Chris Lee & Partners Ltd

Market News 29 January 2018

Whilst January has been a quiet trading month for financial markets there has been no shortage of opinion offered by analysts about what they think 2018 might hold for investors.

The word ‘’bubble’’ or ‘’bubbles’’ has appeared in a lot of the material I have read with varying degrees of alarm and covering most sectors – bond bubble (Europe), share market bubbles (mostly the US), housing bubbles (Australia, Canada, NZ and elsewhere), bitcoin bubble (particularly Asia).

As we have stated before no-one knows exactly what will happen and investing is more about positioning for what is likely to happen.

Positioning for what you want to happen is another strategy and it sometimes works.

For a number of years now January has also been the month when many market participants have predicted higher interest rates and although their predictions are yet to materialise the number who share this view has risen significantly.

Many believe that inflation, although still quite weak, is making a comeback and that central bankers will need to be proactive and raise rates to cut it off instead of chasing it from behind, which has been their way in the past.

Central bankers proclaim that they adopt a proactive (18 month forward-looking) approach to monetary policy, but in reality they are just as reactive to facts as we are and facts are historical.

Ten years of very low nominal wage growth together with high household indebtedness has largely kept the brakes on overall demand inflation in most developed economies, including NZ.

People talk about excess capacity being used up leading to tighter labour markets and higher wages but with improved technology, growing use of automation in industry and continued outsourcing of production to cheap labour markets, like Asia, it’s hard to see much wage inflation in the near future, in my opinion.

Interestingly economists in NZ who have been down-playing the inflation outlook and predicting only gradual increases to the OCR (Official Cash Rate), commencing either later this year or early next, have now moved onto ‘inflation alert’ mode. How quickly things can change.

Our central bank still wants to steer us to 2019 for the first interest rate hikes.

In my opinion the biggest potential for higher interest rates is fallout from the unwinding of quantitative easing in the US and Europe, which is now underway.

Between them, the Fed and ECB have started reducing their monthly bond purchases by US$50 billion per month at the same time as the Fed plans to increase short term rates in the US.

In Europe the ECB has become the main buyer, and in some cases only buyer, of some sovereign bonds and this indiscriminate buying has enabled even the weaker Euro countries, and some companies, to fund themselves at ridiculously low rates.

A quick scan of current 10 year Sovereign bond yields reveals:

- Italy         2.00%

- Greece    3.90% (To all intents and purposes Greece defaulted post 2011)

- Spain      1.53%

- Portugal  1.80%

As you will recall these countries were grouped together with the unflattering acronym of a barnyard animal because of their economic struggles and uncertainties.

When compared to the current yield on a US 10 year Treasury of 2.65%, also considered a default risk free rate, the yield on ‘PIGS’ bonds doesn’t seem enough and as the ECB winds down its bond buying programme this year I think the market will agree, unanimously, and respond with higher interest rates.

So as the Fed and ECB move into quantitative tightening mode, significantly reducing liquidity in bond markets, there will be a shift from US$250 billion net demand to US$550 billion net supply of sovereign bonds to be absorbed by the traditional market during 2018, and this doesn’t allow for new issuance, which is also set to soar in the US to fund its growing deficits.

Many analysts believe that this sudden supply glut in bond markets will force rates to rise and it’s hard to see how the outcome could be otherwise if the Fed and ECB actually follow through with their planned withdrawal from markets.

Jeffrey Gundlach , the supposed ‘Bond King’ because of his success in accurately predicting Treasury yields over a long period, believes that US 10 Treasuries will reach 6.00% by 2020 (currently only 2.65% but rising) and that interest rates will rise slowly at first and then suddenly. 2020 is very close in investment terms.

Like many others Gundlach believes that simultaneous quantitative tightening by the Fed and ECB will be sufficient cause for rates to rise.

He also believes that the 10 year Treasury rate is seriously out of whack with inflation, as measured by CPI, and with nominal GDP growth, and this also will cause interest rates to rise.

As we know US Treasury yields are the bell weather for global interest rates and if rates rise in the US they will rise elsewhere, including NZ, although 10 year yields at 6.00% within 2-3 years seems unlikely to me.

Rates at these levels would be intolerable for central banks and they would have to re-intervene. Given that they are always ‘intervening’ the question for us is will they succeed with the current plans for change to the type of intervention?

Quantitative easing was intended to provide ample liquidity and low interest rates so that businesses could invest and grow, creating bigger profits, more jobs and more tax revenue, like a big money go-round.

Unfortunately much of the money created and redistributed through the banking system didn’t reach the real economy (and the majority of employees) and was used instead for share buybacks and invested in equity and property markets pumping up asset prices to where they are today.

As a result of the easy money environment global debt has increased significantly over the past decade and in many instances economic or financial success are only holding together because of low interest rates.

