Chris Lee & Partners Ltd

Market News 28 February 2022

I clearly misunderstood (as did financial markets).

Vladimir Putin has offered a peace keeping force inside Ukraine.

Political risks surrounding Ukraine will now feature in headlines for years. China will undoubtedly play the same hand with Taiwan.

It is deflating to observe governance from ego by way of weaponry.

INVESTMENT OPINION

 

OCR­ – The Reserve Bank increased our Official Cash Rate by 0.25% to 1.00% last week.

No surprise.

They want to keep us on our toes and said they seriously considered the option of a +0.50% move but then they undermine this declaration by not actually changing their near-term interest rate forecasts.

If they are not willing to ‘front load’ the interest rate increases early in the process of increasing interest rates (with +0.50% increments), will they ever do so?

The statement that offered the greatest change of sentiment was the increase to the terminal (high point) for the OCR in this cycle to 3.35% from 2.60%.

The +0.75% additional to the terminal OCR height indicates an updated concern about actual inflation and pending inflation risks.

The theme remains the same: interest rates are on the rise, but not to the level that investors would like.

US Fed Funds – The ‘auction of opinions’ in the US sees the latest ‘bid’ (prediction) lifted to an expectation of nine increases to the Fed Funds Rate (OCR equivalent of NZ). This is JP Morgan’s updated guess.

Nine increases, at 0.25% each time, would lift the US overnight interest rate up to 2.25%-2.50% range from the current 0.00% - 0.25% range.

Publishing ever more aggressive forecasts for interest rate hikes still feels a little like a game, but holistically speaking a 2.50% interest rate does not feel even close to being restrictive, so this JP Morgan guess is as realistic as any other when you start from 0.00%.

Over time analysts will unquestionably look back and try to understand the impact of the 0.00% interest rate period (negative in Europe), whether it was truly necessary, and there will be a variety of calculations about whether the settings created economic benefit or harm.

I don’t wait with anticipation for such opinions because then, as now, they will seem ethereal and very hard to use as foundations for the more important forward-looking decisions of the day (whichever day).

The only way I could rationalise 0.00% interest rates as having been beneficial is if they aided marginally higher levels of business (under duress) and thus held employment levels marginally higher.

In practice one should ask whether this was necessary given the vast sums of taxpayer funds paid out to business and the public during the intensity of the pandemic.

I am beginning to doubt that we needed free money and cheap money simultaneously.

The central banks have a dilemma during 2022. Should they remove the cheap money or the free money first?

They are shaping to remove the cheap money (increase interest rates).

Whilst most forecasts are for the US Federal Reserve to increase the Fed Funds rate in a sequence of +0.25% movements, one of the US Federal Reserve governors appears to have been tasked with testing the waters for a +0.50% first increase.

Michelle Bowman says (presumably with authority from the Chairman) that she is open to the idea of a 0.50% increase in the Fed Funds rate.

I expect that the Chairman (Jerome Powell) will now monitor 3-5 days of subsequent market reactions (both interest rate changes and commentary).

On the subject of forward-looking interest rate assumptions and related inflation concerns, John Mauldin’s article from 19 February was particularly good if you’d like to understand the subject a little more deeply.

He stresses that inflation is always a problem if we lose control of it, but he is not confident the interest rate fight being discussed will be sufficient, and he rightly highlights that the yield curve (chart of interest rates out into the future) is increasingly confirming that a recession is developing.

In the US returns on 30-year government bonds are now lower than on 20-year bonds.

I could forward the text if you are curious to read in more length.

In the meantime, we have 15 more days to speculate, postulate and pontificate about what the Fed might (or should) do.

Kiwisaver – I experienced a hollow feeling when I read that Minister David Clark has launched a review of Kiwisaver.

I don’t have a lot of confidence in David Clark and am not keen on politicians meddling with Kiwisaver. What next, regulate banks to calculate mortgage repayments over 25 years, not 30 years?

One article claims to have revealed that the minister is considering the removal of the $521 government subsidy. For goodness sake (or words to that effect); was Clark’s proposal titled ‘’How to reduce New Zealand’s savings rate?’’

Is the government not tired of launching expensive reviews?

More value would be gained from paying employers to interview employees who at this point have enrolled, or contribute regularly, to Kiwisaver. Then offer them some free financial advice.

Secondly, increase the subsidy back up to $1042 for contributions from those who are employed and on the 17.50% marginal tax rate (or lower).

Keep the subsidy at $521 for those on the 33% marginal tax rate.

Yes, OK, the flipside of this policy could be to remove the $521 from those on the 39% marginal tax rate.

Lastly, in my new suite of policies, without the need for an expensive review, I would increase the minimum contribution to 4% (from 3%).

I would explain this last point to New Zealanders as a necessary change given the high probability of low investment returns expected over the coming decade.

If the compound annual returns decline (below inflation rate on some assets) the only other way to increase the nominal sums saved for use in retirement is to increase the capital contributed to the fund for a while.

Again, some free financial advice to do the math for people so the picture becomes clear to them.

This is really a commentary for your children and grandchildren. At the very least, make sure they are enrolled and contributing…. and asking their local MP to stop meddling in Kiwisaver!

