this problem of water shortage in New Zealand.

I’ve been thinking – Kevin Gloag writes:

As the year draws to a close financial market participants who made predictions for the year will be readying themselves to be scored.

Our own Michael Warrington steps up next week.

The results of a survey published earlier this year, scanning a period of 10 years, highlighted for me just how difficult financial forecasting really is with investment analysts and other market experts achieving a success rate of only 50% on issues where they were certain of the outcome.

Needless to say on issues where they were less certain they fared much worse.

The two burning questions for most investors is when will the share market take a correction and what’s going to happen with interest rates.

During 2017 interest rates have remained very low as most expected but share markets have risen well above most people’s expectations.

In fact throughout the year most investment bankers, analysts and stock market gurus have been screaming correction, many still are, the question is when. No-one knows.

There is a mountain of daily information available on financial markets and everyone has an opinion and a theory and there are hundreds of different authors.

After years of reading there are some we have learned to pay attention to and I often jot down snippets of information that I think might be important in terms of trying to unravel the future.

We try and stay abreast of US market developments knowing that what happens in their equity and interest rate markets will also reach our shores.

You might ask how US equity markets have reached new highs this year when so many of the largest investors have been predicting a correction and betting against the market.

I read recently that high frequency traders, with their computer based trading systems, drive around 73% of daily volumes on US equity markets.

Their trading algorithms, known as “algos”, know what you are buying and selling and automatically execute trades based on pre-programmed criteria. They can process millions of trades in seconds and can predict market movements and speculate on trends.

In 2017 the trend and momentum has been up.

Momentum trading can go both ways.

Where New Zealander investors tend to be diversified across different asset classes Americans seem to invest primarily in stocks (shares) and more of this investing is now being done through index tracking exchange traded and mutual funds, which have experienced phenomenal growth in recent years.

When money is pouring into index funds the managers simply spread the money across all of the stocks in the index, usually weighted by market cap.

There has not been a significant market correction since the big flow of money into index funds began a few years ago.

As we have mentioned before it’s surprising just how few stocks have actually done the lifting as share markets have soared to new highs.

The S&P 500 index for example is up 15% year to date although one third of its stocks are down for the year.

Are share prices in the US out of whack with the US economy? The following two stats would suggest yes.

 Since 2009 the S&P 500 index has tripled while GDP growth has averaged only 2% per year.

In 2011 S&P 500 companies sold US$1.05 trillion worth of stuff, last year they sold US$1.16 trillion worth of stuff.

Since 2009 10 million people have dropped out of the workforce and the job market in the US is the same size today as it was 20 years ago.

The inputs to higher production are more available workers and productivity gains, neither of which is evident in the US economy today.

An article this week by Patrick Watson, one of John Mauldin’s team, outlined the current weak economic expansion in the US and what he sees happening next. I think it is well worth a read.

For those interested the article can be found here:

http://www.mauldineconomics.com/connecting-the-dots/how-tax-cuts-will-trigger-recession

Looking elsewhere for guides to the future China’s huge debt expansion has seen its debt to GDP ratio blow out to an eye-watering 277 per cent.

 By comparison Greece’s debt looks quite modest at just 179%.

I’ve always believed that European banks would be at the epicentre of the next financial crisis and even though they talk up economic recovery in the region I think it is a bit like the recovery in the US – weak and running out of puff.

The biggest problem is debt.

The world now has twice as much debt as it did before the GFC and even at today’s historically low interest rates much of it still can’t be serviced.

I wasn’t surprised to read recently that total non-performing loans in EU banks are now greater than 1 trillion Euros or 5.4% of total loans, a ratio 3 times higher than any other region in the world.

10 out of 28 EU countries now have non-performing loan ratios above 10% with the highest being:

Cyprus       49%

Greece       46.6%

Slovenia     19.7%

Portugal     19.2%

Italy             16.6%

Ireland        15.8%

The Italian banks now house one third of all non-performing loans in the EU.

New ECB rules will soon require Banks to bring to account all non-performing loans where no security is held.

These write-offs will destroy capital – who is going to recapitalise the banks and at what cost?

All at a time when, because things are going so good, the ECB is about to halve its bond buying programme as it begins to wean the Eurozone economy off years of stimulus.

