Market News – 18 February 2019

Thank you.

We regularly receive calls from new customers who tell us that a current client of Chris Lee & Partners has referred them to us.

There is no greater compliment than word of mouth recommendations, so, we wanted to say thank you to clients who have this level of confidence in our services that they are willing to recommend us to others.

We appreciate it and will always do so.

INVESTMENT OPINION

Bank Deposit Guarantees – If asked I’ll wager that the public would say ‘YES’ to any proposal for the introduction of bank deposit guarantees.

However, it’s not that simple and if pressed further into the debate I am equally certain that most of the public would recognise that you do not get something from nothing.

If a guarantee is added it represents a risk reduction for depositors through a transfer of risk to someone else and this has a real cost for the providers of the guarantee. Someone must pay for that cost and you won’t find it hard to conclude that depositors will pay for the service they are receiving.

For a depositor to ‘pay’ they will receive a lower interest rate, a logical response to carrying lower risk.

A deposit guarantee scheme is the provision of insurance. Do investors need this insurance?

I argue they do not.

Many investors can afford to self-insure against this risk, and they have access to well-regulated financial advice to further reduce their own risks of financial loss. It’s certainly easier to do this and to reduce costs than to find higher returns!

Paying for guarantees on bank term deposits would be wasted ‘money’ (returns) in my view.

I am far more inclined toward the central bank’s increasingly conservative regulation of banks, and the subsequent reduction of risk to you as an investor because this development brings with it other certainties for the NZ economy (broad financial stability and downward tension on the use of debt).

If a guarantee was initiated for a limited sum, say $100,000 per depositor per bank, the immediate reaction would be for depositors to spread money around various banks.

This resulting diversity for an investor seems logical, but if I was a banker I would view the situation as anti-competitive; ‘why can we not compete for you as a client on an undistorted playing field?’. We work hard to manage the best performing bank and we would like to compete for access to (say) $300,000 of your money as part of our business strategy.

The Reserve Bank clearly views complex subordinated bonds as distorting what is equity on a bank’s balance sheet and providing an unintended competitive advantage to the major banks over the smaller banks. So, surely the RBNZ would also see a deposit guarantee scheme as an unnecessary distortion too, probably in favour of the smaller banks.

You can tell that I am not a fan of a bank deposit guarantee scheme.

I was taken to write this piece for you after reading two good opinions on the subject in response to Treasury seeking feedback on the subject, and because all of our clients have bank term deposits.

One opinion was written by Dr Bryce Wilkinson (another of the long list of excellent people I have worked with) who was happy for me to re-present the link to his item:

http://www.nzinitiative.org.nz/reports-and-media/opinion/the-case-against-taxpayer-guarantees-for-bank-deposits/

For the sake of balance, Bryce suggested that I also point you to an opposing view from Geoff Mortlock, here:

https://www.interest.co.nz/opinion/97926/geof-mortlock-argues-new-zealand-needs-stronger-protection-depositors-counter-reserve

There is no action for you to take, but I’d encourage you to read these two opinions because you’ll always have money in bank deposits, so the subject is perpetually relevant to you.

Speaking of perpetually, and banks…

ASB Repayment – We continue to be energised for our clients following the announcement that the ASB perpetual peference shares (ASBPA and ASBPB) will be ‘repaid’.

Holders of ASB perpetual preference shares have received a notice from the bank (technically issued by CBA Funding) announcing repayment. Our clients also received an email from Kevin Gloag to ensure they had observed the good news.

The letter from the bank was well written. It speaks to the legal detail of the ‘buy-out’ notice and the ‘transfer’ of securities, but it also makes clear that holders of the perpetual preference shares do not need to take any action. You will all be ‘repaid’ (technically you will be paid for the sale) on 15 May.

The repayment is very exciting news as its rewards investors for the confidence they placed in the financial advice to buy these securities while the pricing was discounted in the face of declining interest rates for annual reset securities.

Everyone’s financial returns will differ based on entry prices and time frames, but if you’ll allow me to discuss a rough performance range:

If an investor purchased the securities at 85 cents in the dollar (a credible point through the middle of trading for the past 10 years);

The investor(s) received dividend rewards of between 3.50% - 6.50% over the years (slowly declining); plus

They will now receive a value uplift of 15 cents in the dollar (for this calculation).

With simplistic math you can divide this 15 cents uplift by the years of ownership to see that investors will gain an additional 2-15% annual return making it an impressive overall return for investors who purchased securities at a price discount.

This is an impressive overall return regardless of your specific time frame.

I have made no attempt to address differing tax implications, I just wish to illustrate the high overall reward delivered by this investment to many people when they combine annual income with the value uplift on repayment. These investors did not need an increase to New Zealand’s interest rates to secure the attractive reward.

By the way, Kevin Gloag is too humble (and maybe short of breath – Ed) to blow his own trumpet on this subject of investment in subordinated bank bonds (various securities types) but a huge proportion of the high rewards that our clients have enjoyed from this sector is directly linked the deep knowledge that he gained about bank equity and regulatory capital risks.