Reporting – The current reporting season is upon us and if you are receiving emails from the companies that you own, directing you to reporting and slide shows, I encourage you to take a moment and read them.

The summaries are well written and useful for investors.

There are some good, and very good, financial performances being reported.

The item that prompted me to write this paragraph was having just read the Chorus report.

The business that ‘you’ own (if a Chorus CNU shareholder) hasn’t changed much, but the foundation for their operation has matured to the point that the regulatory settings and new investment commitments are now well defined and are leading into a cash flow surplus situation.

That financial and regulatory clarity has enabled directors to launch a share buyback programme and to announce their intention of rising dividend payments for 2022 (35c), 2023 (40c) and then 2024 (45c).

Reliable profits and rising dividends are precisely why one chooses to own a company.

Given that the majority of you are users of Chorus services, it is somewhat of a virtuous circle; if you keep paying your monthly communication costs CNU will remain in business, and typically pay you a dividend!

Fun – Bloomberg reports that Davy Jones is now the world’s largest owner of high value vehicles from the Volkswagen Group.

Ever The Optimist

Australia has opened its borders again and begins the process of attracting people and activity back to the economy.

Australia is already enjoying very strong trade activity (cross border exports in particular).

This will become ETO2 once New Zealand reaches the point of the much-needed opening of our own borders and we open channels to engage with Australia’s current financial strength.

ETO II

Wouldn’t it be fun to include the dairy pricing every week under ETO.

Well, this week the forecast price per kilogram of milk solids has been increased again to between $9.30-$9.90 (The mid-point is +$0.40 on the recently defined increase!)

Just wow.

Investment Opportunities

The new issuance market may have looked a little quiet to the casual observer, but for your information, over the past month, there were nine new bond deals raising a total of $4,555 million.

$4.5 billion is quite a good month’s activity for all the lead managers. They’ll be pleased.

Retail investors participated in providing $125 million to Investore Property and $800 million to Westpac Bank.

The other $3,630 million was borrowed by (collectively) Housing NZ, Local Government Funding Agency, Asian Development Bank, Inter-American Development Bank, Rentenbank and NWB Bank.

The continued borrowing in New Zealand dollars by these international names reflects ongoing confidence in the regulation and stability around our financial markets.

Genesis Energy Ltd has announced their intention to issue a new 6-year senior bond (more details to be announced tomorrow).

The bonds will be rated ‘‘BBB+’’ credit rating.

The interest rate is likely to be set above 4.00%.

China Construction Bank (New Zealand) Ltd has appointed several NZ banks to assist with a new 5-year bond offer (yet to be announced).

The intention is to make this bond available to retail investors (investor pays brokerage).

CCB NZ has a ‘’A’’ credit rating.

The interest rate is likely to be set around 4.00%.

Mercury Energy – The half year results announcement included a disclosure that it is considering offering a new subordinated Capital Bond during the second half of the financial year (which ends 30 June 2022).

For preparation, you may recall the details of Mercury Energy’s other Capital bond (MCY020):

A 30-year legal life (to 2049), 5-year initial fixed rate period (2024) then possibly retained until 2029 but I suspect the corporate preference is to redeem and reissue the investment so as to retain the ongoing equity recognition available to the company by ensuring that residual life is always greater than 20 years.

With the returns on senior bonds rising to 4.00%, and a little above, the return on a Capital Bond should really be knocking on 5.00% returns now.

Let’s see what happens over the next few months.

Travel

Chris will be in Auckland on March 14-16 and has three available meeting times on Tuesday 15 March (Mt Richmond Hotel, Mt Wellington).

Anyone who would like an appointment is welcome to contact our office.

All other travel booked for March is now full.

Michael Warrington

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Market News 21 February 2022

The larger the scale of government, the weaker the governance shall be.

Good regulation doesn’t require large government.

Indeed, without commenting on content, good regulation would be revealed by better outcomes for society followed by smaller government (less involvement).

I don’t think we are seeing this at present.

INVESTMENT OPINION

 

Rio Tinto – If it wasn’t so serious it would be funny.

Rio is again making noises that it wants to stay in Tiwai Point – ‘quelle surprise’, given the cheap renewable energy on offer in the current global environmental setting and the pricing of aluminium.

Rio presumably wants its ‘pathway beyond 2024’ to be paved with high quality bauxite and cheap electricity.

Dear Government – Say nothing. Pay nothing.

Dear Meridian – offer Rio the wholesale floating price.

Dear Transpower – get the wholesale grid improvement to the North Island complete, on time. (and on budget? – Ed)

Dear James Shaw, ask your government to stop offering free carbon credits to Rio Tinto (massive subsidy) and start offering that economic lever (reasonable carbon costs) to our local owned producers.

Stop selling NZ short.

NZX – The NZX is continuing its expansion into markets activity beyond its heritage of debt and equity securities, witnessed by the latest announcement purchasing 33.33% of the Global Dairy Trade business.

Fonterra has also invited the European Energy Exchange to purchase 33.33% to widen the global reach through additional business independence.

It would be nice to see dairy derivatives return to the NZX, and maybe now EEX, even if they are a tri-party arrangement with the ASX. Blockchain technology should enable simultaneous participation by the three of them, which would surely boost volumes.

Boosted volumes would help Fonterra with one of its key objectives from this transaction: wider distribution and deeper price discovery for their producers.