In fact the ECB and the Fed will be tightening at the same time by way of less bond buying with a combined $1 trillion of reduced liquidity forecast for next year, beginning in less than 4 weeks.

The Fed is also proposing to increase short term interest rates although I see zero chance of 4 increases during 2018 as is being predicted by Goldman Sachs.

Knowing how GS operates I guess that if this is what they are saying publicly they are probably positioning their own trading accounts for lower rates.

It might be no coincidence that Trump, who has surrounded himself with former GS executives, has recently nominated Marvin Goodchild, an advocate of negative interest rates, to one of the vacant seats on the Fed board.

I don’t know how the Fed and ECB together withdraw this much liquidity from global markets and still hold down interest rates.

Higher interest rates would mean higher debt servicing costs and this would spell disaster for many countries, businesses and households.

NZ’s household debt ranks 7th highest in the world, a field lead by Australia whose household debt totals 123% of its GDP and 190% as a proportion of disposable household income.

Imagine the carnage in NZ and Australia if mortgage rates increased by say 2.00%. Households would be snookered, as would the banks, as would the property market.

Home ownership in NZ might be at its lowest level in 65 years but we don’t want a price collapse induced by mortgage defaults.

Labour’s plan to build 100,000 houses over 10 years is very ambitious and roughly the equivalent of building Timaru every year for 10 years.

I’m not sure where the trades-people will come from to drive this bold plan. The building sector already appears fully extended and we will soon curb immigration.

Finally I read some stats recently which got me thinking about the reported level of child poverty in NZ.

In 1820 94% of the world population lived in extreme poverty. By 1990 it was 35% and 2015 9.6%.

40% of those who remain impoverished live in two countries – Nigeria and India.

Sadly a lot of children in NZ are doing it tough but is it the system letting them down or their parents?

The level of child abuse and number of children killed or badly injured by family members or caregivers is a national disgrace.

If you gave an extra $200 a week to the parents of the kids who are going to school in bare feet with no lunch do you think their situation would improve?

I think 2018 will be a year of considerable change and challenge.

Kevin Gloag

Investment News (Michael writes)

NZSIF – Patient investors in the NZ Social Infrastructure Fund will be pleased to have read the previous Annual Report and the latest Interim Report, which discloses imminent full investment and the likelihood of ongoing dividend flows after March 2018.

The slow journey to full investment has cost us some ‘Present Value’ on our money but in my view the prospects for good financial returns, including dividends, are upon us.

The interim report describes the updated Net Tangible Assets as being $1.18 per unit and there is a likelihood of 6-7 cents per unit in dividends 2018-2019 (rising from there I recall).

Patience is again rewarded.

UDC – I see that buyer of UDC, HNA Group (aka Hainan Airline), is being reported as selling some its assets, signalling a reversal of its strategic spending spree in recent years.

It’s hard to tell what this means for ANZ and its ‘as yet unconfirmed’ sale of UDC but it is now ‘late 2017’ so under the normal course of events I would have expected this sale to have been confirmed by now, based on what we were led to expect.

It does remind us of the influential reach of the Chinese government.

I hope UDC depositors don’t get tangled up in an unexpected turn for the agreement between ANZ and HNA.

Ever The Optimist – China is reported as reducing its import tariffs on approximately 200 items and leading us to believe that this strategic change will continue.

This contrasts with Donald Trump’s ‘keep them out’ approach for the US.

ETO II – NZ car sales again set an annual record, the fourth in sequence.

NZ is either getting something right for (and by) our businesses and the employed, or we are borrowing too much money!

ETO III - I attended a rubbish collection programme around the Wellington coastline recently (organised by Sustainable Coastlines) and was pleased to see two things:

Heaps of the younger generation out helping; and

Meridian Energy’s support for the co-ordinators.

Not a financial story, but one with optimism all the same.

ETO IV – I am pleased to read that ‘we’ of the previous generation get better with age; 1980’s band Depeche Mode is outselling young guns like Ed Sheeran based on 2017 tour statistics.

Investment Opportunities

Kiwi Property Group – has announced a new issue of 7-year senior, secured, bonds (NZX code KPG030).

We estimate an interest rate between 4.25% - 4.30% p.a. (set tomorrow).