For example US Government debt has increased 113% over the past 10 years but their debt servicing costs have only increased by 5% because the cost of money has declined so much.

From our perspective 10 year Treasuries at 6.00% would mean mortgage borrowing rates much higher than where they are today, and unmanageable for many homeowners with household debt levels in NZ amongst the highest in the developed world.

Our banks (for the public) and government rely heavily on borrowing offshore so any increase in global yields would immediately be felt here.

NZ interest rates have been amongst the highest in the developed world which has given us an advantage when competing with other countries for funding but with rates now rising overseas that advantage is disappearing quickly and it seems inevitable that our rates will have to increase to re-establish a suitable risk margin for global investors.

Although I am firmly in the camp of higher rates in coming years I think that increases will be small and gradual because, sadly for investors, central bank policy and commercial bank behaviour has enabled borrowers to pig-out on debt and increasing debt servicing costs would cause too many obvious problems.

I also believe that the massive global debt overhang, with China top of list, and stagnant productivity will continue to constrain growth, even though growth has improved in many major economies.

I can see problems in the European bond market as the ECB withdraws its support and their bond market could easily blow-up, leaving Draghi with some difficult decisions.

If Gundlach is right, although I doubt it, and 10 year Treasury yields do reach 6% by 2020 then the waiting for the next financial crisis will be over.

A significant increase in the cost of money would have a huge negative impact on the value of most assets, particularly shares and property. This fact remains true even if Mr Gundlach is out a little on the timing of a meaningful increase to intertest rates.

----------

Sharemarkets have started the year where they left off, particularly in the US, where the major indices have all reached new record highs.

The Dow Jones was up 1000 points in the first 8 days of January and then raced past 26,000 for the first time, with the price/earnings ratio for the Dow stocks now pushing 24x, being a large excess to long-run averages.

The NZ market has been much more subdued largely because it is made up of mostly dividend stocks which are very sensitive to interest rate movements, and with interest rates looking slightly up prices have been flat.

Having a bourse of mature, stable, profit making companies who pay reliable and predictable dividends has made NZ a popular destination for global investors in search for yield, with both our interest rates and dividend yields traditionally offering attractive returns relative to other developed economies.

The high yielding nature of our share market should help cushion it in the event of a major correction although big events bring all markets down.

Sentiment is an important factor in share market investing and some of the latest run is probably been driven by the fear of missing out as people witness one of the longest running bull markets of all time and want a piece of the action.

Some market watchers in the US believe that, based on fundamentals, the current US stock market is the most overvalued market of all time and many liken its latest rise to the craze on cryptocurrencies where naïve investors are buying coins just because prices are going up.

This is probably true but until sentiment changes market hype suggests it’s going much higher yet.

----------

Cryptocurrencies have become the latest investment craze, especially among younger investors it seems.

Early investors in the two largest and most well-known cryptocurrencies, Bitcoin and Ethereum, will have made a fortune, on paper at least, with a few thousand dollars invested initially now worth tens of millions.

Note that everyone continues to value their investment, and profit, in real money terms!

So what is driving the price momentum and do cryptocurrencies have any real value?

Many, including Warren Buffet, believe that the crypto- craze will end badly for investors and others have likened it to pyramid selling.

When 100,000 people, out of a total population of 4.5 million, register in a single day to trade crypto-coins it definitely has a large speculative and ‘fear of missing out’ ring to it, in my opinion.

This is how many people registered a few Sundays ago on a trading platform based in Christchurch.

Unlike Japan, where there are 300,000 shops who supposedly accept crypto-coins for payment, or Europe where you can buy and upload cryptocurrencies onto prepaid debit cards to go shopping and withdraw cash from ATMs (although VISA is clamping down a little now), the digital currencies don’t seem to have much practical use in NZ in terms of buying goods and services.

Cryptocurrencies, using Blockchain tehnology, are unregulated systems where ledgers are maintained in multiple locations globally and continually updated without the approval or control of any government body or authority.

No government can seize cryptocurrencies or block a transaction or act to depreciate its value and there is no reliance on a bank or banking system to transfer funds.

As we know governments like to regulate and control so it’s not surprising that South Korea, China, Israel and Russia have all recently imposed restrictions on cryptocurrency trading, some threatening total trading bans.

Central Bankers in markets where cryptocurrency speculation is rampant must be very concerned.

There are over 1400 different cryptocurrencies with a total market value of about US$500 billion.

It makes sense to me that digital currencies will be part of the future of payments but in a controlled and regulated environment that makes the trading environment more robust and reduces price volatility.

The current price volatility which has seen the likes of Bitcoin’s price double then nearly halve in only a few weeks makes the current set-up unusable as a payment system but I’m sure its fixable.

Sweden is already considering introducing a digital form of government backed money and China has developed a digital currency for some types of daily transactions.