It’s very nice to see two significant NZ businesses removing geographic boundaries from their ambitions.

US Energy – The US continues to be energy self-sufficient, and this is an important influence on global politics.

Oil imported from the Persian Gulf has dropped from 30% to 8% of consumption and at a glance this appears to be for sustaining stockpiles because local and Canadian oil meets consumer demands.

Subsidies into the renewable energy sector and the enthusiasm for hybrid or electric vehicles seem to support an extended period of energy self-sufficiency for the US.

The US economy will feel less net impact from the current global tension around energy pricing.

I hope this means there will be less reason to get the guns out.

Inflation – So, what can we invest in that will protect us against inflation?

Heineken says beer.

They are increasing pricing in response to inflation data.

Did you drink one less in response?

Ever The Optimist

Around New Zealand 65-75% of mortgage holders are ahead on their repayment obligations to the bank.

Median Data ranges (by region) show repayments between 7-19 months ahead of schedule and by amounts between $5 - $18,000.

This is excellent news on two fronts:

1.   It confirms the individual and collective intelligence of the majority with respect to responding to financial signals around us; and

2.   That ‘we’ are building up equity buffers within our economy (savings can rise).

With thanks to Westpac for publishing their data.

ETO II

Dairy farmers are going to become sick of townies offering them hugs, but they deserve every single one.

Dairy pricing has enjoyed its third sequential price increase during product auctions and pricing is threatening to break above all time highs. (2013)

After 2013 dairy pricing fell, but I don’t think this will happen in 2023 because the problem 10 years ago was the market allowed China to overstock its inventory and then temporarily withdraw from the market (price slump).

On the basis of ‘fool me once’, and dairy farmers are not fools (and hopefully Fonterra no longer is) I doubt we will be caught out by that selfish playbook again.

It was hardly relationship building behaviour at the time.

New Zealand’s primary industries are highly important parts of generating real net income (from trade) for NZ and ‘we’ should be doing everything possible to improve financial outcomes for them.

I share the NZX’s hope that expanding the ownership of the Global Dairy Trade platform will expand its market reach and thus be beneficial for NZ dairy farmers distribution options.

https://www.globaldairytrade.info/en/product-results/

ETO III

Horticulturists deserve hugs too.

We bought some desserts for the ones we met during our most recent research trip in Central Otago.

They had worked impossible days and hours to harvest the cherries (but some blueberries had to be ignored and thus wasted) and they kindly discussed the business details with us at the Chatto Creek pub.

Even though we were interrupting their much-needed down time, they still got up and helped us with an important matter.

Such good people. So important to our collective success.

Investment Opportunities

Investore Property (IPL030) – issued $125 million (as planned) of new 5-year bonds (25 February 2027) at an interest rate of 4.00% (the credit margin was surprisingly at the low end of the range).

Even though IPL paid the brokerage costs of this issue I don’t think investors have gained any marginal value from their support of this new capital raise. One can now buy similar bonds at yields above 4.00% and thus pay any brokerage costs from the higher yields on offer.

We are grateful to the investors who participate in this bond offer through Chris Lee & Partners.

Westpac Bank – also completed an issue of $800 million 5-year bonds (16 February 2027) at an interest rate of 3.696% (+0.80% margin).

This issue is evidence of my value comparison above; only +0.304% yield difference between a ‘AA-’ rated bank and an unrated borrower (IPL). Let’s call it +0.45% once brokerage is factored into the equation, which (my point) isn’t enough additional reward for risk.

The ability to issue $800 million was a nice piece of evidence relating to the current confidence held by investors, and to the scale of cash that investors have accumulated over the past 6 months.

Some investors are concluding that the central bank plans to increase the overnight cash rate (OCR) means that long term interest rates are doomed, and to be avoided.

I think this is a mistake.

WBC success with $800 million issuance gives me a little confidence that not all investors are closing the shutters.

Further, New Zealand bond investors do not invest ‘’long’’ term, so the average duration of their portfolios is short or very short and thus the exposure to financial loss is very modest indeed.

Throughout my 14 years providing financial advice to the public, investors constantly link their age (whether 60 or 90 years) to the view that a 5-year bond is too long to consider.

5-years is short. Northern hemisphere investors would say very short.

10-year bonds are the focal point of long-term bonds around the world.

The average maturity of all US government bonds on issue moves between 65-70 months (5-6 years). Interestingly the NZ government bond average is about 7.8 years at present.

My point is that NZ fixed interest investors average term of investment is more like 2.5 years (less than half the average of bonds on issue) because even if they have included some bonds maturing beyond 5-year terms they invariably hold very large sums in shorter terms (reducing the average).

They do so even though their investment horizons are typically decades long.

This means many investors missed some benefits during the long period of declining interest rates. Some investors now think they are exposed to damage with interest rates rising but the damage will only be modest (less than paying brokerage for trading, or the penalty of low returns on short terms).

For the sake of some math – If half a person’s portfolio is held in fixed interest assets and only has an average life of 2.5 years, and (guess) interest rates rise by 2.00% across that cycle, that fixed interest portion will only lose marginal value of about 5.00%.