We took this deep knowledge to measure the low default risk and relatively high return and presented it to clients in the form of financial advice and for the content of our country-wide roadshows a few years ago to keep investors abreast of important changes to bank regulations which were introduced in 2013.

To be fair to Kevin nobody here blows a trumpet, it would sound awful, but when I reflect on the value that our clients have received from many years of participation in the subordinated bank bond market, I am very pleased about the high returns they have received.

Long-time clients will recall investing in what I’ll call ‘generation one’ bank capital securities such as BISHA, BNSPA, RBOHA, RCSHA, ANBHA (CASHA! – Ed).

Our view at the time was that the banks were operating at the edge of regulatory tolerance using these securities as ‘equity’ on their balance sheets, that they would all meet their financial obligations for these securities and thus the rewards to investors were attractive for the risk involved.

Our view was validated when the central banks tightened capital regulations and effectively enforced the repayment of the generation one securities on the next available date (Interestingly Rabobank’s RCSHA haven’t reached that date yet, being June 2019, and investors will be sad to see this one repaid).

It’s fair to say we were relieved, rather than unsurprised, when Credit Agricole repaid CASHA. We had less knowledge and less confidence in the European regulators and the French banks!

The central banks then set tougher rules for when a ‘bond’ could be viewed as ‘equity’ on a bank balance sheet.

The banks promptly started issuing ‘generation two’ of bank capital securities such as ANBHB, KCFHA. One or two banks spotted the unhappy regulatory tone and stopped issuing such securities for raising equity.

All the while ASB Bank left its perpetual preference shares on issue, now 15 years of age (2002 and 2004 issuance).

Oddly the Reserve Bank of NZ singled out Kiwibank for criticism early with its generation two subordinated bonds.

Again, the central bank in NZ declared that they were dissatisfied with the use of ‘bonds’ as ‘equity’ and have now announced proposals to only count ordinary shareholder funds plus retained earnings as equity. Their latest proposal is very robust in its target equity ratios, but the definition of true equity is as it always should have been.

Regardless of the unsettled proposals from the RBNZ it is highly likely that ANZ and Kiwibank will repay their generation two subordinated bonds that have counted as Tier 1 bank equity.

The latest RBNZ development on bank capital and the highly critical report on poor customer service from the Kenneth Haynes banking review in Australia are probably the drivers behind CBA and ASB repaying their NZ perpetual preference shares.

Regardless of the drivers we repeat our compliment from last week about the bank’s decision to repay these securities. To leave these securities on issue as a cheap loan that had morphed from equity accounting would have been a deeply inappropriate stance to take in capital markets, especially one as small as New Zealand.

Now this high yield game appears to be up. Investing in complex bank securities for high interest rate rewards and very modest risks will no longer be an option.

The 10-year ride made for a much longer wave than we could have expected for you when it began.

I’m not sure where you’ll put all the ASB millions that are being returned (then ANZ and Kiwibank in 2020), but that doesn’t change our satisfaction from watching these repayments occur.

You’ll have seen our developing comments that we are supportive of the newly proposed regulations for bank capital and Kevin has, as usual been getting his head into how they’ll work and the impacts they are likely to have on our clients.

Kevin plans to write Market News for you next week in our latest effort to keep you up to date with the evolution of bank capital and its impact on the investment options they present to you.

INVESTMENT NEWS

RBNZ – The Reserve Bank of NZ released its latest Monetary Policy Statement last week and for reasons that I wasn’t abreast of they changed the day and time.

An MPS is always a little dry but it is also highly valuable information for investors to consider and it’s nice to have Adrian Orr’s style to make the content a little more readable.

Here’s the link to the full statement on the RBNZ website for the curious:

https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Monetary%20policy%20statements/2019/mpsfeb19.pdf

The status is unsurprising, being ongoing very low interest rates, often with negative real returns.

This interest rate environment is making it very hard for investors to consider the sale of any other asset type, regardless of market valuations or impending regulatory changes.

CEN – Contact Energy is displaying the success of its strategy to slim-down and focus on electricity generation and retailing (they have been selling their gas industry businesses) and a reduced capital spending programme, witnessed by reduced debt profile and wider earnings margins.

They have reached the point of increasing their dividend payments to 100% of free cash flow which resulted in an increase from 32 cents per share to 39 cents per share.

This may mean that the gradual rise in their share price slows as investors perceive there to be less savings, or wider margins, to be achieved in the years ahead but ultimately, we invest for recurring profits and dividend payments so this dividend increase will appeal to all shareholders and is a robust display of financial success for the business.

Most investors hold shares in the electricity generation sector, predominantly as a result of the share floats arranged by the government so I suspect their observations will lead them to realise that whilst the core product is the same for most, they all go about it with slightly different strategies from different geographic locations.

Ultimately this means, to me, that there is no ‘best’ generator/retailer of electricity and like a lot of investing claiming a diverse selection across the sector makes good sense.

