Market News 27 July 2020

With me being away on a 'research tour of the Mainland' recently, occupying some of my writing time I thought I'd reprise an article that was well received in its first run: Financing Retirement.

Most of you are very good at this process, but given the enormous shifts occurring in potential returns on investment the implications for your savings (capital) are large too.

How much do I need?

How long will it last?

Lower returns will soon compromise balancing passive income with general spending levels; do you take more risk to find more return or alter your conclusions about spending capital in retirement?

Cutting spending is an option, but not a desirable one if you hold plenty of equity (savings).

Much of the wording below is the same, but some has changed for contemporary reasons and at other times I have added supplementary comments (bold text in brackets).

So, here is a 2020 version Financing retirement

At its core we save money during our working years to ensure we can finance our retired years.

This is a paragraph about asset allocation.

Consolidated conversations with clients leave me hearing from people that the annual cost to run a house each year sits between $40-50,000 without luxuries, such as international travel (no longer accessible).

For a couple, National Super is currently about $32,000 of after-tax income (excludes heating supplement), so another $15-20,000 income per annum is necessary to reach that recurring annual expense.

Mathematically one can calculate how much money they require in savings to reasonably ensure the comfortable financing of their future from passive income. For example, if you are 65 years of age and conclude that you’ll have as much as 35 more years left on this planet, the approximate financial scenarios are:

Spending capital option:

$400,000 saved now, expecting to earn about 2.00% (down from my 4.00% previous estimate) pre-tax (at 17.50% marginal tax rate), without the impost of annual management fees, will support approximately $15,000 (down from $20,000) of spending over 35 years (capital runs out at that point);

For capital spend to sustain $20,000 spending per annum for 35 years at 2.00% earnings you now need about $530,000 saved; and

The not spending capital option:

$1,100,000 (was $600,000) saved now, again invested at the current 2.00% pre-tax (17.50%, no fees) would deliver a recurring amount of approximately $20,000 (old target) after tax income per annum (capital is roughly maintained in 2020 terms).

In both cases the actual income would vary based on contemporary returns, but interest rate returns would also vary based on inflation over time so to some extent real returns should be sustained over time allowing an inflation adjusted spend near to today's $20,000. (Proved to be a poor assumption because interest rates have moved from above inflation to below in less than three years!)

$400,000 is a substantial sum of money to accumulate through ones working life, after paying off a home; $1,100,000 is unreachable for the majority.

If you want a truly inflation adjusted portfolio you should only spend earnings of about 2.00% and compound the balance of your income to ensure a rising capital sum in your portfolio (hopefully also 2.00% if the world manages to keep inflation stable in the targeted ranges).

The prospect of a 4.00% gross return is currently only possible via investment in property and shares asset classes (more risk), and not from fixed interest investing. We see this situation continuing for many years now.

However, this inflation adjusted scenario (save 2% of your earnings annually) would require that you hold almost twice as much in savings today, and that isn’t a practical target for most people in my view.

For my $1,100,000 scenario above to apply, and have you retain 2% for inflation protection, you would need to earn say 4.00%+ gross, and this can now only be done with a portfolio dominated by property and shares (a significant increase in risk settings).

Given that fixed interest investments are the lowest risk option for aligning your assets and income with your probable spending future, do you have sufficient money allocated to fixed interest assets to provide you with substantial comfort (asset aligned with spending) in your base case financial future?

Remember that the lowest risk asset should be expected to deliver the lowest ongoing return. If an investor is to stand any chance of exceeding today's 2.00% (down from 4.00%) pre-tax interest rate returns they will need to consider come investing in items of additional risk.

Investments allocated to higher risks, such as property and company shares often deliver higher returns than interest rates, but so should they otherwise there is little point in accepting the higher risk profile (more volatile valuations).

I touch on returns for risk further down in this article for you.

If you happen to have accumulated more savings than $1,100,000 (up from $600,000) and you agree that $50,000 is a workable annual rate of spending, then you have the luxury of being able to consider more investment into higher risk assets (such as property and shares). This, in turn, should support more luxuries and discretionary spending (virtuous circle).

You may have deduced that once savings exceed $530,000 (near surety of $20,000 spending per annum for 35 years) an investor opens the door to the potential for some higher risk investing (an expanding tolerance for risk), and hopefully higher returns, on the balance of their savings.