It’s hard to say what will happen to current bunch of cryptocurrencies, they may well be banned if governments and regulators can’t impose controls that eliminate it use for money laundering and to dodge currency controls and economic sanctions.

More likely they will be encompassed inside a fully regulated environment and there will be a major consolidation, or clean-out, of the current cryptocurrency sector.

To have real value they need to be more widely accepted as a means of payment for goods and services.

Meantime they will sit mostly in the hands of speculators and bubble away.

Asset bubbles are particularly damaging when they are accompanied by high levels of leverage which hopefully may not be the case with the crypto-bubble, particularly in NZ.

Even though several hundred thousand people have registered to trade in NZ I think it is extremely unlikely that they have sold or mortgaged their homes to invest in cryptocurrencies.

Payments are made by credit card, which have limits, and I suspect that most New Zealanders will have invested only modest amounts and will be treating it as a bit of fun.

Elsewhere I’m not so sure.

 Asia accounts for 60% of all cryptocurrency trading and Asians have a liking for chasing rising asset prices and in America, well anything’s possible in that market which is why I wasn’t surprised to read that the Bitcoin frenzy had infiltrated their share market.

Cryptocurrencies have no intrinsic value, the value is entirely in how much someone else is willing to pay for them and although there is real and growing value in blockchain technology owning some coins that use this technology for transfer and recording data doesn’t give you a stake in blockchain technology development.

This hasn’t stopped investors in the US embracing companies who have simply added Blockchain to their names.

A small struggling biotech company listed on the NASDAQ changed its name from Bioptix, Inc. to Riot Blockchain and announced it was investing in cryptocurrency-related business. Its share price proceeded to jump from $4 to $46 in less than two months.

Another NASDAQ listed company, Long Island Iced Tea, which makes iced tea and lemonade, announced that it was going to invest in block chain technology changed its name to Long Blockchain Corp and immediately watched its share price more than triple.

This is clear evidence of nonsensical behaviour in financial markets.

There are many more examples all of which have shades of the “dot-com” bubble, which as we now know didn’t end well for many investors.

----------

And while the future of the cryptocurrencies is still very uncertain there seems little doubt in the IT world that blockchain technology is the way of the future.

Blockchain is a distributed and continually evolving ledger of information and a new way to store and exchange data.

Being decentralised blockchain eliminates the middleman and allows individuals to share information with each other – peer to peer style.

In simple terms it is a way of keeping track of things, with millions of copies of the list or ledger and all new transaction checked and then updated on every list.

The experts are convinced that blockchain technology is the biggest thing since the introduction of the internet, and will offer cost savings and efficiency gains in hundreds of industries by eliminating the middleman.

Already on our own doorstep electricity and gas network owner Vector is trialling blockchain technology that allows peer to peer trading of surplus solar and battery power without using one of the electricity companies and Australian exchange operator ASX is planning to upgrade its post trade settlement process with blockchain technology at a considerable cost saving.

Medical experts believe that blockchain technology will be huge in the healthcare sector by storing patient information, especially useful for accident and emergency situations and others believe it will eventually revolutionise the whole financial services industry.

Whatever that means?

----------

Travel

Kevin Gloag will be in Christchurch on 8 February.

Chris Lee will be in Christchurch on Tuesday 27 February (pm) and Wednesday 28 February (am).

Edward Lee will be in Nelson on Monday 12 February, Blenheim on Tuesday 13 February, and Auckland (Queen Street) on Wednesday 28 February.

Michael Warrington is planning trips to Auckland, Tauranga and Hamilton shortly, probably later in February and early March.

David Colman is planning trips to Lower Hutt in February and to Palmerston North, Wanganui and New Plymouth in March.

Any client or investor is welcome to contact our office to arrange a meeting.

Kevin Gloag

Chris Lee & Partners

---

Market News 22 January 2018

Maybe Bitcoin, and their peers, will be more disruptive to the electricity industry than the finance industry, meaning that Energy Commissions have more to worry about than central banks?

Mining, as I understand it, requires ever-increasing amounts of computing power, and thus electricity use, to be successful in mining crypto currencies such as Bitcoin.

The very high price of Bitcoin supports the mining costs, including the cost of high volumes of electricity use.

Think of it as, say, like smelting electricity in Southland NZ because you get a discounted supply of electricity from Manapouri to ensure that a profit margin exists (imagine if they made tangible Bitcoin out of aluminium – Ed).

I am not a fan of subsidising the aluminium smelter but at least it employs high volumes of people, unlike Bitcoin mining.

I’ll guess that New Zealand’s low line speed for the internet will be sufficient to exclude us as a location of choice for Bitcoin mining so I doubt the NZ Electricity Authority has much to worry about.

Investment Opinion

 

Exchange Traded Funds (ETF) – The volume of funds invested via ETFs has exploded in recent years but those available on the NZ market (NZX) have been more modest in their growth rates.