Further, owning a few shares in the sector has proved to be a good hedge (protection) against the rising price of electricity as a consumer and I suspect this balance will be perpetually true.

Trustpower – TPW’s latest statement alerts me to the fact that my electricity prices may not rise in the year ahead.

There are always two sides to market pricing expectations.

TPW directors intend to revalue the assets on its balance based on expectations of lower electricity pricing in the future.

They do not expect a significant impact on underlying profits and have been paying special dividends as a result of their robust financial position.

They will use the money raised from last week’s bond issue to reduce bank debt, which is a nod to the fact that bond funding now offers two benefits; cheaper pricing and longer duration funding.

Investors should re-read that last sentence.

Fletcher Building – We look forward to reading FBU’s first half result on Wednesday, the first full half year for ‘new’ CEO Ross Taylor (great batting average – Ed).

The Formica sale, debt reduction that affords and new strategic focus implies that FBU will return to paying dividends.

I once said that it will take Ross Taylor two years to prove to investors that his new strategy will be effective. He is six months along that path so let’s give him more time yet before throwing too many headlines around.

Insurance – I know, not our space, but I do wonder if any of the insurance companies are troubled by reporting the strong increases in profit at the time our regulators are so unimpressed by their service levels?

We know they pounce of each unique risk event to explain their ‘need’ for increased pricing without doing any math for us on the present value of permanently increased pricing alongside temporary risk events.

EVER THE OPTMIST – I really like that Kiwi Rail’s chairman, Greg Miller, is talking in terms of 10 to 20 year plans.

Last week he spoke to a government working party about the potential for a new, modern, large dry dock to support our larger ships and preference to operate more coastal shipping for trade.

He carefully didn’t describe pricing or location but Wellington or the Marlborough Sounds are nicely central and protected from prevailing weather patterns.

I’d love to see Wellington make productive use of that large lump of land right beside the current Interislander terminals. If not a dry dock, then maybe level it as a camper van site with direct access to the ferry and water taxi pick up to take them to town.

INVESTMENT OPPORTUNITIES

Trustpower – Confirmed the issue of its new 10-year bond last Friday, setting an interest rate of 3.97% for the period until 2024.

Thank you to those who participated in this bond offer through Chris Lee & Partners.

If you missed the issue and still wish to invest, please contact us urgently as we have a modest amount of the bonds still available for clients.

Contact Energy – has announced that it is ‘considering’ an issue of a new 5-year senior bond. Details will be announced next week but we offer the following as a head start:

CEN has a BBB credit rating and the bond will mature on 15 August 2024.

We estimate that the interest rate will fall in the range of 3.30% - 3.50% (underlying interest rates have increased a little).

We expect this to be a fast-moving bond offer, confirmed by contract note (no application form) and investors being charged brokerage.

We have a list for those who wish to invest in this bond offer. Please contact us promptly (coming days) if you wish to invest once this offer is formalised).

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

Edward will be in Napier on 25 February and in Auckland (Remuera) on 8 March.

David will be in Kerikeri on 4 March, Lower Hutt on 20 March.

Chris will be in Auckland on February 25 and 26.

Kevin will be in Christchurch on 7 March.

Mike Warrington


Market News – 11 February 2019

The looming breakdown in the nuclear arms proliferation treaty between the US and Russia is a bad look, is symbolic of poor leadership and it further undermines global stability and thus economic potential.

INVESTMENT OPINION

Mortgage Market – The Reserve Bank proposals for a significant increase to equity settings for banks will have prompted dozens of meetings around New Zealand by financiers’ keen to pinch lending business from those armed with less equity.

One early mover has purchased the management contract for First Mortgage Trust with a likely expectation of being able to pick up a lot of mortgage lending business with near zero equity requirements for its managed fund business.

It’s not a stretch to imagine that Kiwisaver managers will be addressing the potential to include mortgage lending under the fixed interest asset class, especially if the higher equity demands made on banks increases the interest rate returns on mortgage lending.

Until recently Kiwisaver managers sought highly liquid assets so they could easily cash up if a Kiwisaver investor switched funds, but I suspect that fund managers will be becoming ever more comfortable with the core scale of their clients and the long term funds under management.

Mortgages are not all that liquid, they can’t easily be sold on to a different investor as a single item, however the securitisation of mortgages has proved that mortgages can be sold if bundled, so all the non-bank lending sector requires is a friendly mortgage warehouse provider (short term finance custodian) to ensure a bundling facility is always available to buy individual mortgages, should the need for liquidity arise.

I don’t actually think such a mortgage market facility will be required often because NZ demographics dictate that the scale of funds under management in Kiwisaver funds will continue to increase for many years and the conservative investing preferred by our population will demand a high proportion of fixed interest assets within the portfolio mix.

Given that you cannot easily withdraw from Kiwisaver until 65 years of age, and do not wish to dance from manager to manager, would you rather they invested in strongly rated corporate bonds at yields between 2.50% - 3.50%, or begin to include good quality mortgage lending at 4.00% - 5.00%?

