Chris Lee & Partners Ltd

Market News – 27 January 2020

Correction; my next research trip became a Melbourne update to attend the Australian Tennis Open.

What an excellent event.

It reinforced why major cities should aspire to host events to attract visitors. So many cities do things in much the same way so it is important to offer points of difference.

Large parts of running a city, or a country, are like running businesses (or should be) – enable and encourage participation, have a point of difference, serve well, careful allocation of financial resources, have a marketing programme etc.

I don't have a good knowledge of Melbourne and Victoria's finances but as a visitor I think they run their city well.

From a distance, based on headlines, you might think the Australian economy is in trouble but looking across the Melbourne skyline I lost count of the cranes, I had to give way to pedestrians more than I remember last time, I had to pay more to eat and drink after queuing to get in and business seemed to be busy for retailers.

It also rained, several times, but it is quite inappropriate to complain about rain in Australia at present.

INVESTMENT OPINION

Asset Allocation – I read an interesting article from the US recently from an analyst who concluded his asset allocation thoughts with 'no change' given the current set of financial market and economic circumstances.

To jump straight to the conclusion, he still feels that a moderate risk investor should have a 50/45/5 portfolio, or more specifically 50% fixed interest assets, 45% shares (including property) and 5% cash.

I found myself thinking his asset allocation was beginning to look conservative.

This got me thinking about why asset allocation should evolve (changes to risk and return assumptions) and is now a time to make change?

Long-time readers will know that in the past we preferred retired investors (or approaching retirement) to hold a higher proportion of fixed interest assets with 75% being common and 100% being perfectly satisfactory if the investor preferred to avoid share market volatility altogether.

Our view evolved, as it should, in response to the evolving risk and reward scenarios that presented themselves.

The speculative nature of expecting higher returns from stronger economic circumstances, and a return to optimistic conditions, supported increased weightings to property and share investing.

Many people now talk about the high pricing of many shares at present and by deduction the rising need to make reductions to holdings in shares, but these conclusions are too simplistic.

During the same period of rising investor confidence interest rates (both nominal and real) have fallen well below the annual returns offered by some of the most reliable businesses.

A key question for asset allocation relates to one's forward looking assumptions about interest rates; what return for risk do you expect from the fixed interest (stable) portion of your portfolio?

We continue to assume very low nominal interest rates, and quite likely negative real returns (interest rates below inflation), for many years (minimum 3 years, expect 5 years and won't argue against 10 years).

Over the past 30 years, with the benefit of 2020's hindsight, investors have been able to lock in high real yields over long terms and then watched inflation fall away beneath them, thus enhancing their real returns.

Investors may not have predicted this at the time; just happy to receive an interest rate they were familiar with and a positive real return.

These people may have spent all that income, not compounded it, but their successful investment decisions supported that lifestyle.

Now the conditions are very different with low nominal interest rates, zero or negative real interest rate returns and more prospect of rising inflation than falling (my view based on the impact of increased regulation).

Typically rising inflation results in higher nominal interest rates but in this world flooded with cash it is becoming more likely that rising inflation will result in wider negative real interest rates, further punishing investment in the fixed interest asset class.

This is why, even in the face of optimistically priced share markets, I wondered if the analyst I was reading had been too conservative?

Maybe he held the same view as me and was intentionally holding the now conservative position in preparation for a retreat in share prices that he hopes will occur next?

Is 50% Fixed Interest asset allocation the new 'Black'? (Orange? – Ed)

No. It's not that simple and every investor's circumstances are different.

The volumes of savings are different; $1 million in savings held by people 40, 60, or 90 years of age results in quite different asset allocation targets.

What other forms of income do they have, what liabilities do they have (known and unknown).

Do they have stored equity elsewhere (valuable houses, holiday homes etc).

There’s a lot of finessing required.

Nonetheless, I wanted to compare the asset allocations of a real investor to the analyst's conclusions so I looked up one of our largest investors settings (ACC).

It is a good example for you to contemplate because they too have a majority of NZ dollar based liabilities, like you, and arrange much of their investing (assets) to offset their liabilities whilst trying to enhance returns and reduce risks.