This is beginning to change.

NZX Smart shares funds have increased by 15.5% in the past six months, from NZ$1.8 billion to NZ$2.1 billion and I’d expect them to be aided further by the new government’s (Winston!) push for lower fees in the fund management sector (Kiwisaver specifically).

As investors have done around the world, NZ will continue to discover the lower fees of ETF on the NZ market too. Investors no longer need Warren Buffett to remind them of the influence of fees on net investment performance.

I had a quick look at the comparison between ETF volumes in Australia and NZ as I tried to understand how ‘undersized’ our ETF market is currently. My measure of ETF volume relative to GDP is a bit limited given that typically the funds are invested outside the economy but I was thinking of the ratio from a savings perspective.

Australia has approximately US$25 billion invested in its local ETF market relative to a national GDP of US$1,202 billion per annum (2.10% ratio);

NZ has approximately US$1.5 billion invested in the local ETF market relative to a national GDP of US$185 billion per annum (0.70% ratio).

The late arrival of more variety on the Smart Shares ETF market will undoubtedly mean many NZ investors own ETF on the Australian market, and via custodians in the US and Europe, but I can make similar assumptions for a portion of the Australian investors.

Whichever way I look at it the NZX market for ETF needs to increase both for market liquidity, to cope with asset allocation change requirements of investors, and to enable lower net fees across the selection.

SmartShares offer the advantage of being Portfolio Investment Entities (PIE) delivering a domestic tax efficiency that international ETFs do not offer.

Hopefully, as we walk the ‘chicken versus egg’ line of ‘bigger funds delivering lower fees’ (NZX needs to progressively cut the SmartShares fees) we could see the NZX ETF market double, then double again in size.

Maybe Kiwisaver investors who no longer receive government or employer contributions post 65 years of age, but want to retain diverse market exposures, will consider use of SmartShares to retain their portfolio whilst cutting the annual fee impost significantly (cut in half for many, but cut in third for the Kiwisaver industry average).

Did I tell you that I had asked my Kiwisaver to cut my fees now that the balance of my account was large (100k+)?

The reply was ‘thanks but no thanks’.

I am thinking about my options.

When investors are 65 years of age and no longer captive to the Kiwisaver structure they can easily withdraw and self-manage the funds (as we would encourage). It seems obvious to me that the fund managers will surely need to cut the post retirement fee structure, at least to the level of the SmartShares ETFs.

If the NZ ETF market doesn’t expand then it’s structured poorly.

We are contemplating adding a few ETF items to the Current Investments page of our website to ensure investors are considering them within the mix of asset allocation, whilst trying to keep your overall investment costs down.

Disclosure – I own a few NZX shares and in theory they should make more money as the size of collective SmartShares funds grows.

BlockChain – We have another signal to be increasingly careful with investment decisions and the balance of risk within your portfolio; people are now investing in words rather than businesses.

I use the term ‘investing’ loosely.

Presumably if I use the term BlockChain in our newsletter the value of the content goes up too?

The Fear of Missing Out syndrome (FOMO) is resulting in investors, or should I say speculators, placing money into businesses that use the term BlockChain (or Crypto Currency) in their name of future strategy.

We have often told you about the good quality development that was BlockChain, or Distributed Ledger, technology and we look forward to it being progressively rolled out across various government and commercial users for the gains it can deliver.

However, it is my view that the primary beneficiaries of this evolution will be technical folk and software developers with the skill to provide such systems to customers.

Staff costs at the average wage are something to be alert to when you are an employer but staff or consultant costs at $150-$500 per hour that BlockChain will cost erodes business profits very quickly during the development years.

It is true that technology adds value to business, usually through the leverage it brings to service delivery and time saving but huge sums of money are often spent on acquiring such evolution.

I look forward to reading about more early adopters and then experiencing some benefit as a consumer (or tax payer if the government gets it right with its vast data management) but I do not expect to be investing in a business simply because they show me they can spell the word BlockChain.

Venezuela – offered another reason to be doubly careful about crypto currency and its use.

Nicolas Maduro, President of Venezuela, but without control of the country’s legislature, jumped on the ‘give them what they want’ band wagon and declared he would issue the equivalent of US$6 billion in a crypto currency.

It would be exchanged for hard currency with nations buying oil from them.

Unsurprisingly the Venezuelan legislature responded by saying they would not support the crypto currency issue and would make it null and void once Maduro is removed from power.

I still see a future for crypto currencies, but I am just not clear which ones will be credible enough for genuine international use, and to avoid just looking like the value in my Airpoints account.

It feels easy to discourage you from adding Venezuelan Petro Coins to your digital wallets.

Investment News

 

Europe – Important ‘things’ are developing in Europe.