Side Story – I saw an interesting story about Booster Funds taking an increased shareholding in a private business (a small winery) and it led me to an exciting discovery that Kiwisaver fund managers have moved beyond the listed and liquid investments and are beginning to include smaller, unlisted investment opportunities in portfolios.

Booster established the ‘Tahi Fund’ which has the express intention of investing in unlisted New Zealand businesses that require more capital. Initially they have a viticulture focus but intend to expand across other primary industries.

This is great news for NZ business and for Kiwisaver investors.

Back to my lending story.

We won’t experience a return to the finance companies of old for term deposit opportunities because they too are regulated by the Reserve Bank, and you’ve seen that the best quality lending is being ‘gobbled up’ by professional lenders; witness the sale of F&P Finance and closure of its deposit taking prospectus, and now the imminent closure of UDC as a deposit taker.

If the RBNZ proceed with its higher equity demands on banks, will they increase the settings for Non-Bank Deposit Takers too? (currently 8% or 10% depending on credit rating status).

I agree with the article by Mike O’Donnell including his hopes that some of the newly developed ‘lay by’ financing via ‘App’ services (such as AfterPay) will knock many of the excessively expensive payday lenders out of business.

There may be a small playing field for finance companies scaled between $5-19 million but they won’t feature on the landscape for investors receiving financial advice.

Simple extrapolation is usually unsafe (the sea level rose 1cm last year so it will rise 1 metre this century and cause lots of trouble) but it isn’t too much of a stretch to conclude that Kiwisaver funds have a role in the Reserve Bank of NZ’s future for lending in NZ, and as a result, the cost of a NZ mortgage should not increase by the +1.25% that Deutsche Bank recently suggested (top of their estimated range).

Competition will reduce some of the increased interest rate on mortgages (even though my personal preference is that the cost of debt increase to influence consumer behaviour).

It’s not hard to find Kiwis who will express upset over the scale of bank profits and the difference between what they charge on a mortgage and what we receive on our term deposits and bonds.

Ipso facto, it shouldn’t be hard to find support from Kiwis to have their Kiwisaver funds invested in local mortgages and to retain some of this margin of financial benefit (let’s call it 0.50% - 1.00% per annum) to credit the savings of Kiwis.

Is the RBNZ governor Adrian Orr playing a longer game than bank executives realise?

Increased equity on a bank balance sheet could well simultaneously improve NZ’s financial stability and increase NZ’s savings rate, especially through Kiwisaver.

Remember Adrian Orr’s immediate past role was the CEO of NZ’s largest investment fund.

 

US FEDThe Chairman, Jerome Powell, must be frustrated by last week’s commentary about the Fed Funds rate setting and the implications of their recent notes.

The headlines that I see from market participants all declare that the Fed is turning the corner and will soon be easing interest rates lower again.

Talk about putting (inaccurate, unwanted) words in the Chairman’s mouth.

The US has only just reported nonfarm payrolls for January 2019 of 304,000 being 150,000 higher than forecasts and confirming a sustained average of around 234,000 per month. These are good employment outcomes and consistent with the post crisis data of the past eight years.

Alongside this data unemployment has been declining and still sits at around 4.00%.

Lastly, the rate of increase for the average hourly wage has been rising slowly as economic conditions improve. Post the 2008 crisis, pay increases were 1.9% - 2.0% for a few years, then they moved to +2.0% - 2.5% between 2015-2018. Over the past three months the increases have exceeded +3.0%.

Yes, there are plenty of things to fret over within the US economy, but employment and widening consumer options isn’t currently one of them.

The extra-ordinarily low interest rates over the past decade and the willingness of the central bank to inject even more liquidity by purchasing bonds to finance others has been more than generous enough.

One of the current problems is that debt became so cheap and so available that the funds borrowed were often misused, so the Fed is quite correct to remove a good proportion of this financial generosity from the system.

Speaking of the Fed’s buying of bonds, they are on a track to ‘sell’ these bonds slowly over time. Much of this will occur through bond maturity (repayment) rather than sale to other investors in the market. In fact, the Fed will continue to buy bonds from the government but they plan to buy less each time.

This evolution will require private investors, banks and other nations, to increase the volume of US Treasuries that they purchase for their portfolios.

I am already reading articles that question the market’s ability to absorb these ‘additional’ bonds but this is not the Fed’s problem; monetary policy should be set to provide ideal market conditions for managing private or state savings.

If banks purchase ‘more’ bonds, but then need avenues for borrowing short term cash, the Fed can support this via short term secured loans (secured with bonds now owned by the bank) and in providing such facilities the Fed will have successfully moved itself from being a long term lender (not its preference) to being a short term liquidity provider (a normal market function).

Circling back to where I started with this paragraph, the market’s expectation that the Fed will begin to cut interest rates soon seems well wide of the mark to me.