The offer will be arranged by contract note, with KPG meeting the brokerage expenses.

Investors wishing to participate in this offer are encouraged to contact us no later than 5pm today, confirming an investment amount.

Payment will be required by 18 December.

Deal Lists for 2018 potential deals –

Investore Property Ltd – senior bond;

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

We have contact lists for each of these offers that investors are welcome to join by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (New Issues) email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

No further trips planned prior until the New Year.

Chris will be in Christchurch January 23 & 24 and Auckland January 30 & 31.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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Market News 4 December 2017

Apparently, I am not the only person concerned about over-regulation and over-reach by regulators.

An eagle-eyed NBR reporter spotted that the ANZ bank wishes to meet the FMA in court and formally discuss a behaviour that the FMA proposes to apply; clearly the ANZ believes the intended behaviour is inappropriate.

Investment Opinion

Tighter Monetary Policy – The markets are worried about a lack of inflation in the US, which might block the US Federal Reserve’s ability to continue increasing its Fed Funds rate.

The market’s response has been to flatten the yield curve, meaning, push long term yields down as short-term interest rates are rising. Sometimes this indicates a fear of recession.

I think the bond market is setting itself up for a fall (in price terms, so interest rates up).

The excess of buyers for long-term bonds, willing to trade on the view that a recession might occur, and bond yields will need to fall, are forgetting that the US Federal Reserve holds a few trillion of bonds that it is now quite keen to sell.

It is true, US inflation is not as robust as the Fed would like, and they may need to move a little slower with the strategy of increasing the Fed Funds rate (currently 1.25%), however, if lower inflation brings long-term yields down the Fed should jump on the opportunity and sell more bonds off its balance sheet.

If US savings and bond trader demand dictates a high level of interest in buying long-term bonds, then the Fed should act to satisfy that demand.

The flatter yield curve will undoubtedly be driving additional price rises into the share market, further inflating the level of equity indices, leaving very little room to move (up) without higher company profits. If the market’s concerns about recessions turn out to be accurate then the share market couldn’t sustain current levels.

The Fed cannot argue that it doesn’t want to manipulate markets because it has been doing so aggressively for years now. So, if they sell more bonds from their bloated balance sheet than expected, push long term yields up a bit and share markets recede a bit it releases unwanted tensions from two places (Fed balance sheet and share market pricing).

I am reluctant to describe it as a ‘bear market trap’ but financial markets would be wise to have a chat with Goldilocks before making too many assumptions about the Fed not supplying additional bonds back into the market.

This scenario is just another possible outcome from the stretched pricing that can be found across financial markets at present.

BlockChain (DLT) – As banks move, probably quite quickly, toward the use of Distributed Ledger Technology (DLT) within banking services I do hope that our central bank is forming its own strategy for DLT use and oversight.

I am making many assumptions here, but, if settlement within the NZ economy with NZ dollars (NZD) can be considered a single ledger, then, I would prefer that the Reserve Bank of NZ was the regulator of that particular ledger.

That ledger is, by definition ‘distributed’ across the many who share it. (hence being a DLT).

All participants in the NZ economy use a bank account (or several) to consolidate their settlements, so, if the RBNZ was to insist that all banks become licenced users of the newly labelled and RBNZ regulated ‘NZD DLT’ not only would they expand the industry’s use of acronyms, they would also improve the efficiency and security of payments across our economy (and tax collection agency – Ed).

It sounds so simple, like most sustainably good things.

Bitcoin – whilst on BlockChain, after rising to yet another daily record of US$11,000 the Bitcoin price fell 10% in 10 minutes.

Investing in Bitcoin takes bravery, not analysis.

US Tax Cuts – in my opinion section because it would be ‘fake news’ otherwise.

There is plenty of optimistic talk about the progress of the proposed tax cuts, but they are looking increasingly ineffective in my view because:

Tax specialists are concluding that the wealthiest will be the beneficiaries, not the wider low-income people; and

Some of the US (and the world’s) largest companies are declaring that they will simply pass through most of any corporate tax cuts to their shareholders (AKA the wealthy few).

Yes, this reinforces incentives to save and to invest, rather than borrow (at a personal level) but there are plenty of such incentives already and they haven’t been effective in helping the wider ‘employed’ population.