Angela Merkel appears to have set the basis for a formal coalition agreement with the Social Democrats to secure her fourth term as the country’s leader.

In doing so she has confirmed the naivety of those predicting she would resign when the first coalition attempts failed and will surely be recorded as one of Germany’s most impressive leaders.

Apparently one of the outcomes sought and achieved by the SDP is a need to move further toward a united Europe, with greater contributions from Germany. Several references to the importance of the French-German relationship are positive given that their yesteryear differences are a significant part of why the European Union exists.

The other significant news item from Europe was the announcement from the European Central Bank (ECB) that it will soon follow the US with moves toward tightening monetary policy and stop buying bonds from the market (Quantitative Easing).

In a separate, but related, matter the ECB confirmed it had sold all of the bonds it held issued by South African owned retailer Steinhoff International Holdings NV after ‘accounting irregularities’ surfaced. The ECB lost half of the money it invested – EUR$100 million.

This discloses the probable scenario that Quantitative Easing will cost central banks far more than they are willing to admit, especially when they took taxpayers’ money and ventured into loans to private companies (bonds) and in some cases into shares.

The aggressive ownership of other government bonds had an element of ‘many musketeers’ about it (‘all for one and one for all’) but once it started applying capital to the private business sector it attached those private commercial business risks on to public money, which is incongruous in my view.

If Steinhoff is to fail for commercial or corruption reasons, then it should do so without the presence of public money.

I don’t know if central banks publish the specific holdings within their now massive portfolios, but you can be sure that the markets will now be very sensitive to further losses from defaults and market value declines.

In an interesting, yet diametrically opposed situation, the Swiss central bank (SNB) has announced a profit for the past year of CHF 54 billion as a result of the risks it took by defending its currency when all others around it were crumbling.

The SNB sold massive volumes of CHF and invested the currencies purchased, such as USD, in a wide variety of bonds and shares. The US dollar portion alone is reported as being valued between US$90-100 billion (making them a very large shareholder in Apple).

Rather than ‘create money’ to buy local assets and artificially support the local market, the SNB declared, firmly, that their currency (CHF) was well over-valued and agreed to sell their CHF holdings, and shift this asset into markets they deemed to be undervalued (especially if they were to be underwritten by those local central banks).

It is beginning to show itself as a clever strategy.

All things being equal, and with the view that Europe and the US economies provided sufficient diversity, the SNB adopted a policy of selling expensive assets and buying inexpensive assets, just as Warren Buffett would and you and I should.

The new assets owned by the SNB have surged higher in value and the CHF price has receded a little. Maybe they will begin to slowly reverse their strategy as the central banks of the world begin to reverse the artificial approach taken to monetary policy?

Switzerland has a population of about 8.5 million people. In a single year its central bank profit could pay off 86% of New Zealand’s national debt (not private debts). Perhaps to be fair I should describe it in per capita terms – SNB’s annual profit last year, per capita, would pay off 50% of NZ’s national debt, per capita.

https://www.nationaldebtclocks.org/debtclock/newzealand

Without needing to admire, or criticise, central banks for their robust participation in financial markets (success or failure financially) you would be very wise to accept the lesson; you will make more money by betting with the central bank than against it.

Switzerland’s central bank is very clear proof of this as it applied its robust actions by betting ‘with’ the other major central banks of the world, making Swiss tax payers winners, probably at the expense of tax payers elsewhere.

Auckland Airport – has displayed what I consider to be an admirable behaviour with the sale of its 25% shareholding in North Queensland Airports; sell things that you do not need and avoid excessive debt elsewhere.

Their board would rightly describe it as the more effective deployment of the capital by measuring potential returns from North Queensland against the large capital outlay now required for the expansion of Auckland Airport (the core asset).

Shareholders should be pleased with the 3x profit made on the investment and the sale might also confirm that AIA has learnt that Auckland was not receiving the traffic flow through this flight path to NZ that they anticipated.

By contrast, what AIA has learnt from its shareholding in Queenstown means that I doubt this asset will ever be put up for sale.

Good profit, good learning, good governance.

Mercury – I also think Mercury Energy deserves a compliment for its research into battery storage (Tesla trial) for energy management within the NZ grid.

If the regulatory climate is opposed to water storage (as a form of energy storage) then it is appropriate that the electricity sector considers other options to support longer term capture of energy generated from sources that cannot be stored: solar and wind.

It’s illogical to me that people would fight against the natural storage of water, where water fall is a NZ competitive advantage, (energy and irrigation uses) but one response is the use of mined resources to make limited life batteries; unintended consequence?

However, good on MCY for testing the various options across the NZ energy supply/demand spectrum.

All For One – In another sign that supports the world’s preference to operate with collective reasonableness, the Philippines will join an elite group of 50 jurisdictions worldwide which report cross-border banking statistics to the Bank of International Settlements (BIS) as part of the global database.