Interest rates are low enough already, right?

INVESTMENT NEWS

Aussie Banking – The Hayne report is out, being the review into the Australian financial services sector.

I’m yet to read the full detail but my first impression is that the dark clouds that were put in place over the sector during the build-up (review hearings) have not delivered the cold wintery blast that many must have expected.

Indeed, bank share prices have shot up the day after the report’s release, which will no doubt frustrate Justice Hayne and his supportive parliamentarians.

The share price movement is a good illustration for investors of the difference between expectation born of anxiety around financial risks and the ultimate reality of a situation.

Several of the executive summary points look a bit woolly to me and that is likely to result in unclear reactions from the government and financial regulators, which in turn will make it easier for banks (et al) to dance around the intentions.

At first glance sectoral change appears to have been oversold and under-delivered.

Easier to List companies – China plans to make it easier to list companies on its stock exchange, especially technology companies, easier to borrow money to invest in shares and opened its derivatives market to foreign investors.

Are these looser regulations a little like printing money in other jurisdictions, providing an artificial boost to a subdued market place?

Tighter regulations intend to improve standards, so is it certain that weaker regulations will reduce standards?

This development may relate to a mix of their weak financial market conditions and possibly to the trade war with the US and the legal attacks on Huawei’s business.

Apparently the newly weakened regulations in Shanghai undermine their immediate neighbour in Hong Kong to the South, let alone other global market centres.

The new technology exchange was announced by President Xi late in 2018, highlighting the source of this weaker regulation.

At face value it feels like a troubling development to me, but in the interim it is likely to support China’s share market.

Housing – Councils have reported that they issued 32,996 consents for new dwellings in 2018, a high since 2004.

I gather that our migration ‘data’ is being reviewed down, retrospectively. I thought we had a pretty tight reign over the people moving across our borders.

Statistics NZ reports that the average NZ household has 2.7 people (is this a nominal number or a productivity measure? – Ed) so in theory NZ is building more than enough homes for the 2018 population growth (or preparing for more again in 2019).

Within the data there were regional splits, plus splits for apartments and retirement villages.

In my view these last two lie at the centre of solving some of our accommodation shortages; apartments present a more efficient use of land area, and many people prefer this style of accommodation, and migration to residential villages frees up a wide array of ‘family’ homes across all regions.

Plenty of commentators’ express doubts about the Kiwibuild programme (effectiveness and distribution of subsidies), and I share those concerns.

If the government wishes to offer subsidies maybe they could provide an inexpensive bridging finance scheme for those wishing to switch into retirement villages?

Usually those making this move only have one major asset, their home, and they are thus dependent on its sale to settle the purchase of a retirement village unit. The retirement villages are often generous with the settlement window, but even presenting the deposit on the unit may be difficult for the new resident.

The government would not need to reinvent the wheel to provide such a service.

With more than a little bias (I’m an investor in Heartland Bank), the government could provide a white labelled service backed into Heartland Bank’s Seniors Finance to support the financial settlement from one property type to another. Heartland would do all the documentation, no government department required.

Promoting the evolution of how our community is using its property assets to better align with the population’s requirements would be an appropriate government policy for residential property.

Let’s leave the property development decisions to those with the private money who are making the choices, and the developers will deliver them the product they desire.

Amazon – Did you happen to catch the fourth quarter profit result from Amazon?

Probably not, but I’ll touch on it here for your because AMZN has now comfortably passed above the scale of the New Zealand economy on its own and is another reminder of just how small the NZ village truly is.

NZ GDP is reported as being about US$206 billion.

Amazon’s sales revenue for 2018 was US$232 billion.

Amazon is reported (on geekwire!) as having 566,000 employees, about 9% of the NZ population.

It’s logical that NZ didn’t join the bidding to offer a location for a new Amazon office, we wouldn’t have enough people available to work for them.

We can’t even find enough people to plant trees.

Jeff Bezos’s story of industry consolidation is hugely impressive.

There was one other thing that businesses should learn from the profit announcement; even discounting the marketing intent from the statement, consumer use of ALEXA for verbal interaction with the internet jumped by ‘tens of billions of commands’ in 2018 relative to 2017.

If this is what the consumer wants, suppliers will need to try and make sure that ALEXA, and other word command searches, can find their business and solve the customers desires. (Hey ALEXA, have Mike call me – Ed).

Nice try.

I think it is far more likely that you’ll be standing at your kitchen bench and dictate an email to me, whilst peeling the carrots, where ALEXA will find an email address for me in the Contacts on your phone, or computer.

You’ll know just how clever ALEXA is when she asks ‘would you like me to copy the email to Kevin Gloag because he is more likely to know the answer?’

Lately there have been a growing number of stories about Apple, challenging them for their next clever technology idea and worrying that we may have witnessed peak performance from them, but I seriously doubt this.

Regardless of the business brands driving the changes, I think there will always be remarkable technological developments ahead of us. The obligation of the businesses we are invested in is to embrace those technologies that add value to both the consumer and to the business.