They do not enjoy a gross excess of income because now that assets closely balance against liabilities there is a political tension to keep ACC levies at modest levels and there are no Public Service Association holiday homes to sell off as a backup for cash.

From its annual reports you can see how this major investor with very talented analysts arranges its asset allocation.

Their asset allocation split in 2019 was:

Fixed Interest – 67% (6% in cash);

Property – 4%;

Shares – 29% (included use of private equity funds).

Within these groups they assign 'only' 24% to offshore investing.

Remember this is the asset allocation held during one of the most bullish periods for share markets that most of you will remember (height and length of time).

Regular readers may remember us publishing a copy of information from Vanguard on long term returns (90 year history). The data made it clear (and it is logical) that over long stretches ownership (shares) outperforms lending (fixed interest).

Yet in the face of this knowledge, and very long term future, ACC still adopts a conservative stance to its asset allocation settings.

The tension presented by their highly defined liabilities places a necessary discipline on the investment management team to ensure that their first priority is to ensure those liabilities are met (payable, on time).

Of use, I thought, was the summary paragraph attached to the asset allocation summary:

The Board's Investment Committee regularly reviews long-term benchmark investment allocations for each Account's reserves portfolio, based on the advice of the Investment Unit.

These benchmark allocations take account of both our long-term expectations for the returns from the various investment markets and

the need to limit the Accounts' various risk exposures.

Setting benchmark asset allocation involves striking an appropriate balance between the objective of enhancing returns and the objective of reducing risk.

ACC aims to maintain a high level of consistency in how it evaluates this trade-off from one year to the next, as an inconsistent approach over time could lead to worse long-term investment results.

Our investment staff may make short or medium-term decisions to vary from benchmark allocations, within risk control parameters set by the Investment Committee.

If you replace the bold text with your name, and consider us as your advice unit, then your investment decision making process should be very similar to that of ACC.

I do wonder though if ACC's asset allocation settings will change, with slightly lower fixed interest holdings if negative real returns settle in, as I expect they will.

We now insist that all financial advice customers establish defined asset allocation settings to measure their actual portfolios against.

The more definition you have for investing (rules) the easier you will find the process and the better your outcomes are likely to be.

We are happy to help.

Volcker Rule – The poor man (Paul Volcker, highly respected past governor of the US Federal Reserve) has only just died and the lobbying is escalating to remove the 'Volcker Rule' from banking regulation.

Volcker was a conservative regulator and responsible for monetary policy during the difficult period of sharp increases in interest rates to counter loss of control over inflation in the 1970's and 1980's.

The Volcker Rule essentially limits the speculative investment behaviour of banks to protect bank customers.

Paul Volcker died in 2019 at the age of 92 and Trump's response is to immediately try to liberalise banking regulation, including challenges to the Dodd Frank Act.

It must be obvious to most that too much rope resulted in poor outcomes in the past. The only prospect of more rope being a good idea is in the hope that one trips up long before they find themselves at the gallows.

EVER THE OPTIMIST

The kids are almost back to school!

INVESTMENT OPPORTUNITIES

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

Oceania Healthcare Bond – Oceania have announced that they are preparing for their first bond issue. The terms of the offer have not been announced yet, however if you would like to be added to the list please contact us.

TRAVEL

Kevin will be in Christchurch on Wednesday, 12 February. Afternoon appointments only.

Edward will be in Nelson 4 March, Auckland (Albany) 11 March & Auckland (Mt Wellington) 12 March.

David Colman will be in Lower Hutt on the 20 February, Palmerston North on 26 February and New Plymouth on the 27 February.

Johnny will be in Christchurch 25 March

Mike will head to Hamilton, Tauranga and Auckland over late February and early March, dates to be confirmed.

Mike Warrington

---

Market News – 20 January 2020

My next research trip (absence from duty – Ed) sees me in the UK later this year.

If locals have unwanted GBP in their sock drawer, they are welcome to drop by and sell them to me!

It’s still not clear whether I’ll be observing ‘Brexited’, or not.