Remember that it has moved forward by the underlying interest rate reward held (let’s call that 2.5 years multiplied by 2.50% rewards from 2021 interest rates) = +6.25% received.

Net gain = +1.25%

Behind inflation, sure, but ‘capital stable’ which is one of the fundamental demands from investing in fixed interest assets.

If you sell all those bonds to try and beat the market. Then one day buy them back when your (perfect) timing encourages you to do so, you will have paid the balance of that +1.25% to the broking community. (biased thank you).

I apologise to those who dislike math whose eyes have glazed over.

You’ll observe that I have now assisted investors with reinvesting money from 5-year bonds three times! And, I don’t consider my time here to have been all that long.

Here are the key points to take away from this ramble:

New Zealand fixed interest investors (self-managed, who did not capitalize valuations on the way down with interest rates) are not highly exposed to interest rate changes (up or down);

Do not waste money through unnecessary trading of fixed interest assets;

Constantly check your view that interest rates are going up a lot, and do not invest large sums in short terms for long as this will be your lowest point of return well into the future.

Again, we are grateful to the investors who participated in this bond offer through Chris Lee & Partners.

Who is Next – We are led to believe that the next bond on offer will be a subordinated item, from an entity that you’ll all be comfortable lending money to.

We think we can predict the terms of the lending (life of the product, concessions in the terms and conditions etc), so the remaining question will be the interest rate offered.

In a market where risks are evolving and volatility is increasing, investors should be charging more for marginal risk. In my view a subordinated bond should be offering to pay a minimum of 5.00% plus costs of the issue.

Fletcher Building has announced a 4.75% return for the rollover of its subordinated capital notes, which is a little light, but inertia from investors and no transaction costs (fair enough) means they will get this deal done, as they always manage to.

Raising new capital should require payment of higher marginal returns.

As soon as we can discuss more detail, we will establish a list and investors will be welcome to join it.

IAG has pre-announced in its public statement the following, as a precursor to the likely handling of its subordinate bond at the June 2022 optional redemption date:

IAG’s NZ$350m subordinated notes first optional redemption date is on 15 June 2022. As such, IAG may seek to issue a new NZ$ Tier 2 instrument prior to 30 June 2022, subject to market conditions. No money is currently being sought and the new NZ$ Tier 2 instrument cannot currently be applied for. If the new issue is made, it will be made in accordance with the NZ Financial Markets Conduct Act 2013.

The equity recognition offered by these securities incentivizes IAG to make an offer to repay the old securities and ask the public to invest in a new offer of similar securities.

There is plenty of water to flow under this bridge yet. We will revert to you once more progress is detailed and begin an investor list then (perhaps May?)

Travel

David will be in Kerikeri on Monday 28th of February and Whangarei on Tuesday 1st of March.

Chris will be in Christchurch March 8 and 9, and Auckland March 14-16.

Michael Warrington

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Market News 14 February 2022

There have been plenty of reasons to yell at Covid and to poke holes in the government response, but I’d like to compliment the government on one aspect:

They paid a premium price to buy the best vaccination product.

99% of the time you would predict that government or council would select the cheapest price in a tender, however, this time they were either well advised (or forcefully) and they paid top dollar to access the Pfizer BioNTech vaccine.

The comparisons are:

Pfizer: US$25.50

Novavax: US$25.00

Janssen: US$17.10

Astrazeneca: US$10.60

I didn’t see Moderna mentioned but given it has the same high efficacy as Pfizer and Novavax it likely carried a similar price.

Yes, price matters, but effectiveness matters more.

Government bodies seems to constantly waste money, but they didn’t with this item.

This decision advances health and should advance economics (if we are given the chance!)

INVESTMENT OPINION

 

New Year – I am so pleased that 2022 is the year of the tiger, one of my favourite animals.

The tiger is so much more imposing than the other options, save for the dragon.

Crouching Tiger, pending Dragon (2024); keep your eyes open.

Don’t underestimate the markets potential to surprise you.    :)

Gong Xi Fa Cai.

 

Government – Having complimented government for a Covid related action above, I might offer a criticism and ask why select committees have started refusing to accept submissions via email when remote services are desirable during an environment of Covid restrictions and risks!

I think I know the answer: they don’t like the leverage that technology is providing submitters who ‘back in the old days’ were required to make the commitment of attendance in person.

Or rather, they don’t like the leverage it provides to critics.

Frankly, the government should be embracing the use of technology for public submissions if it increases the scale of participation in law development.

Funny old ‘business’ politics.

Government II – OK, another criticism because it is item that will slow New Zealand’s productivity and thus its economic performance.

I dislike the new unemployment tax.

New Zealand does not have an unemployment problem to solve, so why add another expense?

It is hard to see recurring inflation risks in NZ given the decisions our government is making at present.

KPG – Here’s another example of how my mind works.

I viewed the latest announcement that Graeme Hart was entering the property development business through purchases in the Mt Wellington area as good news for Sylvia Park and thus Kiwi Property Group.

Graeme Hart has been reported as buying properties in the Mt Wellington area for development.

My initial reaction was that it felt late in the game for residential property development, but then I reminded myself that Hart is much more successful in business than I am, and indeed most people.

I haven’t yet read the address so remain curious about the specific location.