Theoretically one reward for a high savings rate during one's working life is the virtuous circle of being able to invest in some higher risk assets and thus receive a higher average rate of return than a lower risk investor. (double down on this lesson for grandchildren)

Risk tolerance is a scientific question relating financial capacity, not an artistic question relating to emotional conclusions.

So, the more money you save, either the higher your investment risk tolerance can be, or the more you can spend, or both if it is managed carefully.

You sometimes read that the young should always take higher risk investment positions, which I agree with; this relates to the time they have to recover from errors, and initially the modest scale of the funds placed at risk relative to that time factor.

I do not wish to say that a portfolio of below $530,000 for a retired person should not include property and shares, it probably should, given the relative returns, but it does mean that a smaller portfolio should be managed with relatively high levels of care and attention. (and financial advice!)

As ever, a portfolio should try to minimise the impost of annual fees because a 1.00% annual management fee raids $5,300 per annum from a $530,000 portfolio, which may only be earning about $10,600 per annum income (pre-fees). (You can see where most of the reward for risk finishes up from your portfolio if fees are high)

Allocating savings to higher risk investments is an imperfect science and requires various perspectives before making decisions, complicating the process of reaching conclusions. Defining investment rules with your financial adviser is critical to this decision-making process.

I am thinking of Albert Einstein as I say that; an item is only moving fast if it is considered relative to a stationary object (perspective I) but not if considered relative to another moving object (perspective II).

Linked to my comments above about higher returns being available from higher risk investing I came across a very useful table of data on Vanguard's website.

Plenty of fund management businesses will direct you to data about greater returns from higher risk investment over time, but usually their time scales are 12 months, 3 years, 5 years and if they have done OK as a brand they'll display a 10 year measure, but the Vanguard data went back to data post 1926 (until 2018 as I have not refreshed the data).

90 years, crossing an enormous range of major political and financial events is surely enough to validate the performance reporting.

The relativities will remain the same in the post Covid19 era, but the nominal returns will be much lower for many years.

Vanguard combined property into their 'Shares' label so I cannot differentiate tangible property performance from business performance, but I suspect these two have a low enough coefficient (properties are rented by successful businesses, plus government) to accept this combination.

Vanguard then displays a migration of risk taken form 100% fixed interest (deposits, bonds) through various blends

The tables show the following results:

Average return, Best Year, Worst Year and Number of years with a loss.

I have displayed a few of the data sequences here to display that over long periods of time that the diverse portfolios of increased risk delivered higher returns.

100% Fixed interest investment:

Average annual return    +5.4%

Best year (1982)           +32.6%

Worst year (1969)          – 8.1%

Years with a loss           14 of 92

You can be assured that the 'average' result in this category will decline over the next 5-10 years.

70% Fixed interest and 30% shares:

Average annual return     +7.3%

Best year (1982)            +28.4%

Worst year (1931)          –14.2%

Years with a loss           13 of 92

50% Fixed Interest and 50% Shares:

Average annual return     +8.4%

Best year (1933)            +32.3%

Worst year (1931)          –22.5%

Years with a loss           17 of 92

30% Fixed interest and 70% Shares:

Average annual return     +9.3%

Best year (1933)            +41.1%

Worst year (1931)          –30.7%

Years with a loss           21 of 92

100% in Shares:

Average annual return   +10.3%

Best year (1933)            +54.2%

Worst year (1931)          –43.1%

Years with a loss           25 of 92

It would have been very useful if Vanguard had published average annual volatility in value of each subset above to expose you to the swings in wealth that you’d need to tolerate from them, if chosen.

Viewed through this long-term lens (perspective for Einstein) you can clearly see the rising returns alongside participation in higher levels of risk.

Frankly, that's a relief to see it proved over a very long period; it wouldn't make sense otherwise.

You can also clearly see the impact of more volatility when investing with more risk through larger loss proportions and more years when losses in valuation were experienced.

I found the fact that the best and worst year were often in the early 1930's revealing. 1982 showed up a couple of times.

Regardless of the very sharp decline, and then rise, for share markets during Covid19 influences, 2020 may not even show up as an exception for calendar year data in the Vanguard series when we look back, which would be remarkable.