INVESTMENT OPINION

Bank Profits – Like me, I’ll bet that you all thought banks would be making less money following the global pressure from regulators to increase equity, to reduce risk taking and to pay large fines for their poor form with client service and Anti Money Laundering effectiveness.

Maybe you thought Bitcoin, Visa and Paypal would manage to pinch some of the profit from the table.

Yet last week JP Morgan reported its largest ever profit, in fact the largest ever for any US bank, and financial analysts now expect similarly strong results from Goldman Sachs and Morgan Stanley.

I happen to agree with the theme of lower revenue opportunities for banks, and lower returns for equity employed, but I have no doubt they will find a way to extract a certain volume of money from my pocket, with a level of effectiveness second only to my local council.

By ‘effectiveness’ I refer to extraction, not application, of the funds.

Gross Global Debt – We seem to discuss this topic often, but I agree with its importance, so we’ll likely continue to do so.

This paragraph was prompted by a report from the Institute of International Finance.

I sometimes wonder where they gather their data and thus ponder its accuracy; they say this data is based on Bank for International Settlements and International Monetary Fund. Regardless, the theme is absolutely correct because excessive use of debt is proved by cross referencing elsewhere in the economy (Gross government debts, scale of bank balance sheets, and non-bank financiers etc).

The rise is also intuitively correct as a reaction to the ever decreasing nominal and real cost of debt (interest rates).

The statistics quoted in the report are:

Global debt now $257 Trillion dollars;

Rising at US$3 Trillion per quarter at present;

US$32,500 (NZD$50,000) per person for the 7.7 billion people on earth;

The debt is 3.2x the world’s annual GDP;

Mature markets (definition?) share of the debt (US$180 trillion) is 383% of GDP for those nations;

Emerging markets (still includes China) share at US$77 Trillion has doubled since 2010;

US$200 Trillion are debts for those operating outside the financial sector;

US$70 Trillion is government debt, which seems to imply taxpayers are responsible for US$9,000 each (NZD$13,500);

Household debt-to-GDP have reached a record high in Belgium, Finland, France, Lebanon, New Zealand, Nigeria, Norway, Sweden and Switzerland. (Not a club we should aspire to be part of – Ed);

Debt issued in the currency of another country, typically US dollars, has doubled from US$4 Trillion to $8 Trillion. This typically unhedged debt leaves huge risk of massive cost increases to the borrower nation, witness Argentina. A collapse in their currency can mean something like a 100% increase in the overall cost of the debt against the borrowing economy.

Debt is leverage and the exposure is to ‘our’ incomes. Even if the cost of the debt remains very low, as we expect, the scale of debt is rising much faster than incomes (economic activity).

I agree with the generalised conclusions in the various articles; this cannot end well.

It is very difficult though to spot whether the trouble will arrive at the front door, the back door or through all window simultaneously.

Central bankers claim they are ready for the battle, but this only serves to confirm that they are aware of the problem and are preparing for the need to respond. Their response can only be the continued reduction in the cost of money, which likely perpetuates the problem.

The most logical response so far is to steer your lending (fixed interest investing) further toward the stronger end of the range.

Fortunately, in NZ most of our fixed interest options are relatively simple and relatively strong.

International bond funds though, with too much latitude in the credit ratings they can lend to? Maybe not so much.

Lower returns, especially from your fixed interest investments are today’s reality. Don’t fight it by seeking to find ever greater complexity or default risk to keep your returns up.

Dennis Gartman Rules – I had intended to share these with you late in 2019 but too many other ideas reached the front line and I learned about the pressure’s editors must face every day.

I first read Gartman’s trading, and investment strategy, rules in the 1990’s and they are still quoted regularly, years on, proving their long-term value. The specific wording sometimes changes subtly but the core meanings are the same.

Dennis Gartman is a highly respected investment analyst based in the US.

I hope Dennis won’t mind me displaying respect to him by repeating them here for you to ponder in the New Year:

NEVER, EVER, EVER ADD TO A LOSING POSITION: EVER!: Adding to a losing position eventually leads to ruin, remembering Enron, Long Term Capital Management (I can explain this item to you because I was involved – Mike), Nick Leeson and myriad others.