Other than via Mangere Bridge, almost all other traffic traversing the Auckland isthmus from North to South passes through Mt Wellington’s boundaries (Both Great South Rd and SH1).

Sylvia Park sits fair square in the middle (probably the reason KPG chose it – Ed).

Graeme Hart’s actions are yet another reminder that Auckland is New Zealand’s busiest economic hub and it will remain so.

The best businesses are not spending much time on interest rate predictions and financial market headlines because they are focused on credible strategic plans producing, serving and selling over 1, 3, 5 and 10 year time periods.

Super – For the sake of New Zealand’s long term financial strength, I like that the debate about National Superannuation has been re-opened by the OECD review of NZ and that this time one party (National) has accepted the need to increase the age for receiving it.

NZ cannot go through the ongoing sequence of huge expenses, especially Covid related, and not consider alterations to our income (Tax base), our spending and the net financial position.

We all must contribute financially to improving NZ’s financial position and to prepare ourselves for the next expensive event.

Given that everyone’s circumstances are different I’d quite like the government and opposition to re-open the debate initiated by Peter Dunne when he tried to enable an early and late start option to National Super with a commensurate reduction or increase to the sums received.

I would be happy if anyone diagnosed with a terminal illness was switched on immediately, at the full rate and a minimum of 5 years was paid to that person’s family if they did not survive that long.

I genuinely think it would make sense to tell my kids that they must wait until 67 years of age to receive National Super. If the government removes the suppressive 39% tax rate, makes Kiwisaver compulsory (or at least increases the minimum contribution) and reduced the tax on Kiwisaver funds it would encourage the young to save and succeed simultaneously.

Don’t under-estimate the intelligence of the younger generation I think my kids would accept ‘my’ new settings for National Super.

They’d certainly have sufficient years to prepare for the change (saving an extra 3% of their income now, for 30 years, would provide them with roughly the same as two years of National Super payments. This implies Kiwisaver at 6-8% of income for those under 35 years of age.

Dear Parliamentarians,

(because my attempts to become President for a day are being ignored)

We don’t need all the tough decisions to be about recoveries and spending more money; please make some that relate to productivity and savings.

Politics – Recently I have raised concerns about the likes of Presidents XI, Putin and Erdogan as examples of economic damage being caused basis on selfish political preferences.

Today’s criticism is levelled at the European Union (EU), and in this case France, for its spiteful and unproductive reactions to UK’s exit from the EU.

France is demanding ‘wet signatures’ to slow cross border trade between the UK and Europe.

Transactions are generated and processed electronically for the trade on the trucks, as you’d expect in this era, but the French are currently demanding that physical copies be created so they can be signed before crossing a border.

Presumably the French then scan the signed documents back into digital form!

If you’ll excuse the pun, this is missing the wood for the trees by 180 degrees.

I read a good article about the importance of political harmony if climate change efforts are to stand any chance of success relative to the Paris Climate Change goals.

This one example of unnecessary political disruption by the French undermines my hopes for climate progress and important economic efficiency and productivity.

PS: If any nation genuinely wants a dose of inflation to push asset values well above debt levels (lower debt to equity ratios) just contract in President Erdogan. He has delivered 48.69% inflation to Turkey.

Cryto Currency – This subject is becoming more interesting as many players are assuming positions, or changing their positions in the digital currency, or crypto currency, space at present.

This is to be expected as they all try to understand their own foundations for use, or not, and then hope to make robust decisions about involvement, or not.

Central banks are making declarations about whether they are in, out or undecided and they will all unquestionably be determined to continue regulating the country’s payments environment.

Central Bank Digital Currencies will not attract value through scarcity, but integrity. They are the only chance of widespread public acceptance, which is a good thing.

Above central bankers though, nations (politicians) are also deciding whether to accept or ban digital (or crypto) currencies from the economy. Already some are out, and others are in, whilst most are sitting on the fence, presumably monitoring the success and failures of the early movers.

Of great interest to me last week was Facebook’s decision to exit the space.

Facebook, with its enormous following, had proposed to establish its own digital currency for both its disciples and the wider public to use.

They launched it as LIBRA and then changed its name to DIEM. I am not sure that pinching Latin terms was appropriate for such a service, it may have been time to establish a new brand (FaceCoin with Zuckerberg’s head? – Ed).

The interesting part though is that they have already exited the space and sold old technology and any intellectual property or patents to another business.

If a private business with approximately 2.9 billion active users (www.statista.com) doesn’t think it can establish critical mass with a privately organized digital payment method, can anyone?

Does any private business ever want to?

The reasoning in the announcement, which made complete sense to me was: it became clear from the group’s conversations with federal regulators that they would not be able to launch Diem.

The buyer, Silvergate (banking service business), plans to continue with the structure, which seems to confirm that regulators will not allow dominant customer service businesses to also try and ‘monopolise’ payment methods.

An observation – Note the legal challenges being made against Apple and Google for the control they are exerting over their marketplaces for technology services (App stores).

So, you can see that regulatory tension is rising in the digital currency space. Again, this should be no surprise.

Unregulated crypto currencies, or those who try to avoid disclosures, will continue but surely, they’ll lose ground with the majority across the economy and thus be further relegated into the shady or illegal sectors.

They may retain some value as they are useful to those who wish to be invisible, but my guess remains that their value will decline not expand.