Trump is in power because the few misunderstood the many.

Trump’s chances of being re-elected will be undermined if his tax changes are delivered to the protected few.

Along with the norm of profit monitoring, the US share market, and thus all markets, are disproportionately optimistic about the potential for tax cuts and ongoing lower interest rates (Powell simply copying Yellen at the US Federal Reserve).

My point: I think share markets have discounted too much optimism into the US tax and interest rate scenarios.

Investment News

Cash – Buried in a yelling match of headlines about Bitcoin’s rising price (apparently sponsored by NASA – Ed) I read a contrary article, based in fact, that made me smile.

The European Central Bank (ECB) had conducted a comprehensive study to analyse the use of cash (Euro), cards and other payment instruments used at points of sale (POS) by euro area consumers in 2016.

Guess what they found?

For transactions completed at the Point Of Sale (POS) 80% were settled with the use of cash and only 19% via use of card (leaving 1% for Bitcoin? – Ed).

I’ll guess the balance were more likely to be barter than bitcoin.

POS analysis doesn’t seem to capture online trading such as that provided by Amazon, but it’s clear that cash is not dead, at least not in Europe (especially its Southern states).

Cash – and whilst I am on the subject of cash, skilful investment company Rangatira announced its mid-year results recently and advised its shareholders that it now sits on $40 million cash (50% of its assets!) because it is yet to find any suitably priced new investments.

There is a very clear and simple message here for investors.

Banks – again, one of those who help us manage our cash (see above) has put its hand up to disclose incorrect risk and capital calculations.

This time the miscreant is ASB Bank.

In an attempt to have the public see balance, ASB Bank has reported two countervailing errors, one which lasted for nine years and understated its capital position and another error lasting 12 months that overstated its capital.

This isn’t a physics presentation; I don’t see balance, I see double the error rate.

ASB announces that ‘the errors have been corrected’.

How can we be sure? There is no reference the Reserve Bank in the story.

Has the central bank completed a specific audit of ASB to address this newly disclosed failure within its measures for financial stability?

If they have, why haven’t they reported to the Minister and to the wider community?

If they haven’t, why haven’t they?

The ASB story could have an implied executive summary of ‘self-discovered risk error, sorted out, nothing to see here’ but if that was the case it would leave the bank assuming that self-regulation is appropriate when clearly their behaviour, and that of Westpac, concludes otherwise within the sector.

A quick look across the Tasman would find you reading a constant stream of regulatory failures by banks, enormous fines being handed out and the possibility that Australia’s Prime Minister will lose office in part due to his strident defence of there being no need for an inquiry into bank misbehaviour.

Given the way the banks have ‘managed’ their risk calculations, which impact capital requirements, it should be less of a surprise now that the RBNZ proposes to migrate capital requirements for NZ banks, to the simplest and most robust end of the spectrum.

It is also now clear that the RBNZ should return to their 2008 proposal for a consistent set of Risk Weighting measurement rules.

Foot Note: I shan’t forgive ASB for this error until they raise more ordinary shareholder capital and repay their local Perpetual Preference Shares, which are long past their ‘use by’ date. (bias declared).

Not Good News – Environmentalists may be rejoicing Anadarko’s announcement that it is leaving the NZ oil and gas prospecting business but in reality it is a serious signal that the NZ government and businesses should contemplate more deeply.

‘In this continued low oil price environment we have to make very tough decisions about where we invest capital and frontier areas like New Zealand will always find it hard to compete’ (bold highlight is mine – Mike)

Yes, we are considered a frontier, ‘in a galaxy far, far away’ and Anadarko has reminded us that with uncertain resources, great distances for delivery and low oil prices our resources are not worth pursuing.

The oil industry and the government licensing fee revenue should be adjusted to reflect this industry expert’s decision.

At its simplest it speaks to the lack of probable profit for the risk, but it also speaks to Anadarko’s increasing oil supplies in America (shale), the Gulf of Mexico and Africa (a more profitable galaxy far, far away – Ed).

It might also speak to their monitoring of changes to the world’s vehicle fleet (electric) over the next 20 years but this would be at the margin.

I hope it doesn’t speak, between the lines, to the NZ regulatory framework.

Allied Farmers – deserves a compliment for reaching the point of again being able to pay dividends to its shareholders.