Years that incurred a loss were a quarter of the time or less, and typically were only 1/6th of the time all the way up to the inclusion of 50% in shares.

Vanguard's research showed that in the last 50 years, equity returns (shares) remained positive during 10 out of 11 previous rate-hike periods. This time may be different, of course, but market timing is the wrong strategy. (Vanguard)

It is worth re-reading that paragraph.

We make a lot of noise through headlines across the 'share my thoughts in a Nanosecond' internet but none of the best and worst years feature in the era of the internet (since 1989).

Maybe the internet's speed of information sharing smooths out market volatility, in a similar way to Exchanged Traded Funds surprisingly supporting market liquidity, rather than the opposite, which they have impressively done again during Covid19 volatility.

Transport yourself back to the top of this article, helping people understand the level of savings they may need in retirement, and based on the scale of those savings when they might consider introducing higher levels of average risk in the pursuit of higher average portfolio returns.

If you are to spend your capital in retirement, which represents a sequence of future liabilities (spending), then having a relatively high proportion of fixed interest investing makes sense, until those savings exceed $530,000.

Thereafter (or a little prior) an investor should be considering inclusion of some property and shares investing in a portfolio.

The greater one's savings, or the time available, the greater the potential for accepting these higher investment risk proportions within the portfolio.

For the record, in the current share market, I am not encouraging readers to simply go out and take more risk. I am however, again reminding them to have a personal investment policy to manage your money against and yes, that it should have exposure to property and shares investing (and to get financial advice).

If all your future spending plans are covered by part of your savings pool, maybe you will discover that you are underinvested in terms of risk and the remainder of your savings can and should be applied to investment with a higher level of risk.

Now that you are being told to expect interest rate returns below inflation, this too will impact on your investment allocation decisions.

Whilst many people don't like the thought, all of the investors considering the above will also have a debt free home and home equity release businesses provide another assurance that you can access additional spending money if the unintended happens and the savings pool runs out. This is yet another reminder of a person's capacity to pursue some additional returns via higher risk profiles.

The sharp decline in investment returns over the past two years makes it a certainty that more people will be forced to spend some capital in retirement.

I hope your retirement spending plans are well financed, I hope you have a good set of investment rules, I hope you can see that accepting some additional risk often delivers additional returns and I hope you are receiving financial advice (from us).

 

 

Ever The Optimist

Fonterra, and other milk processors, predict higher milk price payouts for the year ahead.

Our primary industries are again going to remind us that they are critical to the financial success of this lucky country.

Seminars

 

OUR seminars are now all but finalised. 

Please check dates and times, as some have changed.

Any client or investor wishing to attend is asked to email us with their numbers attending. There is no charge. We need to know approximate numbers to ensure we have an appropriate-sized venue.

Kapiti – Southwards Car Museum

Tuesday, August 4at 11am

Wellington – Wilton Bowling Club

Wednesday, August 5 at 11.30am

Christchurch – Burnside Bowling Club

Monday, August 10at 11.30am

Timaru – Sopheze on the Bay, Caroline Bay

Wednesday, August 12 at 1.30pm

Albany – PLEASE NOTE CHANGE OF VENUE – Fairway Events Centre, 17a Silverfield, Wairau Valley (beside Takapuna Golf Course)

Tuesday, August 18at 11:30am

Auckland – Mt Richmond Hotel, Mt Wellington Highway

Wednesday, August 19 at 11.30am

Tauranga – Hotel Armitage

Monday, August 24 at 11.30am

Palmerston North – Distinction Coachman

Monday, August 31 at 11.30am

Napier – Napier Sailing Club, Ahuriri

Tuesday, September 1 at 1.30pm

Nelson - Beachcomber Motel, Tahunanui

Monday, September 7 at 10.30am (limited seats) and 2pm

 

Travel

 

Edward will be in the Wairarapa on 6 August and Napier 13 August.

Kevin will be in Ashburton on 19 August.

Please let us know now if you would like an appointment in your town.

Michael Warrington


Market News 20 July 2020

 

Mike writes:

 

Over the school holidays I decided to head South on a research trip, with most of our time spent in Queenstown, trying to learn about the new tourism business landscape.