And, if NZ wants to keep up, we need our government and business leaders to lead in a way that helps us ride along with the changes.

Post Script: The speed of technological change is difficult to keep up with, but the huge increases in data gathering lead to similarly large increases in data storage, which will remind Infratil investors of the wisdom of their investment in the Canberra Data Centre two years ago.

Even if we are not clear why the data is being used, we should be happy to earn a fee for having people park their data in our storage facilities.

Italy Shrinking – If you read between the lines of a recent statement from the Italian Prime Minister Giuseppe Conte it may be more than just Venice which is sinking.

It’s hard to tell whether his comments were strategic (softening up the EU amid Brexit noise) or a slip of the tongue with ill-judged ad lib speaking, but either way the quote was unambiguous: ‘I expect a further contraction of gross domestic product’.

Maybe he has unintentionally released this week’s data from the Statistics Office early?

Unintentional?

One doesn’t reach the top of messy political arenas with unintentional actions.

No matter. Everyone can see how messy Italian politics is and analysts are already concerned about the impact of Italy’s slowing economy on the European Union and on to its trading partners.

EVER THE OPTMIST – I have reserved this space to compliment ASB Bank on the decision to repay its perpetual preference shares.

This confirms a good governance behaviour for us by recognising that the intention of these securities was to ask the market for ‘equity’ capital but given that they are no longer counted as equity repayment was the appropriate decision.

ASB could have decided to leave the securities on issue as relatively cheap debt funding for the bank, with no repayment tension.

We have long held the view that ASB perpetual preference shares (ASBPA and ASBPB) were good value when discounted in price and from a selfish point of view we are very pleased for our clients that the point of repayment has been reached.

INVESTMENT OPPORTUNITIES

Trustpower – Trustpower is issuing a new senior bond with a 10-year term with an initial interest rate minimum of 3.95% for 5 years (then reset for the subsequent 5-year period).

The ‘fast moving’ offer is being handled by contract note (TPW pays the brokerage expense) and is happening this Friday.

Any investor wishing to invest in the TPW bond offer must contact us prior to Thursday at 5pm and define a firm allocation amount that they seek.

We will bid for a firm allocation on behalf of our clients and revert with confirmed allocations late on Friday (by issuing contract notes).

Contact Energy – has announced that it is ‘considering’ an issue of a new 5-year senior bond. Details will be announced next week but we offer the following as a head start:

CEN has a BBB credit rating and the bond will mature on 15 August 2024.

We estimate that the interest rate will fall in the range of 3.20% - 3.40%.

We expect this to be a fast-moving bond offer, confirmed by contract note (no application form) and investors being charged brokerage.

We have a list for those who wish to invest in this bond offer. Please contact us promptly (coming days) if you wish to invest once this offer is formalised).

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

Edward will be in Nelson on 19 February, on his second visit to Napier on 25 February and in Auckland (Remuera) on 8 March.

David will be in Palmerston North and Whanganui on 18 February, Kerikeri on 4 March, Lower Hutt on 20 March.

Chris and Johnny will be in Christchurch on Wednesday 20 February (afternoon) and Thursday 21 February (morning).

Chris will be in Auckland on February 25 and 26.

Kevin will be in Christchurch on 7 March.

Mike Warrington


Market News – 4 February 2019

Given that Donald Trump became President, it must prove to plenty of people that they can realistically have a go at the job.

The latest to put his hand up is a retired CEO from the coffee industry (Howard Schultz). New Zealanders know that a good coffee precedes good work so all the best to him.

I happen to think that Michael Bloomberg would be a very good candidate to move the US forward from its Trump experiment, but he hasn’t declared his hand yet.

With a few more years of development under her belt Nikki Haley might make an impressive ‘first’ female President.

The 2020 US Presidential elections could become the most interesting in a long time.

INVESTMENT OPINION

Insurance – This isn’t our sector (within the Financial Advice space) but I am unsurprised by the findings of the RBNZ and FMA report about advisers being distracted by income, ahead of client service.

I have experienced it.

I am certain that I was paying for it as a consumer when I look at the price changes on my insurances! Mind you, I think that the lions share of my increased insurance pricing is a function of insurers pouncing on any ‘extra risk’ headline hoping that the news softens my resistance.

In fairness, I have felt like a number, not a client, for many daily transactions, not just insurance.

I was a little surprised that the head of the FMA predicted that the insurance sector was unlikely to change for the better without enforcement. He may be right, but it seemed inappropriate to make such public predictions.

Brexit – The heat is rising in the Brexit Kitchen and from this corner of the world it makes for entertaining reading for some, but not all as today’s news reveals.

UK citizens don’t find the situation amusing at all.

Whatever the outcome between the UK and the EU it will not be as disruptive to NZ as 1973, when the UK joined the European Common Market and cut us off from a lot of trade overnight, because New Zealand learnt a lot from that era about having too much dependence on two major trading partners, the UK and Australia.