Interesting post script: Having reported their first decline in user numbers Facebook suffered the largest value decline ever in US market history (and probably globally) with a US$252 billion decline in value (-26%).

For perspective, NZ annual GDP is about US$210 billion.

Kevin Writes:

 

While Central Bankers around the globe try to battle 30-year high inflation, whilst applying the gentle touch, the governor of the Bank of England has come up with an interesting solution.

He has appealed to Britons not to ask for a pay increase this year to give the UK economy time to recalibrate amid soaring inflation.

He believes that higher wages inflate living costs which can lead to a vicious circle known as the ‘wage-price spiral”, a phenomenon Britain, and indeed NZ, experienced in the 1970s.

Needless to say, in the face of sky-rocketing living costs and 1 in 5 British households struggling to pay their bills, Britons are not amused.

In NZ CPI inflation surged to nearly 6% in the 12 months to December 2021, led by price increases for essential goods and services – food, housing and transport.

And despite record low unemployment in NZ Kiwi households face the same dilemma as the Brits – a decline in real income as rising costs for non-discretionary items reduces purchasing power.

If wages aren’t rising at the same rate as inflation you are effectively taking a pay cut.

In the past 12 months over 80% of NZ workers saw a pay rise lower than the current inflation rate with two thirds of workers receiving an increase of less than 3%.

The recent quarterly employment survey also revealed that increases in wages increasingly came from overtime payments, meaning more hours worked not higher pay rates.

We also have around 100,000 people in what is called underemployment, where people want to work more hours but can’t get them.

Adding together the number of people looking for work with the number looking for more work we find over 250,000 New Zealanders looking for work, suggesting that we are not at full employment quite yet.

So, while the job numbers look good they only tell part of the story and imported inflation and low wage growth are a bad combination.

Those of you who were working for wages in the 1970s - 80’s will remember annual pay increases of 10% or 15%, very much the norm in those days when inflation was rampant.

The big difference between then and today’s scenario is that although debt servicing costs reached 20% or more in the 1980s the amount of debt people carried relative to what they earned was a multiple closer to 3 not 10!

When I see a falling unemployment rate I’m always hopeful for a corresponding reduction in beneficiary payments but sadly this is only fantasy with the numbers of working-age people (18 – 64 years) receiving a main benefit continuing to grow.

In fact, 368,172 people or 11.7% of the working age population were receiving main benefit assistance at 31 December 2021 compared to 289,788 (9.7%) in December 2017.

The big unknown at present is just how far interest rates will rise based on current inflation and employment data.

The Reserve Bank has a new dual mandate of keeping consumer price inflation low and stable and supporting maximum sustainable employment.

Share prices are currently being revalued for higher rates without anyone knowing exactly where they will settle.

The NZX50 index was down nearly 9% in January catching the attention of potential bargain hunters while others with a different view on interest rates might be waiting believing there is more to come. 

Interest rate markets in NZ are currently pricing in the fastest and steepest hiking cycle of all time and my view is it will prove to be overdone.

Mortgage borrowing rates, and corporate bond rates, have increased from low 2%s in late 2020 to low 4%s at present. Still very low by historical standards but quite significant I’m sure for many mortgage borrowers in a country where household debt equals 100% of GDP. That is right up there by global standards.

I also don’t believe the Reserve Bank will increase rates aggressively and get out of step with our main trading partners, particularly Australia and China.

Australia has signalled a cautious wait and see approach to increasing rates and China has deliberately slowed its economy to let the heat out of its property market, where Chinese store most of their wealth.

I also think the big domestic spend we have witnessed over the past 18 months is over as people hunker down under the weight of rising living costs, increased debt servicing commitments and the imminent economic disruption from Omicron.

I think its going to be a hard winter for many businesses, and households, and although increasing interest rates might take care of inflation it requires a gentle hand or a recession could follow.

On this basis I think the Reserve Bank will proceed much more cautiously than interest rate markets are currently pricing for.

 

Kevin Gloag

 

Ever The Optimist

New Zealand unemployment dropped to a new all-time low of 3.2%.

I remember when economists described 4% unemployment as representing ‘’full employment’’.

I don’t think we should reset this tidal marker because nobody has been able to come to NZ and compete for the available roles!

ETO II

Shipping costs continue to decline and have quickly reverted to a mean level.

Baltic Dry Index for the uninitiated: https://tradingeconomics.com/commodity/baltic

Containerised is still holding up for the moment: https://www.statista.com/statistics/1250636/global-container-freight-index/

Declines in these costs will help to suppress the currently heated inflation results.

Investment Opportunities

Investore Property have announced a new 5-year senior, secured bond with a minimum interest rate of 3.95%. Investore own 44 large format buildings which are leased to Countdown, Bunnings, Briscoes etc. Its buildings are 99% leased and have an average lease term of 9.5 years.

The investment document can be found on our website and if you would like a FIRM allocation, please contact our office.

The bond issue closes on Friday 9am.

Seminars

Chris has been forced to postpone his seminars to a later date due to COVID. Once we have set dates (probably in May) we will reach out, but at this stage we will be watching the current situation pan out before announcing dates

Travel

David will be in Kerikeri 28th of February and Whangarei on the 1st of March

Chris will be in Christchurch March 8 & 9.