Like you I was curious to discover how small businesses were actually getting on; tired of the headlines of doom.

What follows is a little like an extended Ever The Optimist.

The first observation was how much traffic is again travelling on all roads. The roads of the South are typically free flowing relative to the North but they were busy everywhere we went.

Queuing for petroleum again. Really?

I had hoped to find it easy to get in and out of Queenstown and to find car parks wherever I stopped, but this was simply not the case. Just getting out of side roads onto SH6A was the same old exercise in frustration that I remember from recent years.

Each time we headed out to dine, or consider shopping, we generally encountered relatively busy businesses. 

When I asked business owners, or managers, how business was truly going the answers were a mix of 'good enough' or 'very good'. All knew they were dealing with new, unknown data as they approach each month without international tourism but they were pleased with what they had experienced post lock down and were energised by the volume of sales during the school holidays.

I talked to other travellers who had visited places off the beaten track, including places as large as Te Anau and they reported some 'closed' businesses and much slower activity levels.

It seems that 'spillover towns' and without wanting to be rude, 'B grade' business outlets are indeed experiencing sharp declines in business activity. International travellers visited these 'spillover' locations more often than local travellers who predominantly focus on the 'jewel' locations.

Actually, 'jewel' businesses may well be OK too. We stayed at a special place out of Twizel, with an above average price point, and they have been relatively busy since Covid19 Level 2. Great news.

B grade businesses rely on an excess of consumer demand and lower pricing. When demand falls as fast as it has these businesses will find survival very difficult unless they run on 100% equity and have alternative sources of income.

These business owners have many difficult decisions ahead of them, including plans to maintain their business assets whilst dormant, or partially dormant, and also find ways to cut costs!

However, I was reminded yet again, after a lifetime of visiting Queenstown that it is a jewel and all jewels across NZ will continue to attract demand, as will other premium service providers.

Queenstown has always experienced cycles between 'boom and bust', insulated over the past decade due to the steep increase in international tourism, but it must now manage to typical economic cycles again.

I appreciate that my research was being done during the school holidays but I lost count of the number of flights coming and going at Queenstown airport.

The paths were packed with pedestrians. You could not just stumble in to your restaurant of choice without a booking. Ferg Burger had its long queues again (albeit not late into the cold nights). The ski fields were packed (top four car parks full). We often had to give way on the mountain bike trails.

People were bungy jumping in the cold! (The $10m from the government is a gross waste of money and a poor decision on their part - Ed)

I thought pricing in shops would have offered greater discounts than they were. I'm not clear whether this spells lower inventories than I'd have guessed, or that most are homogenous product lines so shifting inventory around the country is simple but I didn't sense an urgency to do special deals.

Maybe Queenstown businesses are doing what they should; sell as much as possible at normal pricing to those who can afford to travel here during each school holiday and then discover ways to run a lean ship outside of NZ holidays seasons?

They should all take a lead from Air NZ with its rapid moves to reduce the scale of business until they discover increased consumer demand as each year passes.

The rebuild to happier business levels will certainly take years.

Greg Foran thinks 70% of old scale is the best he can expect for Air NZ. Queenstown businesses should thus plan for the same, or less to be a little conservative. Businesses in areas that are not ‘jewels’ should prepare for less tourist driven activity or be sure to market their point of difference loudly.

As Marie pointed out, many businesses will need to re-learn what Kiwis like to buy, which differs from the fast moving well financed international tourist.

As long as businesses aren't hanging out for a return to 2019 levels of business (not a credible expectation) they definitely have the opportunity to operate good businesses under new conditions.

All in all though, I was surprised by the high number of people moving around and actively participating in the local economies that we visited. I would go so far as to say I was selfishly disappointed that so many people were 'getting in my way' but in truth I was very pleased for the local businesses.

Kevin Writes:

 

The current sharemarket rally, or rebound, has been described as a tug-of-war between market scepticism and the fear of missing out and this seems like a fair analysis to me.

Globally, share markets seem disinterested in real economic data and outlooks, rising unemployment and a global pandemic which is not yet contained.

One of the main drivers of this disconnect is of course low interest rates and the only change likely here is even lower interest rates going forward.