TRADE LIKE A MERCENARY SOLDIER: As traders/investors we are to fight on the winning side of the trade, not on the side of the trade we may believe to be economically correct. We are pragmatists first, foremost and always.

MENTAL CAPITAL TRUMPS REAL CAPITAL: Capital comes in two forms... mental and real... and defending losing positions diminishes one’s finite and measurable real capital and one’s infinite and immeasurable mental capital accordingly and always.

WE ARE NOT IN THE BUSINESS OF BUYING LOW AND SELLING HIGH: We are in the business of buying high and selling higher, or of selling low and buying lower. Strength begets strength; weakness more weakness.

IN BULL MARKETS ONE MUST TRY ALWAYS TO BE LONG OR NEUTRAL: The corollary, obviously, is that in bear markets one must try always to be short or neutral. There are exceptions, but they are very, very rare.

"MARKETS CAN REMAIN ILLOGICAL FAR LONGER THAN YOU OR I CAN REMAIN SOLVENT:" So said Lord Keynes many years ago and he was... and is... right, for illogic does often reign, despite what the academics would have us believe.

BUY THAT WHICH SHOWS THE GREATEST STRENGTH; SELL THAT WHICH SHOWS THE GREATEST WEAKNESS: Metaphorically, the wettest paper sacks break most easily and the strongest winds carry ships the farthest, fastest.

THINK LIKE A FUNDAMENTALIST; TRADE LIKE A TECHNICIAN: Be bullish... or bearish... only when the technicals and the fundamentals, as you understand them, run in tandem.

TRADING RUNS IN CYCLES; SOME GOOD, MOST BAD: In the “Good Times” even one’s errors are profitable; in the inevitable “Bad Times” even the most well researched trade shall go awry. This is the nature of trading; accept it and move on.

KEEP YOUR SYSTEMS SIMPLE: Complication breeds confusion; simplicity breeds elegance and profitability.

UNDERSTANDING MASS PSYCHOLOGY IS ALMOST ALWAYS MORE IMPORTANT THAN UNDERSTANDING ECONOMICS: Or more simply put, "When they’re cryin’ you should be buyin’ and when they’re yellin’ you should be sellin’!"

REMEMBER, THERE IS NEVER JUST ONE COCKROACH: The lesson of bad news is that more shall follow... usually hard upon and always with worsening impact.

BE PATIENT WITH WINNING TRADES; BE ENORMOUSLY IMPATIENT WITH LOSERS: Need we really say more?

DO MORE OF THAT WHICH IS WORKING AND LESS OF THAT WHICH IS NOT: This works well in life as well as trading. If there is a “secret” to trading... and to life... this is it.

CLEAN UP AFTER YOURSELF: Need we really say more? Errors only get worse.

SOMEONE’S ALWAYS GOT A BIGGER JUNK YARD DOG: No matter how much “work” we do on a trade, someone knows more and is more prepared than are we... and has more capital!

PAY ATTENTION: The market sends signals more often than not missed and/or disregarded... so pay attention!

WHEN THE FACTS CHANGE, CHANGE! Lord Keynes... again... once said that “ When the facts change, I change; what do you do, Sir?” When the technicals or the fundamentals of a position change, change your position, or at least reduce your exposure and perhaps exit entirely.

ALL RULES ARE MEANT TO BE BROKEN: But they are to be broken only rarely and true genius comes with knowing when, where and why!

To highlight that it’s not as easy as Dennis might define with his preference for change, here’s another quote from a similarly strong voice in financial markets:

It's so hard to switch and time the changes from one sector to another, says John Buckingham, editor of The Prudent Speculator newsletter. Find a strategy that you believe in and stay put.

To repeat that last line, please think of it when we ask you to establish investment rules that suit you - Find a strategy that you believe in and stay put.

‘Belief’ will mean different strategies for different people.

Actually, here’s another evergreen quote too: ‘When all the experts and forecasts agree -- something else is going to happen’.

EVER THE OPTIMIST

I like the ongoing development across our ski fields that increases the potential summer use of this magnificent locations.

Tourism is our largest export. We need to ensure it remains so and to achieve this requires constant improvement and adding breadth.

Weaker snow conditions will apply more pressure for non-snow activities on these properties and to that end they are doing a great job introducing offers to get down the hill attached to wheels!

They are also developing better food and accommodation on sight for those who simply wish to see, and walk, in the beautiful locations.

Climate change is a problem, but these businesses are finding ways to reduce its impact on the business that is tourism.

ETO II

Rather than simply thanking the Productivity Commission for its most recent report and moving on with political matters, impressively, the Minister of Finance has asked them to now ‘identify policies and interventions that could maximise the economic contribution of New Zealand’s frontier firms’.

This new focus, and relationship endorsement, is good to see in our relatively unproductive economy, especially if we want our minimum, and average, wages to rise further.

INVESTMENT OPPORTUNITIES

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL

Kevin will be in Christchurch on Wednesday, 12 February. Afternoon appointments only.

Mike will head to Hamilton, Tauranga and Auckland over late February and early March, dates to be confirmed.

Edward Lee will be in Nelson March 4, Auckland (Albany) on March 11 & Mt Wellington on March 12.

Mike Warrington

---

Market News – 13 January 2020

So, 2020.

We will all have a very clear view of it by 31 December.

I read almost nothing relating to investment decision making over the summer break and as I return to the front line of considering what should be important to you I don’t feel like I missed much relevant news either.

As we like to preach, if you have a good investment plan, and your investments match that plan, then short term noise, broadcast by the planets loudest people, should have little impact on your short term investment decisions.

Yes, each new piece of information, or flap of butterfly wings in Michoacán, Mexico, leads to contemplation about how our longer term investment strategy may change but this is multi-month thinking, not weekly.

Observe how long it has taken to move your fixed interest weightings down from 75%-100% to more like 50%-75% today. It has been years of evolution.

The good news, in this regard, is that you can head off on your four, eight or twelve week holidays without thinking that you need to stay focused on daily news from the world of investment. You can, and should, focus on your particular sphere of interest.

You have saved funds to enjoy, not to create a reason to be anxious about something.

As I see it, the most obvious pending problem relates to those who do not know how to save, or to live within their means, and they think more debt is a good thing. They are wrong of course, but you are operating in a much safer space so have less to worry about.

So, let’s see where 2020 takes us.

INVESTMENT OPINION 

Japan – My research trip to Japan was thoroughly enjoyable. We saw a lot and learnt a little. It would take years to develop a good understanding of their society but in summary we were impressed.

I see Carlos Ghosn gave up trying to understand the Japanese legal system. I didn’t see him at the airport, so he must have travelled at a different time (or in different luggage – Ed).

As I understand it the legal system and policing are indeed firm, but at a street level I rather enjoyed the respect being displayed in a well functioning society and the cleanliness that we observed almost everywhere we went.

With only a single exception, they do not have people sitting in the street begging. Japan surely must have people finding it difficult to make ends meet but they clearly don’t accept that begging in the street is a solution.

A large proportion of the work force, which we saw, were well into retirement age and seemed happy in their work, which may confirm a financial need but I also suspect it reflects a desire to contribute to society.

I tried to see if an outsider could spot evidence that this is an economy with some difficulties, operating at 0.00% interest rates, but I could not. Everyone seems to be hard at work or on a mission to get somewhere.

Even with one of the world’s only declining populations the places we visited looked very busy to me and the 0.00% interest rate environment should ensure that private savings are directed into property and productive investment.

GST – Over recent years there has been a lot of angst over increases to the rate of sales tax collected. Prime Minister Abe finally increase it to 10% recently (2018) and frankly it should be the path toward debt reduction for the Japanese government.

Japan’s public debt is its most serious economic problem, especially when overlaid on top of a declining population.

Sales taxes are so efficient, unless you are Australian and foolishly start exempting things voters say they don’t like. Good principles are so much better for legislation than wondering whether or not to like coal.

Therefore, if I was Abe san I would promote the concept of increasing GST to 15% and reducing personal tax rates on lower incomes (they are currently higher than in NZ).

Japan provides outstanding public transport. If it was the only reason you visited Japan, it would be reason enough.