Diversity reduces risks for import/export trading in the same way that it helps you and I as investors.

Trade decisions can be rather brutal if a country or trading block flexes its muscles and whilst the world is focused on the US and it’s newly beligerent trading stance the European Union has just dealt NZ a rather harsh blow.

Barely 72 hours after our Prime Minister visited the EU and the UK to discuss a desire for increased free trade flows between them and NZ, where she was probably handled with smiles and champagne, the EU has acted to unilaterally reduce our rights to export sheep meat, beef and dairy products to Europe once Brexit occurs.

The decision has shocked people familiar with our trading history and its agreements.

I learnt that there was an agreement in place that covered a total volume of sales to either the UK or Europe but the ‘divorce’ between these two means that the EU is mandatorily reducing the volumes that they will take under those agreements. The EU is clearly assuming that nations will go straight to the UK to negotiate new trade agreements that the EU will not be able to influence, and that is the crux of the matter ‘influence’; the EU don’t like losing some of it and it’s why 52% of Britains voted for Brexit.

NZ is not alone with this gripe, apparently 25 countries are affected. So my initial read of the situation is that the EU has been more widely disruptive to global trade with this decision than all of Donald Trump’s bluster combined.

One fact disclosed by this decision is confirmation that power corrupts.

Corruption?

Sure, it meets the definitions: act illegally (breach of legal agreement) for financial gain; or

Debase something by making errors.

Both fit the action.

Another fact is a reminder that NZ must continue to develop wider trading options to reduce reliance on this selfish and blinkered behaviour by political ‘leaders’ (followers – Ed) around the world.

NZ is a mere village in the global society. We have very little meaningful influence.

The final fact is that this is another nail securing the current slowing trend for global economic activity and it’s hard to see this trend changing for a few years whilst all the largest players are behaving so poorly.

So, the UK Brexit debate may continue to be amusing for many of us but its consequences reach us via a wider consolidated risk of slower economic activity, which under a loose generalisation should result in lower interest rates and lower share prices (less profit potential for many).

From a NZ government perspective, it would result in a lower tax take if activity and corporate performance slows.

I worry a little about self-imposed actions that may hinder our economic performance, such as the compulsion aspect of the proposed ‘Fair Pay Agreement’ regulations. The report recognises this folly with its reference to there being no ‘one size fits all’, which should be a surprise to nobody.

I like New Zealand’s moves to increase the minimum wage because it recognises rising costs being endured by the population and it reminds businesses that to be successful, they must be good at sales and service, not at suppressing staff costs. However, the FPA, if passed into law, will result in perverse and unintended outcomes that will, in my view, ‘cost’ employees, not benefit them. Employers will respond to an FPA and the removal of general use of the 90-day rule by reducing their combined employment risks and expenses and this must reach employees.

I am trying not to be political with these comments, but none of these developments contribute to a rosy outlook for investment and there’s no escaping that fact simply because we don’t like saying the conclusions out loud.

It was painful to read that NZ endured its worst trade deficit  in 2018 and whilst much of it was blamed on the high oil prices during the year it is very disappointing that our efforts to export more product haven’t been anything like enough to balance the books.

What’s it going to be like (financially) when exporting gets harder?

Our trend toward electric vehicles can’t grow fast enough. I’m not yet all that keen to own an electric vehicle, and I confess to not being a fan of the Nissan Leaf that is now quite common, but every time I drive past one I thank them for the effort they are making. Long may they pay no road user charges.

Interestingly we are sustaining trade surpluses (our favour) in our trade with China and Australia. (Small mercies – Ed)

It would be naïve to invest under the assumption that economic conditions are improving.

I don’t like to invest based on naïve assumptions.

It’s hard enough to make investment decisions when conditions are optimistic and outcomes seem obvious, which they never are.

The outlook is undoubtedly harder now than for many years, post GFC (crisis), and even if you do feel that you have a very clear view it will be one of low potential returns.

Brexit II – Whilst the US is tangled up in a mire over their President’s wish to build a fence the European Union is insisting on exactly the same thing for the two parts of Ireland.

It’s nuts.

The European Union was formed out of a desire to achieve politicial inclusiveness, less friction and no more war. Their proposals for separatism are diametrically opposed to that charter.

Building a ‘fence’ in Ireland would be like building a fence between Lower Hutt and Upper Hutt because each city couldn’t agree on a speed limit for the road connecting the two.

If they built nothing and said nothing I bet the local people would figure out the best way forward.

INVESTMENT NEWS

FED – The US Federal Reserve has reacted to the data (highlighted incessantly by financial and political lobbyists) and eased off on its track for increasing interest rates and reducing the volume of bonds held on its balance sheet.

They left their cash rate (Fed Funds) at 2.25%-2.50% and injected the term ‘patient’ into their commentary.