Agreeing to both meet the BIS’ rigorous standards and to provide the sensitive data is a credit to the Philippine government and confirms the international importance of the country’s banking system.

For perspective, the BIS contributing countries represent 95% of global GDP so having the regulatory respect of being an accepted participant with the BIS is a meaningful hat tip to anyone pondering country risk when investing.

Ever The Optimist – NZ Softwood logs hit a new export record in 2017 at $2.41 billion with China purchasing $1.8 billion of that.

The local timber industry is concerned about access and pricing but the reality is that China’s demand and higher pricing are excellent news for the forestry industry and for the NZ environment because it is more likely that landowners will re-plant.

Growth in exports is vital if NZ is ever to begin reducing its gross debt levels.

Investment Opportunities

At present the following deals are expected during 2018 and we have contact lists for those wishing to hear more once they emerge.

Investore Property Ltd – senior bond;

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

All investors are welcome to join the lists by contacting us.

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

Travel

Chris will be in Albany (Albany Motor Lodge) on Tuesday January 30 (pm) and at Waipuna Lodge, Mt Wellington on Wednesday January 31 (am).

Michael is planning trips to Auckland, Tauranga and Hamilton shortly, probably later in February and early March.

Anyone is welcome to contact our office to arrange a meeting.

People in other regions who wish to meet are welcome to drop us a note and we will get back in touch with you once a trip to that area is confirmed.

Michael Warrington

---

Market News 15 January 2018

Back at my desk and I still feel like I have my jandals on, so I apologise in advance if this reads as being a little more disconnected than usual.

Just a thought, well outside our brief (as usual – Ed), after reading AMP’s research about the details of Kiwisaver members who are not currently contributing (mostly low-income scenarios, when between 18-65 years of age);

Perhaps the Working For Families assistance package could include compulsory contribution of the $1,042 annual effective minimum into the person’s Kiwisaver account?

I agree with the calls to try and involve all people in saving for retirement;

I understand why many do not;

However, those who feel they ‘cannot’, but are receiving some financial assistance from the government, should have some of that assistance put away for their retired years, just as we are asking the financially robust to do.

I don’t mind some of my tax payments going in this direction.

Seeing a rising balance, of thousands of dollars, would present some ‘future value’ to focus on and might break the ‘hand to mouth’ approach. This in turn could inspire some of these needy people to direct other discretionary funds into their Kiwisaver accounts too.

Whilst I am on the subject of government support for Kiwisaver, I hope one-time workmate Matt Whineray gets the job as CEO for the NZ Super Fund and finds a way to offer Kiwisaver access to their investment portfolio. Adrian Orr is leaving, and Matt is currently the Chief Investment Officer.

Investment Opinion

Crowd Funding – The failure of the Andrea Moore clothing business is more of a warning to investing via crowd sourced funding than to those who would invest more broadly in the retail trade sector.

During 2017 there was a constant flow of commentary about Amazon; ‘watch out, here they come to crush all retailers, yet several NZ retailers are describing higher sales volumes (Hallensteins, Briscoes, Skellerup) this season, regardless of Jeff Bezos rising wealth.

In the US several of the biggest retailers, including Target, JC Penney and Macy’s all reported higher Year on Year sales for 2017. Australia reported a surge in retail sales in November, partly inspired by ‘Black Friday’ surge selling techniques.

Walmart is also displayer retailer confidence by lifting its minimum wage to US$11 per hour; a good political move showing that it will pass on some of the tax cut benefits to its employees and a political challenge to online retailers about paying appropriate amounts of tax in each sales jurisdiction.

Side Bar – I love the concept of ‘Red Bandals’ introduced to the market by Skellerup! This reminds us that brand and marketing play a role in retailing too.

Amazon will not be the reason for the failure of the Andrea Moore business. I think we will soon learn about some simple errors of high expenses and declining sales, even though I am told the product is admirable.

Back to crowd funding;

Andrea Moore raised $750,000 (the maximum) from crowd funding (Snowball Effect) in August 2016 selling 17.65% of the equity in the business in the process.

The shallow nature of financial reporting commitments for crowd funding offers is a significant risk for investors.

Andrea Moore reported revenue of $4.0 million in 2016 (up from $3.3m in 2013) and expected 2017 revenue to ‘jump’ to $4.8m and then ‘launch’ itself to $6.3m in 2018, yet here we are, out of business and in the hands of the receivers 16 months later.

This has either been a catastrophic failure by management over the past 12 months or some questions need to be asked about the status of the company in mid-2016.

Profits reported between 2013 – 2016 had only been rising by about $50,000 per annum (from $100k toward $300k) yet the company handed out $45,000 in gift vouchers to the subscribers for the new shares. I understand the impact of top line revenue versus bottom line profit, but it is the proportion I want to draw people’s attention to.