As we observed in the decade following the global financial crisis low interest rates, excess liquidity, and tighter credit conditions, which all accompany economic downturns and recessions, favour the wealthy and result in misallocations of investment into shares and property.

Although another leg-down in global share markets would not surprise, any price weakness is likely to be met with strong investor interest as the search for alternatives to falling bank deposit rates intensifies.

Deposit rates at all NZ's major trading banks are now sub 2% p.a., across all long terms and is below 1.00% for short terms.

Residential property markets are yet to tank, as some predicted, and are being supported by low borrowing rates, a long-term supply/demand imbalance and by the government wage subsidy and mortgage and loan payment holidays.

The worst is possibly still to come for areas that rely heavily on either tourism or immigration although the flood of inbound Kiwis who have decided that New Zealand is the best place to be, for the time-being anyway, could take the place of immigrants in supporting our economy and housing market.

Mike reported meeting a variety of international people with residency visas who were very happy to remain in NZ for as long as possible.

Owning a rental property or two to support themselves in retirement has been a popular choice for many New Zealanders and with nearly half the population living in rental accommodation and it has proven to be a reliable way of building a retirement nest egg.

I was therefore disappointed, although not surprised, to see a Bill making its way through Parliament that effectively caters for poor tenant behaviour.

The Bill, if passed into law, will make it very difficult for private landlords to end tenancies for disruptive or antisocial tenants.

Although badly behaving tenants only make up around 2% of all tenants this still amounts to about 12,000 tenants and is yet another example of NZ lawmakers trying to accommodate bad behaviour rather than improve or eliminate it.

Our justice and welfare systems fall into this same weak and overly-accommodative category in my opinion, with both systems falling well short of most law abiding and hard-working New Zealander's expectations.

---

Even though closure of the Tiwai aluminium smelter seemed inevitable the actual event caught the market by surprise and following the closure announcement the market wiped $3 billion off the market value of the five NZX listed power companies - Meridian, Genesis, Trustpower, Contact and Mercury.

The five, large, vertically integrated generator/retailers control over 90% of NZ's electricity generation and 86% of the retail electricity market.

Despite several years of uncertainty around the smelter's future share prices for the big 'gentailers' reached record levels last year as more and more investors went in search of reliable dividend income in a falling interest rate environment.

The big question for investors now is whether this is a good time to buy or a good time to sell. (a great time to seek financial advice services – Ed)

When researching for a recent article on the electricity sector I found a lot of material from credible sources on potential closure scenarios, and who might be the winners and losers.

I was very surprised by the varying opinions of industry experts and took this to mean that no-one was quite sure how it would all play out.

One area they did all agree on was that a disorderly exit would be very bad for all parties so it's encouraging to see key stakeholders already taking steps to try and avoid this scenario.

Rio Tinto's decision making has clearly been 'disorderly', and frankly not in good faith, which sets the playing field for future responses to them from our government and Meridian Energy, including the monitoring of the site clean-up and slag removal agreements.

I believe that despite potential for short term disruption demand for electricity is set to increase significantly over the next 2-3 decades and the electricity sector has proven to be very efficient at managing supply and demand imbalances in the past, so any market disruption will be relatively short-lived.

Many of NZ's major industries, including dairy giant Fonterra and our hospitals and schools, still burn coal for heating. Surely, they can now be encouraged to make the change to electricity.

I liken the monopolistic position of the big power companies to that of the major trading banks and believe that given time they will adapt, remain profitable and retain their place as reliable dividend payers.

---

Supermarket fuel discount vouchers have always appealed to me so as a small Z Energy shareholder I am pleased to see them re-enter this space.

Z withdrew supermarket fuel vouchers in 2016 in an overhaul of its loyalty offerings and hindsight suggests that this might have been the first of many bad decisions which has seen its earnings and share price steadily decline in recent years and its dividends disappear altogether.

It might be no co-incidence but 2016 was also the year when Infratil sold its remaining stake in the business, and booked a 400% return in the process, after having bought the former Shell NZ assets in a 50/50 joint venture with the NZ Superannuation fund when markets were still reeling from the global financial crisis.

Shell had always been a 'price leader', particularly in leading the price down, but when Z bought Shell's distribution and retail businesses in 2010 they abandoned this price leading strategy and allowed the industry to enjoy much higher margins.