ALF’s last dividend was paid in 2008, prior to the Global Financial Crisis, which not only disrupted their own operations but brought in the almost indigestible ‘equity’ transaction from Hanover.

The renewed rural focus confirms that ALF has moved on from that dreadful period and is clearly focussed on making its gains from supporting the productive NZ rural sector.

Good on them.

Kiwibank – has, unsurprisingly, announced the ‘early’ (first call date after 5 of 10 years) repayment of its Tier II subordinated bonds (KIW030 with legal maturity date of 15 December 2022).

Regular readers may recall that Kiwibank has plenty of equity as a result of issuing additional ordinary shares earlier in 2017 when the Reserve Bank made a shemozzle of what was recognised as equity for the bank.

Today’s repayment announcement was, thus, only the formality of a reality that was declared on 15 March 2017 by the RBNZ’s unnecessary public pondering about what is and isn’t equity for Kiwibank.

There has been a lot of bond repayment during the last quarter, and there is more to come soon with Trustpower bonds and Credit Agricole’s bonds and there have been insufficient new bonds issued for reinvestment.

Have you found new homes for this cash yet?

Uni Bonds – Unlike many, both at the start and after the earthquake, we were pleased to have the opportunity to invest in bonds offered by the University of Canterbury.

Since then the market for bonds from the education sector has gone very cold, to our disappointment.

Whilst, the latest news on bonds from this sector is out of our reach I found it interesting all the same, Oxford University (as distinct from its colleges) is to issue bonds for the first time in its history.

Oxford, armed with its ‘AAA’ credit rating plans to issue a 100-year bond.

I hope it has interest rate resets because one rate for 100 hundred years demands a lot of confidence in stable inflation strategies.

In reality, I suspect the bonds will be easily issued to the generous benefactors who already donate enormous sums to the world’s top universities.

To the NZ universities, we would welcome your participation in NZ financial markets with further offers of bonds between 5-10 year terms.

Ever The Optimist – India’s economic activity is rising, if you are prepared to use air travel as a reliable anecdote.

Mumbai airport set a new world record of 969 landings in a single 24-hour period (airport with a single runway).

Investment Opportunities

FYI – A small handful of people missed out on investing in the recent Property For Industry bond offer because NZ Post took 7-11 days to deliver application forms to us.

We strongly encourage the use of scanned application forms, using Direct Debit as the payment method for participation in new issues now. If you are not keen on scanning and emailing we suggest either involving trusted family/friends to assist or the likes of Warehouse stationary services.

If you still prefer to deliver a physical application firm you are strongly encouraged to use the 1-3 day premium priced delivery options from NZ Post.

Heartland Bank (HBL) shares – As a final reminder to holders of HBL shares, you were recently approached by the bank offering access to invest in new shares (1:15 rights to purchase) at a price of $1.70 per share.

The current share price is $2.02.

The offer closes on 8 December, so it is now urgent that you make your decision regarding participation, if you have not done so already.

The rights application can be completed online, including the ability to choose Chris Lee & Partners Ltd in the Broker ‘drop down’ selection (we are grateful to HBL for offering the broker link within this online process, a behaviour all others should follow).

Kiwi Property Group – has announced a new issue of 7-year senior, secured, bonds (NZX code KPG030).

We estimate an interest rate between 4.25% - 4.35% p.a. (a minimum of 4.25% has been set). Interest will be paid semi-annually.

This is a fast-moving offer, arranged by contract note, with KPG meeting the brokerage expenses.

Investors wishing to participate in this offer are encouraged to contact us no later than 5pm on Monday 11 December, confirming an investment amount.

Payment will be required by 18 December 2017.

Christchurch City Holdings – offer of new senior bonds, maturing in 5 years (6 December 2022) was concluded last week on Wednesday.

The bonds were issued with a yield of 3.40%.

Thank you to all who participated in this bond offer via Chris Lee & Partners Ltd.

We are happy to help investors to purchase these bonds on the market if they missed the offer and still wish to invest.

Deal Lists for 2018 potential deals –

Investore Property Ltd – senior bond;

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

We have contact lists for each of these offers that investors are welcome to join by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (New Issues) email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

No further trips planned prior until the new year.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

 

 

Michael Warrington

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