My maths assumes they only offered the gift certificates to the new 17.65% of shareholders, which begs the question; how did the other 82.35% of shareholders feel about this leakage?

At a glance Andrea Moore had a good mix of directors, advisers and senior staff, although the independent retail adviser, CEO of Rod & Gunn, will rue his paragraph included in the fundraising effort:

‘Andrea and Brian are from the old school with strong values, work ethic and passion. I have been a sounding board for them for several years and I have always found them to be highly focused on their business with a humbleness and sincerity rarely found in the fashion business. Andrea Moore has a tremendous future and with the right amount of capital the ability to scale their operation is significant.’

I am getting off the point again, sorry.

The point: Investors must be extraordinarily wary about investing via crowd funding channels.

Always ask for financial advice, which might prove difficult to find in detailed terms because financial advisers do not research the smallest of entities because the demand for such analysis is too low, and thus unrewarding.

The cap for fund raising via crowd funding schemes, and their limited disclosure obligations, is $2 million and I am beginning to think this number is too high. Mind you, a lower number wouldn’t have helped Andrea Moore investors.

The venture capital clubs, of which I am a member in Wellington, often raise smaller sums than this, with better information, yet one cannot participate unless they are confirmed as a Habitual Investor (capable of assessing the risks based on limited documentation).

I don’t know what the commission structures are for crowd funding offers but you can be sure they exist and are probably at levels closer to 5% than 1%. This will have played a role in the energy behind marketing the crowd-funding event.

The minimum investment in the Andrea Moore offer was $1,000. I do hope the deal was made up of 750 people who can easily write off the $1,000 but I ponder whether the Financial Markets Authority should be considering rules around maximum amounts per investor to send a message about the higher the risk the smaller the exposure should be.

Crowd funding rules weren’t set up to allow, say, three investors to place $250,000 each into a $750,000 offer and defeat the purpose of the wholesale minimums defined in the Financial Markets Conduct Act.

So, be very careful with investment via crowd funding offers and get financial advice, as you would for all investing.

Active Bond management - not so good in the months ahead?

The bond fund managers that I know do a thoroughly professional job for their clients, but I wonder whether this asset type will become the ugly duckling in the year or two ahead of us.

The extremely low nominal interest rates around most of the world, negative for some trillions of government bonds, has forced investors to accept more risk to receive returns they feel are required to make progress.

You know what I am talking about; in NZ over the past eight years there has been a relatively high use of subordinated bonds to extract returns that were ‘acceptable’ to investors.

The difference between you, with your self-managed fixed interest investments and a bond fund manager though is that the manager must capitalise values every day (based on revaluation). Falling yields have added plenty of Present Value to an investor’s bond funds.

In an environment of stable or falling interest rates investors have nothing to be concerned about. However, rising interest rates will reduce Present Values and lead to some unenjoyable conversations for the fund manager’s call centre.

Our view is not for rapidly rising interest rates, but the US Federal Reserve has made it clear that rising interest rates is the next (current – Ed) cycle.

US Fed spokespeople are executing a carefully co-ordinated strategy of ‘maybe, maybe not’ to sponsor plenty of market debate and to avoid any reactions of shock as they walk interest rates up.

The market is getting the message; the US 10-year Treasury yield has ‘broken’ above the relatively important 2.47% level and closed mid last week at 2.55%. In fact, the very next day it lifted to 2.58% as China said it was reviewing its purchases of US bonds.

If China stops buying bonds (slows) and the US Federal Reserve start selling bonds (not buying replacements) then the market must deliver additional demand from other investors. ECON101 states that additional demand will require a change in price (higher returns).

I still expect a slow upward journey, but the upward trend is becoming clearer with every passing week.

That being the case, bond funds become less attractive relative to managing your own term deposits and bonds and until interest rates do rise it no longer makes as much sense to invest in longer-term bonds (7-10 years).

Investment News

US Tax goes into Shares – The US tax package is, and will be, a big influence on markets for 2018 and it’s beginning to read as though it will replace the current low interest rates as the fuel for the bullish share market.

I have not read many commentaries that conclude these tax cuts are the answer to revving up the US economy. It’s more common to read that it will help shareholders at the expense of rising government debt; as if US 20 Trillion wasn’t enough debt.

I’m a simple man but I thought the benefit of tax cuts should go widely to those who pay the taxes and not just those who own the most assets. Taxes are a cash flow lever, not an asset valuation lever.

In contrast to the minority influence of the tax cuts I have been pleased to read about a number of US states increasing their minimum wages. This is far more likely to assist the wider economy and perhaps prod a little more inflation that the central bank says they would like.

Noted above, whilst minimum wages in the US should rise anyway, Walmart deserves a compliment for aligning an increase with the new tax cuts (discounting political lobbying desires).