Z's main competitors – BP, Mobil and Caltex (now owned by ZEL) – also reaped the benefits and margins at the pump doubled in a few short years.

These were good days and Z rewarded its shareholders with attractive dividends and a share price that more than doubled within 3 years of listing on the NZX in 2013.

Inevitably more competition arrived and eroded the inflated margins but Z decided on a strategy of protecting margin at the expense of volume.

History shows that as Z stood its ground and tried to retain margin the smaller players led by NPD, Gull, and Waitomo took prices lower securing meaningful market share and establishing themselves as serious sector participants.

Consumers sent a clear message that price was the key driver, not loyalty, convenience and customer experience, but Z was too slow to react and a succession of earnings downgrades followed.

Because Z provides a nationwide network as opposed to selected sites, like the smaller players, its overhead costs are much higher but its poor recent performance seems to be largely the result of poor management and governance and probably taking too much for granted after a long period on the pigs back.

Pleasingly it seems they now have a new strategy which involves leading on price, not just up but price leader on the way down also. My supermarket voucher seems to be further evidence of this.

Z controls more than 40% market share of retail volume and following its recent capital raise and the disruption in the retail fuel sector caused by Covid19 what better time to use the strength of your balance sheet and dominant market position to put the pressure on your competition.

Z and the other big energy companies should be able to take price war pain much longer than the smaller companies, plus it should help repair their poor brand profile of being greedy and the dearest in town.

In respect of their shareholders I think they have a responsibility to suspend all staff and executive bonuses until dividends resume. 

---

Seminars

OUR seminars are now all but finalised. Please check dates and times, as some have changed.

Any client or investor wishing to attend is asked to email us with their numbers attending. There is no charge. We need to know approximate numbers to ensure we have an appropriate-sized venue.

Kapiti – Southwards Car Museum

Tuesday, August 4at 11am

Wellington – Wilton Bowling Club

Wednesday, August 5 at 11.30am

Christchurch – Burnside Bowling Club

Monday, August 10at 11.30am

Timaru – Sopheze on the Bay, Caroline Bay

Wednesday, August 12 at 1.30pm

Albany – Albany Executive Motor Lodge, Corinthian Way

Tuesday, August 18at 11:30am

Auckland – Mt Richmond Hotel, Mt Wellington Highway

Wednesday, August 19 at 11.30am

Tauranga – Hotel Armitage

Monday, August 24 at 11.30am

Palmerston North – Distinction Coachman

Monday, August 31 at 11.30am

Napier – Napier Sailing Club, Ahuriri

Tuesday, September 1 at 1.30pm

Nelson - Beachcomber Motel, Tahunanui

Monday, September 7at 11.30am

---

Travel

David Colman will be in Palmerston North on July 22.

Edward will be in the Wairarapa on 6 August and Napier 13 August.

Kevin will be in Christchurch on 6 August and in Ashburton on 19 August.

Please let us know now if you would like an appointment in your town.


Market News 13 July 2020

When I was a young(er) new entrant to financial markets investment bankers (Mike Milken in particular) used the description 'Highly Confident' relating to their belief in getting the deal done.

Today the US Federal Reserve prefers to use the description 'Highly Accommodative' given the need to support today's lack of confidence.

The Fed coined another contemporary description too, aimed at the banks: 'Inappropriately Optimistic'.

The irony here though is that because of the excessive flood of cash coming from central banks, investment bankers are probably still telling borrowers they are 'Highly Confident' of being able to issue bonds and borrow money for them!

INVESTMENT OPINION

Online Business – Field Days online?

Of all the online service replacements I have considered since March, pondering how the way we operate might change, this one seems the most challenging to me.

Being online is not like being in the field.

A variety of famers I know do indeed have a smart phone but they do not view the 'cloud' as the place where proper discovery and agreements are made.

Take a look at the offering if you're curious - https://www.fieldaysonline.co.nz/

I wish them well, but I hope they are back at Mystery Creek by 2021.

Price Manipulation? – Some of you will laugh at my use of a question mark, always suspecting that the largest players in a variety of sectors manipulate price outcomes.

There are plenty of cases in history that help to form your presumption.