Chris will be in Auckland March 15, 16 & 17.

If you would like to make an appointment, please contact us via email.

Michael Warrington

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Market News 7 February 2022

Too much change (scale), too fast (rate of change), seldom succeeds when the affected population is large.

I think New Zealand is currently experiencing this set of conditions and it concerns me with respect to our economic performance potential.

INVESTMENT OPINION

 

Tourism– Last week the Government described (again) how it intends to open New Zealand's borders to the world.

You might have expected people to cheer loudly and that tourism-related businesses would see their share prices rise, but no. Air NZ share price declined following the announcement.

Clearly the announced milestones are slower than hoped for and for the moment risk takers and business owners can be forgiven for concluding 'we will believe it when we see it'.

I doubt that many businesses are taking new financial risks based on the government announcement.

I think we are learning that 2022 is another year of restricted economic performance for New Zealand.

International guests aren't really welcome until late 2022 and I doubt they'll make early bookings. Australians might, which will help.

New Zealanders can leave, and have more confidence about freedom to return, so a growing number will do so.

This combination isn't ideal for our balance of trade during 2022.

Our tourism sector must continue to run very lean businesses for another year or two and even then success will require persistent hard work and talented planning.

Valuable Eyeballs – In today's technology-heavy and internet-dependent society the ability to reach eyeballs is a saleable commodity.

I had only just discovered the simple mental pleasure of WORDLE and wished its young designer well when last week I was reminded that everything is for sale.

The New York Times has purchased WORDLE for ''small millions'' from its designer (Josh Wardle).

When I was young millions were large. Now you need them to buy a house and shelter from the rain.

The game was launched in October 2021 and three months later Josh Wardle has ''small millions''. Not bad if you can get some.

Wardle, WORDLE; simple, clever.

Some of the best businesses and products are simple.

If you haven't tried it, you should. It keeps another department of the brain functioning, specifically that of your own personal algorithm and flowchart development – start, if, then, yes, no, success.

The NYT initially says it will remain free to play the game, for now, but it is a subscription-based business, so it seems more likely that it'll find the saturation point for numbers then move it behind the pay wall to join its other gaming services.

One pays to see the SODUKU in a physical newspaper, so maybe paying to access WORDLE via the internet is a similar expectation?

I won't pay to use it although I acknowledge that the NY Times (and other international media options) are far more interesting than those offered in New Zealand.

Maybe NYT could make an easy margin by syndicating access to WORDLE to many other pay-walled media businesses globally, such as NZ HERALD in New Zealand?

That makes better financial sense than asking a global audience to subscribe to the New York Times.

I wonder if NYT could quickly protect the concept in other languages?

The reminder is that there is value in what your eyeballs see, and the old media businesses will do everything possible to draw your attention as they continue to fight for your attention against the mega scale technology companies.

It's good to see the long-delayed fightback by the 'old' media.

Interest Rate Auction – The preparation by central banks to increase short term interest rates is taking on the appearances of an auction, rather than an orderly policy debate:

We will likely raise interest rates twice during 2022, possibly three times;

I'll see your 2-3x and raise you to 3x hikes and we will buy fewer bonds;

Mine at 3x, we expect to do 4x plus we'll start selling all those bonds we purchased;

Analysts are now placing proxy bids for 5x interest rate hikes, when they had believed in 4x just last week;

Bank of America thinks the Fed will need to hike 7x during 2022!

There is nothing to 'win' here.

Central banks and analysts do not need to out-manoeuvre each other for some spotlight.

It's always very important that central banks get the evolution of policy right and this is a constantly iterative process, not some far-sighted plan announced in January.

The US Federal Reserve, like other central banks (excluding the Europeans) have agreed that reducing monetary accommodation (adding tension) is appropriate but the scale will develop with data.

Analysts now sitting on an expectation of 5x interest rate hikes in the US are making bold assumptions about how fast the Fed will respond to slow-moving data about employment and what the economy can afford as the cost of debt increases.

We can be sure that the Fed will not want to place negative pressure on employment if they are about to increase household expenses.

Having not even begun the rate hike cycle in the US why would the expectation be for a 'super-sized rate hike' (sponsored by Marvel and McDonalds) as some are suggesting?

As the Federal Reserve of Atlanta president Raphael Bostic (non-voting member of US Fed) was quoted as saying:

Our policy path is not a constriction path. It's a less accommodative path.

If we do three interest rate increases that I have in mind that'll still leave our policy in a very accommodative space.

Bostic is one who thinks +0.50% (super-sized) could be considered but in my view he has been tasked with running a hawkish flag up the pole to test for market reactions.

My view is that surely a central bank doesn't change its stripes (easing to tightening) and double the dose that quickly.

Remember that the European Central Bank is still parrotting no change in their region, China is easing again, and Australia said they will leave their rate at 0.10% but cease buying bonds from the market.

There is a soft tone from the RBA though because it has not yet committed to having its balance sheet decline from its $640 billion level (it may buy replacement bonds with any maturing proceeds) and then it closed with this statement:

The Board is committed to maintaining highly supportive monetary conditions to achieve its objectives of a return to full employment in Australia and inflation consistent with the target.