You’d be surprised by the depth of analysis that financial markets place on every single word used in the Fed’s releases, especially those relating to Fed Funds reviews. Often only two or three words will have been altered, which leads to hours and tens of thousands of words analysing why those changes occurred and spot-checking definitions of those words (US or English dictionary? – Ed)

The BNZ kindly emailed us the full text this time including the changes, of which there were so many it looked like a teacher’s review of a junior pupil’s first ever essay. 78 old words were removed, and 80 new ones were inserted.

Is the governor just trying to mess with us?

Actually, I think he is just better with presenting the English language and in several cases it required re-formatting the sentences. The only meaningful word reflecting the changed tone was ‘patience’; we are willing to stand by for a little longer as we monitor influential data.

However, they still seem likely to hike the Fed Funds rate by another 0.25%.

The market isn’t convinced that another rate hike is necessary, witnessed by their willingness to buy 10-year government bonds (US Treasuries) at a yield of 2.68%.

We’ll all have to be ‘patient’ to discover the end game for US interest rates.

Z Energy – ZEL has reduced the workload of its financial management team to the point that the CFO has departed, and they have boosted the technology workload to a level that required the appointment senior management of a Chief Digital Officer.

It would appear to be a sign of the times, reflecting the way we consume, and the way businesses want us to consume and I like ZEL’s active approach to how their business is changing.

CAT – One of the world’s largest companies, Caterpillar, is a bellwether for economic activity so its weaker sales and profits reporting is a mild concern.

CAT’s performance hasn’t led the analytical comments about the potential for weaker global economics, and it also follows the changing shape of yields curves around the world contemplating the potential for recessions, but the weaker CAT results are where the rubber hits the road (tracks hit the dirt? – Ed) so it’s getting real now.

Quarterly reports are always monitored very closely but in the past the assumption was that they would validate the strong economic activity and general financial optimism, now they will be watched intently to see if they are validating a turning downward in performance.

CAT’s share price declined throughout 2018 and I’d expect that trend to continue throughout 2019.

If you look at the price chart for CAT and overlay it on the Dow Jones Industrial Average (US) the corelation is high.

I’m not trying to wave red flags or deliver scarey commentary, just bring valuable snippets to a very large jig-saw puzzle for you, and me.

EVER THE OPTMIST – Ege, a leading European carpet maker from Denmark, has moved to source 100% of its white wool (for its printed carpet range) from New Zealand farmers.

The reasons are that our farmers consistently produce the whitest wool and can provide assurances through the Wool Integrity Programme relating to product quality and animal welfare.

Coincidentally (?) the country that was dropped from the list of suppliers was the UK.

This may not have any relationship to Brexit but it is indicative of the quality of NZ primary produce.

It would be nice to also be writing that NZ was exporting more value-added products to the world.

ETO II – Air NZ may not be seeing quite as many tourists, and neither is the North island, but the South island numbers are still growing.

Mainlanders will be unsurprised by this given the beauty of the place (a moment for me to claim my ‘born in Alexandra’ heritage).

The measure from Statistics NZ on this occasion was ‘guest nights’ which set a new collective annual record of 40.31 million ‘guest nights’. This reads as a phenomenal number and oozes cash flow for the economy, unlike the travellers sleeping in their cars and vans adorned with ‘I’m a campervan’ stickers who are not captured in this data.

Given the behaviour of the EU above exercising its rights over things it can control, NZ shouldn’t be bashful about its intentions to demand more in payments from tourists as they arrive, or use our public facilities. We aren’t going to earn much more from those who sleep in car parks or under trees and live on 50 cent noodles.

Tourism is an export that we can control even when the tourists come from the EU.

ETO III – The price of milk may have receded a little but the nice weather (global warming? – Ed) has resulted in higher milk volumes, which will deliver higher cash flows to the dairy community.

ETO IV – It has clearly been a week for the optimists; Standard & Poor’s has lifted the credit rating (default risk) outlook for NZ to ‘Positive’.

‘According to the ratings agency, New Zealand has fiscal and monetary policy flexibility, economic wealth and resilience, and stable public policy settings’.

Because I harp on about our trade deficits, I’ll just throw this quote in for balance: ‘It noted, however, the high level of external liabilities remains New Zealand's main credit weakness’

INVESTMENT OPPORTUNITIES

Trustpower – has confirmed they will be issuing a new 10-year bond with an interest rate reset after five years.

TPW plans to offer more details, including indicative yield, next week.

Investors are welcome to join our mail list for this bond offer.

Napier Port – The regional council has approved the sale of some shares in the port and invited investment banks to pitch (beauty parade) for leading the offer to market.

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

Edward will be in Nelson on 19 February, on his second visit to Napier on 25 February and in Auckland (Remuera) on 8 March.

David will be in Palmerston North and Whanganui on 18 February, Kerikeri on 4 March, Lower Hutt on 20 March.

Chris and Johnny will be in Christchurch in February, based at the Airport Gateway Motor Lodge, in Roydvale Avenue - dates to be advised.

Chris will be in Auckland in February - dates to be advised.

Mike Warrington


This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.

Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2019 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz