Chris Lee & Partners Ltd

Market News 31 July 2017

Here’s a remarkable story for you:

Two whistle-blowers in the US are set to share a record $61 million award from the Securities and Exchange Commission for helping make a case against JPMorgan Chase & Co. for failing to disclose to wealthy clients that it was steering them into investments that would be most profitable for the bank.

Meanwhile in NZ we learnt that some whistle-blowers inside a government agency lost their jobs for their efforts to disclose a person who has subsequently been convicted of the crime and sent to prison.

The New Zealanders did receive a back-dated apology for their inconvenience (but no Lotto ticket? – Ed).

Investment Opinion

Insurance – Last week regular market watchers saw an example of the price of insurance in financial markets, or the ‘bird in hand’ method of risk reduction.

Tower (TWR) has been under approach by potential takeover suitors for a while now and its share price had sprung up as a result (from a $0.80 low to about $1.30) although it did not reach as high as the highest takeover offer price ($1.40).

TWR shareholders who lacked confidence that a takeover would be completed sold their shares at prices below the offer being presented by the takeover entities. The price discount that the sellers accepted was the implied insurance premium for the risk that the takeover might not proceed.

On Wednesday, the Commerce Commission concluded they would not allow Vero to takeover Tower.

TWR’s share price fell from $1.26 to $0.86 on the NZX open.

TWR’s share price has subsequently lifted to about $0.96 as the market begins its speculative phase again, pondering the likelihood that one of the other suitors would return to the table to buy TWR for a price above $1.00. (Maybe Fairfax at $1.17 again?)

This is how markets work, constantly pricing in uncertainties (possibles, probables) and certainties (completed deals or robust promises).

I can draw your attention to another example of a price for insurance; relating to Rabobank’s perpetual capital securities (RBOHA).

Repayment of the RBOHA securities sits firmly in the ‘probables’ category for repayment at $1.00 in October, yet some investors are willing to sell at $0.97.

It takes approximately one whole year to earn 3% from a near certain fixed interest item (such as a 12-month bank deposit) so why would an investor agree to give up 3% over two months?

Uncertainty.

And the price they are willing to pay for an assured position (cash back now) is 3% flat or 18% per annum. We buy house insurances annually, imagine an 18% insurance price ratio on house rebuild insurance.

I am sure that sellers are saying ‘it’s only 3 cents’ and a bird in hand makes me comfortable, but in today’s climate those 3 cents are hard to build up so this insurance cost is very high in my view.

There’s another lesson in that; a liquid asset and frequently traded market is a good thing and it is enabling RBOHA investors to exit their investment but market participants (other buyers and sellers) are not your friends; they will extract every ounce of value that you are willing to concede.

This is another reason (of many) why engaging with a financial adviser is wise.

Call Accounts– I never thought I’d put a plug in for more business via newsletters, but these thoughts aren’t selfish to us, all financial advisers would benefit from this opinion and most importantly so will you.

New Zealanders, as a group, have far too much money in very short-term bank deposits.

Most investors making use of financial adviser services are not holding too much money in bank call accounts, but some do and the unadvised typically do.

The ideal amount held in cash accounts, or very short-term deposits, is the combination of an ‘Emergency Fund’ (cash with no defined purpose) plus cash to offset known spending commitments such as a new car or next year’s travel (asset and liability matching).

Thereafter your remaining investible wealth should be put to work in a diverse portfolio and the fixed interest investments should not simply be a collection of short term bank deposits or call accounts.

According to Reserve Bank statistics, greater than 90% of funds in NZ banks are held in daily operating accounts (like old cheque accounts), call accounts, or bank deposits for less than 18 months.

This is an enormous amount of money (more than $150 billion) now earning far less than it should. In a world where 3-4% p.a. returns are common every opportunity to add as little as 0.25% p.a. should be pursued.

If I was a bit anxious I might worry that the financial advice community has not yet convinced wider NZ to give us a call and make some beneficial changes, such is the volume of ‘lazy money’ within the banking system.

Most of the major banks now only pay about 0.1% p.a. on truly flexible call accounts.

These accounts are now pointless. You gain less from a year’s interest than you would lose in fees for a failed payment from the cheque account should you forget to transfer money in from the call account.

Earning more from bank accounts usually involves accepting more conditions such as requiring deposits every month and no withdrawals to attract the more competitive rate (2%-2.50%). There are one or two exceptions to this rule, notably Heartland Bank’s call facility at 2.75%.

It is easy for a financial adviser to help the public into higher returns from the simple adoption of a longer-term investment horizon (1-3% depending on risk type).

Even if I allocate $45 billion of this sum ($150 billion) to represent emergency funds across the population (average $10,000 each) and another $45 billion to offset the spending plans category surely the other $50-60 billion could work harder within our economy and deliver greater returns to the owners.

I guess this risk/reward premise is also true of Kiwisaver fund managers who urge young investors to accept higher risk profiles on their asset allocation.

An additional 1% earned simply by lengthening the investment duration of $50 billion would increase returns to New Zealanders by $500 million.

Who doesn’t need an extra $500 million (per annum – Ed)?

Then imagine your financial adviser helping you to find an additional 2% or 3%.

It clearly becomes worthwhile paying for financial advice (bias disclosed – Ed).

Finally, if your portfolio then holds sufficient saleable items, so that funds can be raised for any emergency exceeding the scale of the Emergency Fund, well, it is still affordable to pay one-off brokerage within a portfolio that is achieving higher recurring rates of return.

The message, just in case it became lost in the rambling is: do not allow too much of your overall savings to be invested in very short-term bank deposits. Get some financial advice and make longer term commitments with the majority of your savings.

Investment News

 

Warehouse – The market became very excited about upside stories when the Warehouse (WHS) placed its stock in trading halt last week ‘pending important announcement’.

The rumour mill spun so hard that media even were calling small Financial Advisers in seaside villages to ask what we knew about the announcement.

The initial hope was that someone wanted to buy into WHS, again recognising the quality of its property network and logistics for importation and distribution.

‘Maybe Amazon wants to buy them?’

The cynic in me reacted by asking ‘who knows something?’ when seeing the share price lift by 10% in the days immediately preceding the announcement.

Happily, though, I was wrong.

It was a classic ‘buy the rumour but sell the fact’ situation, although the safety net of placing the market in trading halt helped a few avoid this error.

In the end, the announcement simply saw WHS confirm that they have sold their recently established, loss making, finance business; hardly good news. At least the current management team has recognised the error early and decided to stick to their knitting (which is not finance for consumers).

Thinking ahead for WHS, in my opinion Amazon is not going to kill all retailers. The best retailers will find ways to compete. Consumers will pay for variety and some consumers will soon want to declare ‘no it’s not from Amazon’.

For the benefit of WHS investors and the many beneficiaries of Sir Stephen Tindall’s generosity I hope WHS achieves a ‘best retailer’ status again.

 

Europe – Greece in particular.

Amongst the library full of information to worry about in Europe, Greece continues to provide glimmers of hope that progress is being made.

In 2015 investors valued a four-year bond (2019) issued by the Greek government at about 55 cents in the dollar (market yields reached 10%). The 4.75% interest rate payable was deemed irrelevant because the debate had centred on ‘when will they default and how much will we get back?’

However, the Greek government and strategies sponsored by the International Monetary Fund (IMF) and European Central Bank (ECB) appear to be working. Confidence is returning to financial markets for Greece.

That same Greek government bond maturing in 2019 now trades at 102 cents in the dollar (i.e. a market yield lower than the 4.75% coupon interest rate) and the Greek government is returning to financial markets to arrange its own loans (new bond issues) without the need for new financing from the IMF and ECB.

This is an impressive turn-around for market confidence over only 24 months.

Successful issuance of new bonds at interest rates of 4% or lower would validate the confidence, enable Greece to begin reducing its debt costs and perhaps even lay a pathway to repaying IMF supplied debt, funding that began in 2010.

Meanwhile the IMF and ECB need to move on with their Italian Job.

Profits – One of the focus items I referred to last week on my YES list was company profits and the current reporting period in the US is starting out reasonably well measured against early reports.

Four that caught my attention last week are four of the biggest influences on the market, Google, Amazon, McDonalds and Caterpillar. Each delivered second quarter (Q2) profits higher than the consensus forecasts of analysts.

Caterpillar is a very large global business (US$68 billion) and seen as a bellwether of economic activity and today its share price is setting an all-time new high (US$114.50 at close) and analysts are upgrading share price forecasts to US$125 (and beyond for future years).

I still agree with the various commentator conclusions about share markets being optimistically priced at present, so plenty of due care is required, but Caterpillar has been underperforming the overall market since 2012 and is appears to be delivering real profits to support a share price catch up.

If so, CAT will contribute additional upward pressure to the US share market pricing, sharing the load (nice CAT pun - Ed) if any other company share prices recede during the current profit reporting season.

It is useful to see a ‘real world’, as in hardware, business succeeding at a time when the majority of new investment is focussed on corporate leverage provided by computers and robots.

Take a look at an overlay of price charts between the S&P500 (top 500 by scale) and the NASDAQ (technology focus), the difference in performance is stark over the past five years; you might as well be comparing Zimbabwe with NZ.

If the technology focused NASDAQ companies are to confirm their value to the other businesses benefitting from that technology (e.g. robots helping CAT to keep costs down) then perhaps the S&P500 index should close the gap to the performance of the NASDAQ?

Speculation aside, the reported profits are real and rising profits help to justify the elevated pricing of the share market and temporarily reduce its apparent risk ratios.

Tightening? – You know how the US Federal Reserve is shouting from the rostrum that it is tightening monetary policy by lifting interest rates and will soon begin to sell the bonds it purchased to help provide more cash to the economy?

Well, last week, the Federal Reserve purchased $6.461 billion of mortgage-backed securities up from $5.656 billion purchased the previous week.

I know, one week does not a year make, but I would have expected the Fed to take every opportunity to make small changes, in the other direction. Maybe buy back only $5.5 billion this week, down $156 million from the previous week; a small but helpful signal for the new trend

Try it again in a couple of weeks. Like a financial detoxification strategy.

Walk the buyback programme toward zero, and then continue by insisting on progressive repayment of the bonds held.

All credible observers of this strategy can adjust to cope with the change. Those that cannot should no longer be in business for it implies they are dependent on state sponsored aid.

I hope this doesn’t disclose a ‘show me, don’t tell me’ problem.

Last week the Fed minutes ‘told me’ they intend to begin their balance sheet reduction relatively soon. Relative to what, Europe and Japan?

I’ll wait until the ‘show me’. If they do make a start you can be sure the progress will not parallel that of a snail; the snail will be waiting at the finish line, asleep.

 

Ever The Optimist – It’s a small victory in a small battle within a large war, but NZ enjoyed a trade surplus in June of $242 million, about $100 million higher than forecast.

ETO II – Fonterra has already increased its year ahead milk pay-out forecast to NZ$6.75 even as the NZ dollar rises back up to 75 cents against the US dollar.

They don’t yet appear to be expanding the value add part of their business though with earnings per share the same as last year.

All the same a combined pay-out exceeding NZ$7 adds to both farmers’ profits and NZ’s trade performance (see ETO I).

ETO III – India has successfully introduced its Goods & Services Tax.

This is good news for a nation making its way through significant strategic economic change, changes that are drawing wide ranging compliments.

Better economic performance from one of the world’s largest populations is a healthy development for those who are concerned about risks of declining global growth.

Investment Opportunities

New Bond? – We caught a sound that implied another bond may be ‘under construction’, possibly subordinated and from a new name.

We’ll keep you posted as disclosure continues.

The fastest way to hear about new issues is to join our ‘All 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

Kevin will be in Dunedin on 18 August and Christchurch on 31 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

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

Michael Warrington

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Market News 24 July 2017

Have you noticed that the evolution of artificial intelligence now means you do not need to take notes about a product you’d like to remember?  

Just email yourself naming the product and Google, and friends, will continuously remind you of the product every time you look at a screen.

Investment Opinion

Pondering– As always, I have been pondering, ‘what’s next’?

Making your investment decisions always involves looking ahead, into the unknown.

We’ve said it before, but it remains a truth of investment, we do not really know what happens tomorrow and that lack of certainty increases exponentially as each future day is added to the horizon.

You should avoid anyone who tells you with certainty, or with an excess of confidence, about the future for your investments.

There is a little value, but not much, in looking through the rear screen when contemplating what is ahead of us. Don’t drive backwards into the future.

I started writing this paragraph because it feels like we are in a slack tide moment; with market drivers neither moving forward nor backward. For the moment the share market pricing is moving forward but the drivers of value don’t seem to have changed.

There is no mist on the moor so I wouldn’t describe it as eerie, but it has me pondering what’s next with respect to influential drivers?

So, what am I monitoring at present as I look through the investor windscreen?

The YES list:

Profits – this falls under the ‘show me, don’t tell me’ banner. Companies need to deliver profits and hopefully some profit growth to justify today’s strong share market pricing. If they do not, their share prices will decline and the overall market would change direction.

Non-Disclosure – I occasionally ask ‘what are we not being told?’ because, per this section of Market News, I am telling you what I am looking out for so as to better manage our investments.

Sometimes undisclosed information is appropriately hidden from view; Spark does not want to disclose commercially sensitive information publicly for competitors to learn from, even if they would be happy for shareholders to know.

However, of more concern is non-disclosure of relevant information that shareholders deserve to know but it is being withheld for reasons of embarrassment, or worse; to minimise impact on personal incomes.

We have discussed what we consider to be poor form by the likes of Powerhouse and Fletcher’s recently. Both have offered additional information to the market but it was later than seemed appropriate to us.

Interest rates – We remain abreast of changing overnight cash rates (OCR in NZ) but currently we know that short term interest rates are not changing far, or fast.

However, longer term interest rates, and the marginal costs of debt for weaker borrowers, are changing a little with upward movement viewed as the more likely future direction. So, the direction and rate of change for longer term interest rates is worth watching.

Long term interest rates are influential to the valuation of all assets and rapid changes in long term interest rates are thereby disruptive to the valuation of your other investments.

If short-term interest rates remain low and longer-term interest rates rise the yield curve (a plot of interest rates across different time frames) steepens and this has implications for banks and borrowers; banks tend to make more money and borrowers borrow for shorter terms, even if this is strategically unwise.

A steeper yield curve changes the risk and reward dynamics of some of your investments.

As it happens I do not expect rapid change for short or long term interest rates, but, the scale of influence is such that this item is always found on the YES list for monitoring.

Weak Leadership – this comment predominantly relates to politics, but is just as relevant inside specific businesses.

Trump’s leadership is bizarre and on balance he looks likely to fall on the weak leadership side once reviewed over a longer period but I don’t lay the blame for the discomfort with the US government solely at Trump’s feet, he is a symptom of longer term weakness in US leadership.

Short term strategies aren’t appropriate ways to tackle long term problems.

The concern is that the US is by far the largest economy in the world, which is again gaining strength through energy self-sufficiency, so we are exposed to bizarre, weak leadership of the most influential economy on the planet, which doesn’t feel good.

North Korea has poor leadership and it could be more disruptive if they reach the point of stupidity.

Venezuela is now experiencing the results of poor leadership but its small scale means most of us won’t be troubled by it.

These people could learn a lot from the likes of Roger Federer.

Trade Barriers – if the US mishandles Trump’s preference to get a better deal for the US and it rolls into an era of protectionist behaviour by other nations we will enter a period of slower average global growth.

Less gross global trading activity will be bad for all, regardless of where the profit margins fall.

New Zealand’s only benefit here is that we are so small that we can be nimble with manoeuvring our trading volumes toward those who wish to do business on the most level playing fields.

The Volatility Index (VIX) – Even if you do not have a list of themes for elevated concern in financial markets we all know that unexpected problems regularly emerge, so it is a concern that the consolidated volatility measure of the world’s largest share market (US) has been declining for 18 months and is at its historic low point.

Something is changing here and I haven’t been able to validate my theory about this decline in volatility aligning with the rise in use of passive Exchange Traded Funds, so I remain a little on edge about the potential for a sharp shift higher when the frighteners emerge.

The Velocity of Money – In the US, the rate at which money circulates in the economy has been on a slowing trend since 1998 and has been well below the normal historical (60 years) range since 2008.

2008, interesting, the start of the Global Financial Crisis.

I pondered if the extremely low interest rates had resulted in people being blasé about the use of money, given that it is so cheap now (near zero interest rates). Maybe this gets combined with the more conservative folk increasing savings rates post GFC?

I tried to overlay the charts for the Velocity of Money and the US Fed Funds rate. It threw up an interesting and relatively stable relationship for 50 years, which then exploded in late 2008.

Interesting again. (We need results, not thumbs on chins – Ed)

The relationship is now settling down again, but it was ‘out of control’ during the crisis management years.

You can see why I am watching it; it is displaying extreme behaviour and I don’t know why!

Debt Ratios – Excessive debt is now one of the repetitive and boring chants across global financial markets.

Boring it may be, but it is real.

Private entities, and some governments, with excessive debt ratios should be avoided. There is so little upside from living on this frontier that it makes no sense to invest in this risk.

Fortunately there are very few examples of this risk type in domestic NZ investing.

The NO list, citing a few things that are not on my worry list:

Inflation – One is always aware of reported inflation data, but nothing about the current inflation climate gives me reason to place it on the more focused YES list.

For example NZ inflation for the second quarter of 2017 was, zero. It brought the annual result, depending on which series you like most to between +1.5% - +2.0%.

In contrast to the early years of my career central banks around the world are trying to add inflation to their economies, but they are struggling to achieve it and they won’t if the velocity of money continues to slow.

Velocity of money, price of money, inflation; cart, horse, delivery.

What’s the sequence?

The NZ Election – this is a non-event from an investment perspective. Long ago I learnt that we have such a moderate, well governed nation that neither side of the house is disruptive to the investment strategy;

The UK – BREXIT is disruptive for them near term (years) but I don’t see meaningful disruption to their long-term economy from it. It is hard for me to conclude that the European Union has been good for delivering increased economic success across a broad range of members, so, being outside the EU should be little different for the UK than New Zealand’s relationship with Australia;

China – this seems to be on everyone else’s worry list but it doesn’t feature for me. Their path to ‘managed capitalism’ has led to many pressure points, including excessive use of debt, but I think the Western analysts assume outcomes based on free market thinking.

I’m not sure why we analyse all things based on free market assumptions given how manipulative our own central banks and governments are but it would be wrong to ignore the level of control now being exerted by the current Chinese President, Xi Jinping.

Regardless of disputes about philosophy, President Xi is displaying leadership when he instructed China's state-owned enterprises to lower their debt levels.

‘Deleveraging at SOEs is of the utmost importance’.

He added that the country's financial officials must also ‘get a grip on so-called zombie enterprises kept alive by infusions of cheap credit’.

‘The central bank will play a stronger role in defending against risks, calling for more work on safeguarding the financial system and modernizing its regulatory framework’.

‘Financial security is part of national security, and finance should better serve the real economy’ (emphasis mine).

China’s debt levels are too high, but I think China has better control of its influential levers than we are giving them credit for.

There is probably plenty not to worry about, but I’ll stop there. I list these few because they seem to feature on worry lists for others.

Who started it? – Last week I read an item that I thought was bizarre; it was issued by the Bank of England.

They (the BoE through its representatives) are concerned about bond bubbles and poor liquidity if stress should affect the market place, especially for corporate bonds.

The ‘report’ was the Financial Stability Paper No. 42 ‘Simulating stress across the financial system: the resilience of corporate bond markets and the role of investment funds’.

After a recent focus of stress-testing banks (reported as a ‘pass’) the BoE analysts’ must have found themselves twiddling their thumbs and thus created a new subject to write a report on: ‘Hey, let’s stress test financial markets now’.

These kids can’t have been employed in 2008. Didn’t the Global Financial Crisis provide them with enough real evidence to work with?

Apparently not, because the BoE now, post report, thinks it needs to ‘conduct further research and assessment of the asset management industry in relation to the corporate bond market’.

Their initial paper highlights concerns surrounding liquidity in the event of a severe market shock. The report said, ‘Under a severe but plausible set of assumptions regarding market participant behaviours, investor redemptions can result in material increases in price spreads (i.e. the difference between buy and sell prices) in the corporate bond market and, in the extreme, a corporate bond market dislocation could occur, threatening the stability of financial markets and institutions.’

‘Plausible set of assumptions’.

Yup, these kids are under 30 years of age (more evidence you are now old – Ed).

There is no need to assume or describe as plausible.

Beyond the GFC, and in their own BREXIT backyard, investment in the UK commercial property market became locked up and it was temporarily impossible to sell such properties.

Managed funds holding such properties closed the doors to withdrawals because cash was not available and could not be made available.

These BoE youngsters, presumably in between Facebook updates, Snapchat messages and Tweets asked:

What would happen if fund managers are forced to sell bonds into falling markets?

What if market participants stop buying bonds?

What happens to the bond market if there are lots of sellers and not many buyers?

OK, these analysts are not only young but they also have no personal savings and investments so they have not interacted with financial markets themselves either.

You do not need to have studied ECON 101 to offer conclusions to these questions.

It is almost funny that these youngsters have not reflected on the fact that the premium pricing of bonds (very low interest rates) is a function of central bank policy of cutting overnight cash rates to near zero and then buying bonds from the market if yields on longer terms remained too high thereafter.

Wait, that can be their first example of the impact from ‘more buyers than sellers’.

As the BoE created the bubble in the bond market, through its unconventional monetary policy (like other central banks), it is ironic (or embarrassing – Ed) that they now highlight the risk of a disorderly market.

What we do not need in future is the central bank coming out during the next period of market disruption and saying, ‘we did warn you to look out for such trouble’.

The reality of the situation is caveat emptor applies and thus one invests according to their own investment policy, which, with financial advice, factors in various ‘what if’ scenarios and results in a diverse, well thought out portfolio.

In the event of market distress such investors will not be found short of cash and whilst they may suffer loss of value they should still be well positioned to react to the situation.

The Bank of England’s concerns are interesting to consider but the current subject matter is not news.

With thanks to Full Circle who drew my attention to the BoE report.

Investment News

 

RBA Neutral Rate – The Reserve Bank of Australia is not in a hurry to change its Official Cash Rate, currently at 1.50%, but the minutes from their most recent meeting disclosed their view that a future ‘neutral’ interest rate setting might be 3.50%.

This wording indicates that the public should not lock themselves into believing 1.50% will stay forever, but equally the RBA gave no hints about when they might begin to increase interest rates and change is highly unlikely over the 12 months ahead of us.

 

I highlight this story only to remind people that if interest rates do begin to rise the majority do not expect them to rise far.

 

US Federal Reserve – I doubt Janet Yellen was looking for, or happy to receive, the compliments issued last week by the Russian central bank, covering the US operation of monetary policy.

These compliments from Russia just feel to me like a big brother teasing a sister in front of their parents.

 

Banks– Australian and NZ regulators (APRA and RBNZ) haven’t finished yet with changing the capital demands of our banks.

We’ll take a look at the current reports and proposals and comment in future Market News items for you, but suffice to say the intention is to continue reducing the risks on bank balance sheets to ensure that our banks are unquestionably strong’.

Ever The Optimist – Delegat Group (DGL) has always been a positive story for me, ever since I met the family as they approached capital markets with their plans for strategic growth.

Capital markets were Sceptical. Jim Delegat was the opposite and put money on the line to back his confidence.

Jim was right.

The NZ wine industry has been on an almost constant growth path both in the scale of exports and its movement up the quality curve.

The prompt for this ETO was Delegat’s reporting yet another record for volume of exported wine at 2.632 million cases.

The current share price for DGL, at a conservative price/earnings ratio of about 12x, suggests that the overall market is still not sure whether to be confident in the business, but you can be sure Jim has stopped worrying about the market’s perspective.

Investment Opportunities

Secondary Markets – In a market that purports to be concerned about rising interest rates there are very few bonds offering market yields that I would consider ‘cheap’.

Senior bonds offering yields above 4.50% are very thin on the ground now.

Keep yourselves fully invested to keep your income up.

The fastest way to hear about new issues is to join our ‘All 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

Kevin will be in Dunedin on 18 August and Christchurch on 31 August.

Edward will be in Nelson on 22 August and Blenheim on 23 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

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

Michael Warrington

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Market News 17 July 2017

Sometimes what you are told by a company has more to do with what they want you to believe than what is real.

I guess they are taught this in Marketing 101.

Investors should try to be more like regulators in their assessment of the facts.

For example, UBER tells us they are a ride sharing company but regulators have long claimed UBER is what they see, a taxi company.

UBER now tells us it plans to introduce time based charges and the opportunity for tipping, presumably to cater for the inconvenience of a passenger disrupting the shared ride offer.

Or might it be the terms of the contract offered to the passenger?

If it looks like a taxi, acts like a taxi and ‘barks’ like a taxi, then, it is a taxi.

I don’t suppose UBER is planning to list on the NZX anytime soon, but if they did I wouldn’t be interested.

Investment Opinion

FATCA – I am really not keen to venture into the field of tax advice, but this one is stirring up a lot of dust so I’ll try and shepherd you into the right corner.

For the sake of clarity, it is you who makes the declaration so take your time; you cannot say ‘but Mike said…’.

Many of you will have received documents from registries, on behalf of companies you have invested in, asking you to make a ‘self-declaration’ about who you are with respect to the US Financial Account Tax Compliance Act (FATCA).

At first glance, the form will give you a headache.

Our government agreed to the US being able to interrogate New Zealanders with respect to our tax obligations to check if we have any obligations to the US IRS.

I hope we gained a meaningful financial benefit from the US in return for our compliance under this new (2014) agreement.

For the US it’s a little bit like the ‘Hunt for Osama Bin Laden’, The US Inland Revenue Service is trying to find taxable overseas income for US residents and citizens hiding out in confined places.

Essentially the FATCA form asks, ‘are you a US tax citizen/resident’.

Self-certification is more efficient than having that handsome new US ambassador going door to door checking, albeit that the process imposes a dreadful form and set of definitions upon us.

That’s the reason for this paragraph.

I am not offering you a rubber stamp for your status, you really must ‘self-certify’ but I did want to de-mystify the obligation for you.

To that end, here are a couple of short-cuts for you:

If you invest in personal names (single or joint), you are investing as a natural person and if you have absolutely no connection with the US, and thus US IRS (tax), then I would encourage you to look very closely at Option 1.

On the most recent form used by Computershare for the Goodman Property bond (a nice clear form) under Option 1 ‘Individual’ there was a simple choice for the declaration; YES or NO to being a US resident of citizen for tax purposes.

We have not met any YES people.

If you invest under an entity, such as a trust or a company you are drawn further into the swamp (the one Trump tried to drain? – Ed) and are confronted by a more complex set of questions.

Unhelpfully you are directed to read the material at the following website:

http://taxpolicy.ird.govt.nz/publications/2014-other-iga/overview

I can see the Computershare and IRD staff now shooting daggers my way for suggesting that this is unhelpful.

Providing the link is helpful, until you get there and are presented with a 97-page document explaining the agreement with the US and walking through the many legal definitions. You would need to be a keen reader and it be raining outside to enjoy this one.

I can assure them (IRD and Computershare) that our bank (ANZ) was no more helpful when it dropped FATCA forms off for Chris Lee & Partners to complete. The material provided was worse than the nice simple form from Computershare and there was no support, knowledge or advice provided by the bank to its customer.

I know the bank didn’t want to put itself at risk of error with the FATCA declarations. We accept that it is our responsibility to make our declaration, but removing the blindfold would have been helpful.

Again, that is the reason for this paragraph.

We cannot, and do not, relieve you of your responsibility to make your own declaration but we are trying to remove some of the mist from the swamp.

A flowchart from IRD would have been more helpful.

If I was (again) elected as Prime Minister for a day I would instruct IRD to add the FATCA declaration to annual tax returns, with manual access for those not doing regular returns.

Then, each taxpayer’s FACTA declaration would be recorded against an IRD number from which the tax payer could share a pdf copy of the current FATCA declaration with anyone legitimately asking to sight it.

This should quickly position NZ to describe a high level of compliance to the US under the political agreement and cut red tape out of the domestic process of capturing and recording FATCA declarations.

This is a tax environment declaration; why are ‘we’ asking for the declaration to travel via third parties such as Goodman Property Bond Issuer Limited, via its registrar Computershare, with input from Chris Lee & Partners (post a reference to IRD) to have the declaration finally rest with IRD? (perhaps this is why NZ unemployment is so low – Ed).

I digress, but this level of bureaucracy reminds me of last week’s modest slip in Ngauranga Gorge, Wellington, where people in orange vests decided to block the Northbound lanes (2 of 3) to review what they might do for the Southbound lanes!

Northbound lanes did not need to be involved in the process in my view.

Back to the point.

Now I cover FATCA for entities (such as a trust or company).

It is likely that retail investors in NZ will define their investment entity as a ‘Non-US Entity’.

It is likely that such investors will find they are not Financial Institutions. I expect you’ll conclude that your investment entity does not ‘conduct as business’ investment on behalf of other persons.

It is likely that the client will discover they are ‘Passive’ Non-Financial Foreign Entities (NFFE).

I say ‘Passive’ because:

An ‘Active NFFE’ means any NFFE that meets any of the following criteria:

a) Less than 50 percent of the NFFE’s gross income for the preceding calendar year or other appropriate reporting period is passive income and less than 50 percent of the assets held by the NFFE during the preceding calendar year or other appropriate reporting period are assets that produce or are held for the production of passive income;

b) The stock of the NFFE is regularly traded on an established securities market or the NFFE is a Related Entity of an Entity the stock of which is regularly traded on an established securities market;

With respect to a), almost 100% of the investors we meet earn greater than 50% of their investment income from passively held investments.

With respect to b), none of our clients are listed on any securities exchange!

I then expect that most will be able to declare that they do not have any US tax residents/citizens involved in their entity (as trustee, beneficiary, director).

So, I believe that all our clients should be able to complete their FATCA declarations with the pen only touching the form either twice or three times, where one action is the signature.

Once you have completed a FATCA form I suggest retaining a copy in your investment folder to remind yourselves of the conclusion that you reached previously to short-circuit the thought process when another declaration request arrives.

If the Hon. Bill English is reading this, please ask Judith Collins (Revenue Minister) to have a chat with NZ IRD about cutting red tape out of the current process.

OCR – There are some interesting changes emerging in the world of Official Cash Rates around the world.

Some central banks are trying to begin the journey of increasing the short-term interest rates for their countries. The US and now its neighbour Canada have actually increased their overnight interest rates and declare that a continuation of this new trend is likely (more hope than conviction in this declaration).

Europe and the UK are gingerly trialling a message that they would like to hitch their wagon to the same track as the US. The Swedish central bank is contemplating a reversion away from negative interest rates; how bold.

Others though are decidedly unmoved (NZ and Australia) and a few are still willing to ease monetary policy (Japan) and the Swiss might also ease again if excessive demand for their currency returned.

Financial market commentary has long discussed the problems being caused by extremely low interest rates (the perverse incentive of money that’s almost free) so I doubt that many commentators will fight the new preference for increasing interest rates, but the journey is surely going to be slow and will not cover a lot of distance.

Unless regulators and lenders are willing to accept some loan defaults, which clearly they are not when we witness the decisions last month for Italian banking, then the gross scale of debt in developed nations is too high to tolerate high interest rates.

Also, economic forecasters remain concerned about disappointingly low rates of growth so it is hard to see where inflationary tension is going to emerge from (you need higher inflation to pressure longer term interest rates higher).

The bloated balance sheets held by the central banks that ‘printed money’ will be hard to exit regardless of their strategic intent.

NZ seems very well placed in this scenario.

Our central bank did not bloat its balance sheet by ‘printing money’ and buying bonds back from the market. It did though introduce new macro-prudential tools to try and manipulate better financial behaviour from the public and these tools are showing signs of gradual success.

Graeme Wheeler has done some things unwell, but pushing through the new macro-prudential tools will be a successful legacy from his time at the central bank.

While the US and others may wish to walk up their short-term interest rates NZ may avoid doing so and as a result the RBNZ may well see the NZ dollar drift lower (its dream scenario) as the previously attractive (to NZD) interest rate differentials are removed, providing a natural trading benefit to our exporters.

All we would need to reinforce such an outcome is for New Zealanders’ to start repaying our own excessive private debt levels!

It is nice to return to ‘normal’ where the world’s central banks are beginning to follow domestically defined courses and not one defined by peer pressure.

Investment News

 

Insider Trading – The UK has reported that suspicious share trading precedes 19% of all takeover notices in their market.

That’s an appalling statistic.

They shouldn’t feel alone though because Australia reports insider trading and manipulation as being 21% of the threat to fair market operation.

This data discloses either poor regulation, poor policing, or both and the Financial Markets Authority would be naïve not to think the numbers were this high in NZ too.

Maybe NZ is making progress on this issue finally with the recent conviction for insider trading of some EROAD shares and the ease with which the regulators can now monitor trading activity by any person’s Common Shareholder Number (CSN).

If the suspicious share price movement in NZ shares, immediately prior to influential news, becomes less frequent or undetectable it will be a good development against one of the FMA’s objective (market confidence).

 

Mind Bending – Like time passing a black hole the information that we are seeing from the Exchange Traded Fund (ETF) sector is messing the continuum of our understanding of investment behaviour.

As we have commented on a couple of times investment markets via ETFs are already at a scale that has active fund managers, and perhaps stock exchange owners, worrying (less so the NZX who owns NZ’s largest ETF fund manager).

The mind-numbing item that I refer to is that on top of such a large current base of investment in ETFs, last week, one of the very largest ETF managers (BlackRock) reported record new inflows of US$140 billion over the past 12 months.

US$140 billion is roughly equivalent to 75% of NZ GDP for a year. Imagine we had no expenses and NZ placed 75% of all finance we generated in a year into a single mega fund manager.

And the numbers are rising.

If I go off track a little (as you do – Ed) I observe that if Vanguard or BlackRock set up a ‘NZ ETF’ they could probably buy the lot.

The growth is all about fees and good on them for placing downward pressure on industry expenses and, by definition, upward pressure on net risk adjusted returns for investors.

 

Yellen – It was as if Chair of the US Federal Reserve, Janet Yellen, had read the draft of this Market News.

In her semi-annual testimony to Congress Yellen described their intention to continue with rate hikes and a gradual reduction of the Fed’s balance sheet but she acknowledged that inflation was still weaker than expected and that interest rates would not have to increase much further to achieve a neutral policy stance.

With a 2% inflation target you might have thought a 2% Fed Funds rate might be considered neutral at present, but the US is still 0.75% (3 hikes) below that point and might now be struggling to get there.

So, I think I’ll take that as confirmation of my view (won’t rise far and won’t rise fast) from one of the most powerful women in global finance at present.

India– I think India is moving very fast with its good set of financial reforms but I guess it will still take years for the good decisions to show up.

The developments though are sufficiently impressive that India attracted praise from the G20 for the effort and direction of the current reforms.

It is nice to have your tummy rubbed but it will be even better when they see faster growth, wider employment, higher incomes, greater tax collection and greater investment.

The G20 was perhaps trying to do its part to encourage more investment from external sources by complimenting the reforms.

Ever The Optimist – I would describe myself as someone who does not ‘go for’ diets urged by various experts, and I’m not about to start, but according to a story last week the Paleo diet may be responsible for increased demand for venison, which has driven the price up.

I don’t mind a diet being the driver of delivering higher income to our deer farmers (agriculture export sector).

Investment Opportunities

Secondary Markets – There are no new bond issues at present, although we do expect more so accumulating cash should, as usual, be rewarded with new opportunities.

The June financial reporting season may deliver a lull in proceedings, until audited accounts are completed. This may mean that new borrowers align nicely with the very large amount of securities expected to be repaid in the final quarter this year.

However, if you are about to leave on a jet plane, or a cruise, and cannot wait please give us a call and we’ll help you source an investment option from the secondary market.

The recently issued Summerset bonds (4.78% for 6 years) are now trading on the market if you missed out during the new issue process and would still like to invest in them.

The fastest way to hear about new issues is to join our ‘All 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

Kevin will be in Dunedin on 18 August.

Edward will be in Remuera on 1 August and Albany on 2 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

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

Michael Warrington

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Market News 10 July 2017

Well, well, look at that, Auckland house prices record a fall even though they have not yet built the thousands of new homes that are required.

It seems that excessive speculation (being addressed by Reserve Bank rules) and excessive buying by fast moving international money (being addressed by Anti Money Laundering rules and China’s restrictions on exporting capital) played a part in driving the market, until now.

The market is now making its way to a more neutral setting.

Good.

Investment Opinion

 

Italian Heist – The Italian tax payers are being taken for a ride.

The latest Italian bank to seek and receive tax payer support is Monte dei Paschi di Siena.

I would have thought that if the bank’s current shareholders could not, or would not, provide sufficient equity to provide a solvent and equity supported future the bank should either be sold to new owners or progressively closed by the European Central Bank.

If the bank was sold to new owners the price should be one Euro, or less.

Monte dei Paschi’s shareholders only offered 2.7 billion of the equity required (plus a little Tier II funding), forcing a decision from the Italian government and the ECB.

Consistent with the soft approach taken when supporting the other Italian banks, the government agreed to invest the other 5.4 billion Euros required by Monte dei Paschi. At least they took a 70% shareholding for their contribution.

The ECB declared the capital restructuring ‘effective’ and thus approved the proposal.

It has become clear that banking regulators the world over think they are just skipping along the Yellow Brick Road and that financial wizardry will solve all.

Failure is no longer a term to be found in the financial dictionary and it is this generosity from the regulators that is fuelling the overpricing of the many assets around the world.

The Bank of International Settlements usually reserves its commentary for banking, financial stability and settlement integrity but even it is beginning to comment in emotive terms about the optimistic pricing of asset markets.

A frequently used, but apt, headline is: The market is priced for nirvana but the underlying economy is not happy.

I am reminded of Market News a couple of weeks ago when I highlighted robust and well respected but opposing views about the state of investment markets. My conclusion is the same today, absorb the information and opinions but make sure your own investment portfolio is consistent with a risk and reward strategy that suits you.

No Fear? – When I first typed these words, I thought of the clothing company but I have used them, unsurprisingly in this context, to describe the consolidated condition of financial markets; hence the question mark.

There seem to be plenty of things to worry about around the globe (according to the headlines – Ed) but apparently finance in the US isn’t one. The VIX volatility index, which is a measure of anticipated volatility on the US S&P500 share market, is extra-ordinarily low at present.

The VIX index trades in a wide range (11% - 44%) with the high being the 2008 crisis and the European crisis and the low being, well…. today.

With the elevated level of political volatility at present and the hyper-ventilating from the media one might say there is an irreconcilable difference between one of the drivers (regulators) and the impact they aren’t having on the economy (as measured by a happy share market).

What gives?

Perhaps we are witnessing a calming effect from the rising scale and presence of Exchange Traded Funds in the market.

I know investors can come and go from ETF’s as easily as any other share but the public are not traders by nature, they are savers and they would like to see some progress in the value of those savings over time that they are accumulating.

Maybe the public’s ultimate display of respect (deserved) for Warren Buffett is to have taken on board his two simple pieces of financial advice when investing one’s savings:

When Buffett dies he will recommend that his wife’s wealth is placed in some cash for everyday use plus the US S&P500 index, via a low-cost ETF from Vanguard; and

The outcome of Buffett’s 10-year bet with the Hedge Fund manager(s) that the S&P500 would beat whatever assets and strategy the hedge funds chose. Buffett was correct, knowing high fund manager fees provided him with a head-start.

Maybe also the market is alert to the prospect of lower future returns after such a strong run up in asset values over the past seven years (post crisis recovery) and thus the wider market is becoming increasingly sensitive about the costs of managing money.

Low annual returns would be crushed by high fee expenses.

If this potential development (a focus on fees) is even close to the truth it is a good sign and demonstrates that investors are becoming more fee sensitive in terms of cost versus added value.

Another more complex reason for lower volatility is simple economics; more sellers than buyers.

Sellers of volatility that is.

Owners of assets, and some traders, buy and sell financial options (exposures to possible market outcomes) and the pricing of those options includes volatility as a factor for setting the price.

If there are more market participants offering to sell options than those willing to buy the pricing should decline (through agreements about lower volatility).

Selling financial options generates income (and accumulates additional risk).

Maybe some funds are so desperate for additional income that they are selling financial options to satisfy income demands of clients and accepting the additional risk involved.

Maybe lower market volatility is a factor of both these ideas above. (Maybe cubed makes you look rather unsure about much here – Ed).

True, there are just too many variables to be confident and one can never be certain in financial markets. However, the unusual calmness of the world’s largest economy warrants thinking about.

What is it that follows calm, in an environment of global warming?

Investment News

 

RBA – The Reserve Bank of Australia has again made no change to its Official Cash Rate, leaving it at 1.50%.

The governor’s comments offered absolutely no hint of changes to the OCR, up or down.

At one point, he at least used the term ‘low interest rates’, implicitly acknowledging that we are still considered to be in accommodative monetary policy conditions. Let’s hope the word ‘low’ doesn’t one day change to ‘current’.

Like the RBNZ statements it touched on what is strong and what is weak but the concluding remarks were for no change in the foreseeable future.

I have long liked the stable and considered approach to monetary policy taken by the RBA.

It is possible that central banks like the RBA and RBNZ that did not print money to help their economies now have the luxury of sitting very still at these low OCR rates as they monitor the slow retreat from money printing by other central banks of the world before inflationary pressures finally return.

The money printing central banks have already conceded it will take many years to reduce their balance sheets (sell the bonds they purchased) to return to more normal monetary conditions.

Once those money-printing central banks do reach a point of neutral monetary conditions they may become very interested in the apparent effectiveness of NZ’s new macro-prudential tools for influencing good financial behaviour by the public, instead of raising interest rates further.

Whilst writing this I found myself contemplating another deflationary force; markets being ‘Amazoned’.

Amazon’s relentless pursuit of markets where products and services operate with high margins that can be undercut (an admirable strategy) is resulting in reduced profits for competing businesses and this in turn will feed into reduced employment.

Take a look at recent Walmart reports for an example of what I am describing.

The reduction to employment may be temporary (people seek work elsewhere) but unemployment has the impact of reducing consumer confidence, especially with discretionary spending. This reduction in confidence (employment and consumption) will have a cooling effect on inflationary pressure points.

If this sequence, as I see it, comes to pass it is very hard to see high short-term interest rates over the coming decade.

Rabobank – sticking to the plan.

I have long admired Rabobank’s consistency and integrity of message.

We regularly report messages about potential repayment to clients holding the Rabobank perpetual capital securities (RBOHA).

The high probability of repayment for the RBOHA was, unsurprisingly, reinforced by the repayment in June 2017 of a US dollar tranche of similar securities (Additional Tier 1 equity).

The NZ tranche at $900 million remains NZ’s largest ever offer of fixed interest securities. More than once I have been asked ‘can they raise enough to repay it?’

Yes, they can, and will (once repayment is confirmed). They probably already have arranged their 2017 funding requirements.

For perspective, the US tranche repaid last month was for USD 2 billion.

Rabobank is planning ahead and we think it would be appropriate for RBOHA holders to do likewise.

Water – We, as in NZ, still haven’t achieved a comfortable balance between commerce and conservation. As a school report might say - ‘capable of better with more effort’.

Protecting waterways has had plenty of airtime where ‘we’ remind land users that we have high expectations for downstream results.

On the flip side, last week a Supreme Court ruling blocked current plans for better water catchment and distribution in Hawke’s Bay (upstream strategies) to support the growth of farming and horticulture.

Both ends of the stream are a little frustrating and this indicates a weakness in the strategies of both sides of the debate.

 

Fairfax – Last week both businesses that approached Fairfax with takeover offers, subject to due diligence, withdrew their offers.

TPG and Hellman Friedman had been shown detailed information about the Fairfax business and had hinted at making takeover offers, at, or just below, current market share prices.

Now those offers have been withdrawn, or not confirmed.

TPW and Hellman Friedman were unusually complimentary of Fairfax’s current strategies for the future.

I’m not sure what other investments TPW and HF have in the media sector but the Fairfax board could be forgiven for wondering if they have disclosed a lot of sensitive business information for no financial gain.

Risk – It may be coincidental that last week’s media presented me with two related stories but it reminded me of how risks comes over the horizon from many different directions; sometimes predictable and sometimes not so much.

Story 1 – Tesla new car sales slow;

Story 2 – Volvo commits to a future of hybrid and electric motors only.

I have long expected the big car manufacturers to rain on Tesla’s parade and Volvo is only modest in size. Once General Motors, Toyota, Honda, VW, Daimler and FIAT achieve the same focus as Volvo the electric motor industry will become very competitive indeed.

The Volvo headline prompted a client to ask about investment in Lithium but my response was that it may help some miners a little but not enough to get too excited about.

Lithium batteries have been around for many years now. Vehicle batteries will gradually add to demand but I expect mining supply will gradually increase to match that demand.

Investors seeking opportunities to gain exposure to Lithium might ask themselves; how quickly will you change from your fossil fuel vehicle(s) to an electric vehicle?

US Banks – Just as Donald Trump claims he will remove the Dodd Frank Act, which demanded far tighter regulation of the banking sector, all the major US banks are reported as having passed the most recent stress test under the tighter regulations.

There’s nothing new in Trump proposing change where none is required but at least I didn’t have to join TWITTER to read about this news; much better that it comes from the US Federal Reserve.

It’s also nice to learn that the major banks are lobbying Trump not to change the law.

Having passed this test, the US Federal Reserve allows the banks to pay increased dividends, or buyback shares if preferred, and this has logically prompted a rally in the price of these banking shares.

So, banking continues along its path of greater strength in the US (and greater subsidy in Europe) providing the wider public with reasons for greater confidence in future financial stability.

It may have been knowledge of this outcome in the banking sector that lead Janet Yellen to declare that she doesn’t expect another financial crisis (where the term is used appropriately) in her lifetime.

She looks well, so I hope she expects to be around for a long while yet.

Yellen credits the structural reform across the banking sector since 2008 as the key development supporting her view.

I guess she’ll be watching her TWITTER account for any changes to that reform and any need to change her opinion on this matter.

Ever The Optimist – The NZ government fiscal surplus continues to rise and it nice to note that more of the growth in revenue came from sustainable tax increases and not just tight control of spending.

Investment Opportunities

Summerset (SUM010) – Thank you to all who participated in this bond offer (6 years at 4.78%) with Chris Lee & Partners.

If you missed the offer but wish to invest in these bonds please make contact and we’ll be happy to help you purchase some on market.

We look forward to the next opportunity.

The fastest way to hear about new issues is to join our ‘All 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

Kevin will be in Christchurch on 3 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

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

Michael Warrington

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Market News 3 July 2017

A few anecdotes for you:

Anecdote I

Congratulations Emirates Team NZ and thank you for the excitement.

Does everyone else think that Auckland based hotels might get over their contempt for Phil Goff’s bed tax after the NZ victory in the America’s Cup?

Anecdote II

The Reserve Bank is concerned that it is not getting its messages through to the public after a negative sentiment was discovered in a recent survey.

As a result, the RBNZ has decided that it shall now distribute messages via Twitter and Facebook, alongside more traditional channels.

This seems to be placing an unusually high-level of confidence in the piano player to fix the tune.

Anecdote III

Recent performance by Tegel implies that this chicken farmer may have lost its way, temporarily.

Perhaps their senior executives should attend the film ‘Pecking Order’ to help develop a new passion for the bird.

 

Investment Opinion

 

Expand to Australia – NZ electricity businesses are continuing their push into Australia, which, subject to financial performance, is good to see after many years of Australian businesses trying to take control of NZ based businesses.

Trustpower, and their parent Infratil, have been long term investors in the Australian energy sector and they continue today with a two-brand strategy of Trustpower and Tilt. Tilt is pursuing growth through the development of renewable energy projects under a regime determined to move Australia away from its dependence on coal fired electricity supply.

Last week saw Vector announcing a new business expansion in Australia, beyond its smart meter investment, by winning a mandate to supply battery storage facilities in Alice Springs as part of the Northern Territories energy management plans.

This move is consistent with Vector’s moves into solar and battery supplied electricity in NZ (449 customers so far and rising) and its ‘only authorised reseller and installer’ relationship with Tesla in NZ for its Powerwall and Powerpack products.

It makes sense that Vector would be trying to expand that relationship across to Australia too.

Vector also reports that it is bidding on three other projects in Australia. There’s clearly business to be had in the ‘lucky’ (?) country.

Currently I am thinking that the greater proportion of luck down under is being felt by New Zealanders rather than Australians.

One of New Zealand’s smallest, but fastest growing, electricity industry companies is also looking at the Australian market.

Flick Electric fields approaches from other markets, including Australia, all very interested in this businesses capability to both connect retail consumers with wholesale electricity prices, and to connect consumers with other private electricity generators (such as another house with solar panels generating surplus electricity).

Actually, a new term has been coined for these people – Prosumers; people who both produce and consume electricity and wish to sell, and buy, surplus electricity between themselves and other prosumers as supply and demand requires.

NZ Businesses like Flick Electric are positioned to make this market a reality.

Some of the major electricity retailers in NZ (such as Genesis, Contact, Meridian, Mercury) are using the current lift in wholesale electricity pricing to try and create fear amongst those buying electricity from the wholesale market but it won’t work. Consumers are relishing the ability to manage their consumption relative to electricity pricing and they can see just how wide historical profit margins have been throughout a whole year.

Retailers add a margin to wholesale pricing to extract a profit and these major generators charge that profitable price all year, not just when we have a dry winter.

Other markets have witnessed the competitiveness of this new service (Flick Electric’s model) and there is an exciting prospect for yet another small NZ business to expand overseas but remain based in NZ, Wellington in this case just like Xero.

Within the same electricity industry, but from a different sub-sector (High Voltage), I am also familiar with another kiwi who built a very successful service business which became much larger through international expansion to the point that major brands tried to buy the business from him. They now see this business as a real threat to them.

For now there is a preference that the business remain owned by current staff, but it is another kiwi success story born from our electricity sector skills.

During the years ahead I’ll be hoping to see these businesses continue their success as they spread their wings beyond the NZ market.

This is not quite an ETO story for below but it’s not far off it.

Mistakes – In business mistakes are made. Good businesses learn from mistakes and get progressively better for it.

A story that caught my attention wasn’t presented as a failure but it was confirmation of a strategic error when Woolworths reported last week the sale of EZIBUY to private equity interests, conceding that this business no longer suited the new Woolworths strategy.

Most readers will remember the huge success enjoyed by EZIBUY, based in Palmerston North, as an early magazine (then online) retailer that delivered by courier to your front door.

They beat Amazon to the concept by 16 years (1978 plays 1994).

Imagine if EZIBUY had pushed on with the concept in the way Amazon has?

World retail domination, from Palmerston North.

As I think about it EZIBUY’s enormous volumes (15,000 per day) probably played a significant role in NZ Post’s decision to make Palmerston North a major mail hub for the lower North Island. I know NZ Post trucks made dedicated visits to EZIBUY having been along for the ride.

Anyway, back to my point, which is not to assume that senior executives of very large companies know what they are doing when they make big decisions (Fletcher Building is a recent example of this thesis – Ed).

Woolworths paid a lot to buy EZIBUY. Too much.

We know this because the sellers of EZIBUY, the Gillespie brothers along with a more recent shareholder (Catalyst Investment Managers from 2007) were happy to accept a 100% sale of the business for $350 million. Not part, or progressive, or earn out based on challenging targets, but 100%, sold.

I don’t know what Woolworths sold EZIBUY for after only 34 months ownership but would anyone like to wager that it wasn’t a lot less than $350 million?

I’ll give you a clue, and not take anyone’s money off them, Woolworths wrote $325 million off its balance sheet value for EZIBUY in 2016, 24 months after the purchase. That’s a chilling loss of $13.5 million per month (or $30 per parcel).

Someone at Woolworths made a dreadful error on the purchase price due diligence, and that’s the point, people make mistakes even if they seem from the outside to work for the best (?) or biggest in the business.

If Amazon had been the buyer of EZIBUY, from Woolworths, I would have been intrigued for the future retail landscape in NZ.

However, it has been purchased by private equity interests.

Let’s hope it doesn’t reappear as an ASX or NZX IPO listing at an inflated price reminding everyone of Dick Smith Electronics.

Investment News

 

University Risk – There have been a couple of occasions when holders of bonds issued by the University of Canterbury (UOC) became a little nervous, notably immediately after the earthquake and after the resulting financial loss announcements.

Student numbers dropped and capital spending went through the roof. Concerns were understandable.

Investors and financial advisers are always forced to make assumptions when addressing future outcomes and our assumption for UOC bondholders was to relax; the institution is too good and too important not to form a successful strategic plan including meeting all its financial obligations.

Successful progress is exactly how UOC’s situation has played out and the good performance is a credit to the governors and senior management.

Underlying our confidence was the fact that given the importance of education for gaining economic success (our own kids plus temporary immigrants who pay more) the government was always going to underwrite delivery of an appropriate strategic plan at UOC.

No minister would ever have promised us this but a story last week confirmed our expectation.

The government contributed an additional $85 million to Lincoln University (College to most) to help finish a property project described as problematic by Treasury.

The Minister said nice things:

 

The new facility will make an important contribution to creating a globally competitive agri-tech industry," Goldsmith said in a statement. "By creating better links between research and industry the new facility will improve innovation and the applicability and speed of technology transfer to industry.

 

Accentuate the positive. What else could he do?

Therein lies an example of the confidence we had that holders of UOC010 bonds should rest easy and in fact enjoy the good returns being paid by a reliable institution.

UOC bonds have been a good opportunity for investors and I am only sad that other universities haven’t issued bonds for part of their financing requirements.

 

Europe – Banks typically love low interest rates and steep yield curves (higher interest rates for longer terms) so I wonder how a central bank feels when a bank chairman starts urging them to tighten monetary policy?

Rabobank’s chairman, Wiebe Draijer, responded to an interviewer question about the timing for tighter monetary policy by saying:

‘I would have hoped they would have already started’.

He went on to say:

‘Right now consumers are confused, they don't understand negative interest rates, they don't understand a zero interest rate and the system becomes volatile as a result. We shouldn't have that.’

I agree. The near zero interest rate environment has been confusing for those who behave well and save money and the low cost of money has perversely encouraged higher use of debt.

The Bank for International Settlements (BIS) reports that global debt has increased by yet another US$500 billion to US$217 trillion. This is such a large number that it is hard to get one’s head around.

According to a few searches the global population is about 7.5 billion and apparently the average per capita income is about US$16,000.

Well, this means that every citizen of planet earth owes on average US$29,000 being 181% of our average income. Coincidentally the BIS has run the warning flag up the pole for Australia where household debt to income has reached an all-time high of 189%.

If ‘my’ US$29,000 loan costs me nothing then I am not concerned. ‘My’ consumer behaviour might be unaffected. Perhaps ‘my’ behaviour isn’t desirable (BIS reports ongoing lift in excessive use of debt) but nobody has truly grabbed my attention yet with a message about better behaviour.

The only thing that will change my behaviour then is if the price of money increases (interest rates up).

Accordingly, I think the US Federal Reserve is finally following the right path by walking up interest rates and reducing the volume of bonds they own (financing provided by them).

Policy makers who do not think the population will cope if a little tension is applied to the financial framework are wrong. The population is smarter than policy makers give them credit for.

Those who are not, and are using excessive debt within their business strategy, deserve to fail.

Interest rates do need to rise, but sadly I do not expect them to do so.

Anarchy – when rules are not adhered to.

What is the point in having new, tighter rules for bank equity and who shall wear the losses from bank failure, if those rules can be waived at the first sign of such failure?

A client in Europe alerted me to a rapidly growing story of discontent linked to Italian banking.

Failed banks Popolare di Vicensa and Vento Banca will be taken over by the country's biggest retail bank Intesa Sanpaolo (once sold by Credit Agricole, which doesn’t give me confidence), but there is a catch; the Italian government must put in 17 billion Euro’s to neutralise the anticipated bad debts.

Yes, you read that correctly, two Italian banks have failed and the tax payer is wearing the losses created by these banks. It should be the shareholders and lenders to the banks’ who are losing money here, not the Italian tax payers.

This is happening on the European Central Bank’s playing field, right under the noses of the Bank for International Settlements (regulator). They are either complicit or impotent.

Maybe I don’t know much about the details of this situation, but I know this much; Anarchy doesn’t rule.

In my household if the rules aren’t followed failure is the result. Punishment sometimes follows (Section 59 acknowledged). Anarchy is not an acceptable option.

Then again, we are not Italian.

Ever The Optimist – New Zealand's merchandise exports rose to their highest monthly level since 2014 in May as the country benefited from rising prices for dairy.

Total exports rose 8.70% to $4.95 billion in May compared with the same month a year earlier and marked the highest monthly level since March 2014.

Reminding us of its importance (scale) dairy exports led the rise, with the value lifting 42 percent, or by $342 million, to $1.16 billion.

Exporting is good.

ETO II – Zespri declares that the kiwifruit industry expects to generate 29,000 new jobs and add an annual $3.5 billion to New Zealand's gross domestic product by 2030.

That’s +2,000 new jobs each year for the sector and that would be impressive.

Investment Opportunities

Summerset (SUM010) – new senior, secured, bond offer (6-year term) with an interest rate of 4.78% p.a. (paid quarterly) is open for investment.

The offer document and application form is available on the Current Investments page of our website: http://www.chrislee.co.nz/current-investments

The offer closes this week so those wishing to invest at this late stage must act immediately.

The fastest way to hear about new issues is to join our ‘All 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

Kevin will be in Christchurch on 3 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

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

Michael Warrington

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