You’ve already seen the turbo boosted start to 2018 for the US share market indices with the US Dow Jones up +2.6% in the first 8 days and the potential for share buybacks with repatriated money is high.

The current trend and the tax money had a lot to do with why I decided to ‘predict’ that share markets might end 2018 higher than they finished 2017.

Let’s see.

EU sidles up to China – I agree with the commentators who say that Brexit has been good for the near-term unity of the European Union and whether or not one believes in the EU’s long term potential it will certainly push ahead in the decade ahead of us.

Last week French President Emmanuel Macron reached out to China to even out trade imbalances between the two regions and to support the Belt and Road strategy being pursued between them. Macron also made a commitment to visit China every year during his presidency.

President Xi expects the EU to speak with one voice so rather than just taking heads of industry on such trips it would be wise to take EU Commissioners along too when visiting trading nations.

A return to more robust growth for Europe (2-3% annually) would be a very healthy scenario from a global perspective, alongside China’s success to reduce the world’s reliance on the US economy.

UDC takeover fails – Well, well, well.

While we were away for summer break the takeover of UDC Finance by Chinese Airline HNA Group has failed to meet the test of our Overseas Investment Office.

This is significant news.

Regular readers may recall that I thought it most odd that a business that started out as an airline in 1993 should now be purchasing finance businesses around the globe, including the UDC offer.

The change of ownership from ANZ Bank to HNA Group heralded a huge change in the credit risk of the business and unsurprisingly depositors have reduced their balances deposited with the business.

This doesn’t cause the well managed UDC a funding problem because of the funding support provided by ANZ but it has undermined a meaningfully large proportion of the goodwill value UDC had prior to this takeover offer.

Clearly HNA was the highest bidder but the under-bidders will surely review the scale of their new bids, when asked, given the value damage to investor perceptions. Borrowers will be indifferent to the change.

ANZ has issued a ‘review our options’ statement but you can be sure that a preference to sell UDC remains the most likely option.

If ANZ had been reading the tea leaves well they shouldn’t be surprised by the failure of the HNA offer.

President Xi has expressed dissatisfaction with the huge amount being invested outside China by businesses such as HNA and I am certain this will have played a part in HNA’s ‘inability’ to provide answers to many of the OIO questions.

Unlike Donald Trump’s many opinions, President Xi’s come with a very high level of gravitas.

For the moment then, UDC’s credit risk is low again but its future is still uncertain.

Payments – You know we have been encouraging you to use scanned application forms and Direct Debit payment method for making new investments, even if you visit an assistant like Warehouse Stationary.

Well, another development in Australia is continuing the retirement of the cheque as a form of payment (usage is down 75% in the past 10 years).

BPay Group in Australia is to launch a service called OSKO that will enable users to pass payments to others, at any bank, via phone number or email address (subject to it being linked to a bank account).

They, and Money Laundering regulators, would also like to believe digital forms of payment might put a dent in the use of cash, but I’d be less confident about this.

Presumably with a frustrated facial expression the RBA confirms that the value of all banknotes on issue as a share of the economy is at a 50-year high.

And then surely with a smile, the central bank says this shows much of the cash is being used for "purposes other than for making day-to-day payments."

My point for you is to prepare for the retirement of the cheque from your payment methods.

Ever The Optimist - I found a good news story relating to Bitcoin, and other crypto currencies; there is a very successful Christchurch based broker for trading these ‘currencies’.

Crypotmania reports client growth from 500,000 to 1,000,000 last year and a troublesome 100,000 requests in a single day!

I don’t need an opinion about the value direction for these crypto currencies to be excited for the success of this NZ based business employing people and profiting from this current mania.

Well done them.

ETO II – I was really pleased to read an article sourced to Westpac bank that confirmed about 66% of mortgage borrowers have taken advantage of lower interest rates to be approximately 12 months ahead of schedule on repayments.

That’s awesome news.

Keep it up, because it’s beginning to look like we are at the low point for mortgage interest rates.

Investment Opportunities

At present the following deals are expected during 2018 and we have contact lists for those wishing to hear more once they emerge.

Investore Property Ltd – senior bond;

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

All investors are welcome to join the lists by contacting us.

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

Travel

Chris will be in Christchurch, at the Airport Gateway Lodge, on Tuesday January 23 (pm) and Wednesday 24 (am).

Chris will be in Albany (Albany Motor Lodge) on Tuesday January 30 (pm) and at Waipuna Lodge, Mt Wellington on Wednesday January 31 (pm).

Michael will plan trips to Auckland, Tauranga and Hamilton shortly, probably later in February and early March.

Any client or investor is welcome to contact our office to arrange a meeting.

People in other regions who wish to meet are welcome to drop us a note and we will get back in touch with you once a trip to that area is confirmed.

Michael Warrington

---