Ceasing purchases under the bond purchase program does not imply a near-term increase in interest rates.

As the Board has stated previously, it will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range.

While inflation has picked up, it is too early to conclude that it is sustainably within the target band. There are uncertainties about how persistent the pick-up in inflation will be as supply-side problems are resolved.

Wages growth also remains modest and it is likely to be some time yet before aggregate wages growth is at a rate consistent with inflation being sustainably at target.

The Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.

You can read the full release here (which is worthwhile): https://www.rba.gov.au/media-releases/2022/mr-22-02.html

This tone clearly differs from the likes of the US, UK and New Zealand.

Last year (I think) I pondered the merit of central banks moving to standard increments of 0.10% or one eighth (0.125%) to enable more subtle signals, more often.

They don't need to hit us with a sledgehammer to make their intentions obvious.

It is clear that 2022 is the year of the Official Cash Rate increase(s) but it is very hard to imagine them all racing each other to the sky and some are reluctant to move at all.

One final point – long-term bond yields should be considered by those expecting large, fast, increases to short-term interest rates.

After reaching 1.85% the US 10-year Treasury bond is struggling to continue higher. Germany's 10-year bond yield isn't really getting above 0.00%.

Negative shaped yield curves (short-term rates higher than long terms) seem unlikely given debt affordability concerns, so the markets are not really expecting central banks to raise interest rates all that far.

Yes, interest rates are rising, and the nominal cost to businesses (and consumers) will rise affecting net financial positions but at this stage I do not expect the scale of the change to be as disruptive as markets priced in during January volatility.

Nominal versus Real – As a generalisation and stripping out plenty of moments of high volatility (1987, 1994, 1997, 2001, 2008, 2020), investors have benefited from the ongoing declines to inflation and thus nominal interest rates over the past 35-40 years.

Fixed Interest investors, especially those who invested in long duration bonds (a portfolio with maturities averaging greater than five years) surfed a wave, riding a board carrying yesterday's nominal returns forward, with widening real returns, as inflation fell away beneath them.

Investors who chose shorter terms, which was typical in New Zealand, had the same experience but the value wave energy petered out much faster.

Those folk who rolled bank deposits for 6-12 months (90% of New Zealand according to Reserve Bank data) or monitored the rate of change on annual reset securities such as Infratil perpetuals (IFTHA) will have the falling interest rate chart tattooed in their memory.

These investors all hope the reverse is now happening, but I don't think the interest rate increases will be all that memorable.

Beyond my current expectations for nominal interest rates (as above under the comments about modest central bank changes) I happen to think that interest rates will not exceed inflation during this period of pressure and thus interest rate investors will be receiving negative real returns.

Now riding submarines, as it were, underneath the waves, and not surf boards across the top.

Fixed-interest investing will still provide an important stability item (ballast) to a portfolio during what looks like a period of volatility and declining values, but it does so with what I'll call an insurance where the premium is the negative real interest rate of return.

During the past decade of relatively optimistic investment conditions (higher interest rates, positive real returns, rising share markets) investors still found it difficult to resolve an ideal asset allocation mix, moving from lower fixed interest returns into shares (including property items).

Once interest rates fell below the central bank inflation target of 2.00% the impetus for more risk grew. This was logical, but as you are seeing this year the increased risk brings with it more volatility.

At face value the declining share market pricing may press some investors back toward more fixed-interest investing (higher asset allocation ratio), but this isn't as simple as it seems; the relative rewards between the asset classes are similar.

Real returns on fixed interest investments are negative;

Real returns on shares (and property) are a little more attractive as a result of lower share prices (assumes they maintain similar profit or growth outcomes).

It's a gross exaggeration to summarise in this way but maybe the gauge of the train tracks (relative returns) is the same now as before, but the tracks have moved a little?

I am still of the view that overall returns across almost all asset classes will be lower this year, but the relativity of returns between them may well be much the same, and thus significant asset allocation changes aren't as logical as some describe.

We all have different drivers for the investment risks we can / should take so be sure to discuss yours specifically with a financial adviser to resolve a good set of investment rules.

Above all, through your rules, ensure that no market state can disrupt your personal financial obligations and lifestyle preferences.

Ever The Optimist

Non-Fungible Tokens (NFT) for good.

A business called Regenerative Resources combined with Elevenyellow (SaaS) and Chainlink for blockchain services alongside some of the world's greatest artists (Avatar, Star Wars, Marvel etc) will create and sell short films as NFT to then fund the planting of 100 million mangrove plants.

They say they will emit 120 tons of carbon during production but the mangroves will sequester 20 million tons of carbon (166,000:1).

If they are successful, they will have redirected discretionary personal wealth, through a new scarcity-based asset (hopes for retained value within a marketplace), into direct benefits for the environment.

No dent to the tax base as no tax deductions are required. It is not 'charity' in the way we once provided it.

It’s a net gain for all involved if they pull it off.

Investment Opportunities

Nothing announced so far, but we are finally beginning to hear noises about possible offers during February or March.

Accumulated cash may soon have a target.

Travel

Michael will be in Hamilton (Cambridge) on 3 March.

Edward will be in Napier on Thursday 17 February (Crown Hotel, Ahuriri) and Friday 18 February (Porters, Havelock North).

Michael Warrington

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