As a friend told me, ‘do not step on the train that arrives 3 minutes ahead of your schedule because it will not be your train’.

Yes, Japan has a very large population, but the likes of Wellington Regional Council would have wasted far less money and achieved far more if they had simply flown to Japan and asked for help in designing a good service for us.

It comes as no surprise that Japan ran the Rugby World Cup well, and on time, and they’ll do an excellent job again this year when the Olympics come to Tokyo.

We will definitely go back to Japan to tour other regions and likely to attend a major event, such as the Formula 1 race because you just know the logistics of participation will be simple to be part of.

Over the past 20 years the world’s economists have spent a lot of time worrying about Japan, but frankly the world has far bigger problems in multiple other jurisdictions.

Japan will be just fine.

Changes – What changed over summer, if anything?

It doesn’t look like I missed anything to get worked up about. The themes that editors herded to the front pages were either stale, or reworded stories from different angles.

Brexit was always going to reach a finish line, so maybe it is finally there.

The Middle East is always volatile and violent. I don’t see this being as widely disruptive as in the past because control of energy is changing around the world, away from the Middle East.

Unsurprisingly the matter of too much debt wasn’t solved during our summer break.

If too much debt and weakening credit ratings (ability to repay) are the largest visible problem, and a measurable and predictable problem at that, then the best way to respond as an investor is to move your lending (fixed interest investing) toward stronger borrowers.

This implies lower returns from the fixed interest portion of a portfolio but part of this yield give up should be offset by the slightly higher allocations currently held in shares (where dividends commonly sit above interest rate returns).

I see we are to get a deposit insurance scheme in NZ. I happen to view this as a mistake, or rather an unnecessary expense to be paid by depositors. Yes, depositors will pay for it.

Adding a deposit insurance scheme immediately after significant increases to bank equity settings seems wasteful to me.

However, it will give the public even more confidence in the money held by our banks and it implies our economy should have no trouble financing itself with lending from international sources even if the ‘too much debt’ story leads to a future upheaval.

I saw that the US Federal Reserve has had to continue providing additional liquidity to the US dollar market, which is leading some to debate the cause. Is a larger problem at play?

Surely we can have complete confidence that central banks of the world will pump oceans of liquidity into the market place to ensure the system is well lubricated. Given that they were happy to bring the price of money (interest rates) below inflation it stands to reason that they’ll make sure there’s plenty of that money flowing through the arteries.

If liquidity trap fears are real, and access to cash tightens, you can resolve this risk within your own investment planning; hold sufficient cash at call and then ladder sufficient funds maturing over each calendar year ahead to meet probable outgoings.

It should be clear to all investors that future returns are going to be lower. Interest rates are already down and higher share prices deliver lower profit measured returns.

Armed with this understanding the most effective thing investors can do is to ensure their personal preferences (life choices) can continue scarcely impacted by the next disruptive event in financial markets.

The focus of your investment strategy for the next five years should have more to do with insulating yourself from financial market volatility and less to do with trying to spot fast race horses and unicorns.

As always, we are happy to help.

EVER THE OPTIMIST 

We thought NZ had done well with its young, female, Prime Minister, but over summer I see Finland has chosen a 34-year-old female to the job. That’s one way of testing the history of pale, male and stale at the top. (and angry – Ed)

Finland’s Prime Minister says she intends to copy Sweden and evolve Finland to a four day, six hours per day, working week.

It’s a very interesting concept and all should observe evidence of progress being made in Sweden.

Ultimately economies need more flexibility, and further movement away from old rigid employment limitations. Maybe legislation to change the centre point for negotiating employment agreements is consistent with such flexibility across an economy.

However, unless costs of major life items (housing, health, food) reduce relative to income a population won’t be able to work for less net income and cope.

Anecdotally I hear of more shared property use occurring in NZ, in response to the costs. This too may form a part of changes to how we earn and consume if employment patterns change.

I look forward to reading more about Sweden and Finland employment progress and if it is effective then let’s look at something similar here. Perpetual Guardian in NZ seems to be making it work.

INVESTMENT OPPORTUNITIES 

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL 

Please advise if you’d like to be contacted next time we are in your area.

Mike Warrington 

---