Did Meridian Energy and Contact Energy manipulate the wholesale price of electricity in December last year for their own benefit and to undermine the electricity retailers who do not generate their own electricity?

The Electricity Authority has decided that they did, formally describing that an Undesirable Trading Situation (UTS) occurred.

I guess this industry regulator doesn't like using the more robust term of 'manipulation'.

You won't have witnessed the UTS event for NZ electricity pricing, but it broadly undermined the pricing you should be receiving for your electricity at home.

Small electricity retailers like Flick Electric and Electric Kiwi try to bring you better retail pricing by charging less relative to the wholesale electricity price, purchased from the market (not generated themselves).

If the wholesale price suddenly rises to be the same as the retail price paid by (in this case) Meridian Energy (MEL) customers there is no pricing margin to enable price competition.

MEL is indifferent to the margin between wholesale and retail pricing because it collects revenue from both generation and retailing, when one falls the other rises.

This is one reason the EA exists, to ensure the market is not manipulated and competition can occur.

If I was a member of the EA I would have been disappointed to witness the MEL and CEN share price increases following the publication of their findings.

Is the market determining that EA has no teeth, or that their findings validate the financial dominance held by the gentailers in the electricity sector? (a timely opportunity to refer you to Kevin Gloag's research item on the sector).

The EA may issue a punishment once a final determination is made, but this won’t bring back the competitive retailers who have been squeezed out of business in the meantime.

Politics – Covid-19 is constantly claiming all the major headline slots, and it is indeed very disruptive to economies, but longer-term problems are developing in global politics and its mix of long-term influence and undesirable outcomes will cause greater damage to the global population.

Vladimir Putin claiming the right to govern Russia until 2036 is one absurdity but given that China has a greater global impact at present Xi Jinping’s leadership will cause more damage.

China's behaviour with Hong Kong confirms its selfishness, and for me, it displays President Xi's lack of confidence in the wider Chinese population to make good decisions.

World history is littered with examples of greedy, egotistical people who thought they knew what was best for others but, ultimately, they did more damage than good for their nation, and thus their people.

Hong Kong was an economic powerhouse with very wide participation from international business. In my view that has changed, rapidly, and Hong Kong will fall fast with respect to its role in international business activity.

Other nations will copy the UK lead and offer residency to the best and brightest wishing to relocate out of Hong Kong.

In the past, such business relocations often took many years to agree to and conclude but I suspect the changes for Hong Kong will happen much faster than that.

Businesses that choose to relocate will, in my view, need to contemplate how they'll operate at a smaller scale so they are undeterred by the inevitable business threats that will be made by China in reaction.

This political disruptiveness makes global investment decisions more difficult to make.

Strange concepts – Tesla is now more 'valuable' than Toyota, according to financial markets.

What an interesting response given that the price of fossil fuel for 'old' vehicles has plummeted to deep lows, which should have extended the life of manufacturing such vehicles.

Green Bonds – Financial markets are always alert to changes that may have an impact on reward for risk.

One of those changes is rising political support for the environment and the detrimental impact commerce has on it.

Historically a small number of investors shifted their investment choices to try and display to capital users that they would not support businesses causing avoidable damage to the environment. However, the majority of investors continued to focus on pure commercial return relative to risk and the 'green' lobby was thus diluted.

Today the regulators are trying again to introduce financial costs for poor environmental behaviour, but more effectively some of the world's largest investment managers are beginning to dictate terms about directing capital to more environmentally sound businesses.

The vast increase to the scale of Exchange Traded Funds has given these fund managers an unusually strong position for setting policy for the environmental standards required to attract new investment.

It will be an ironic outcome if commerce enforces more effective policies for the environment than government has ever achieved.

In recent years we have seen a huge increase in the issuance of 'Green Bonds' that present themselves as being aligned with environmental improvement.

Green bonds are said to be certified, presumably by a group of new businesses who follow the emergence of new regulatory demands.

During the past seven years green bonds have reached a volume reported as now being US$500 billion in size.

It will take years, but I'd be very keen to see a chart that aligns increased issuance of green bonds with some measurable outcomes relating to environmental improvement (not holding my breath – Ed).

Long before environmental performance of green bond funding can be measured well, I think you will see yields on green bonds differ from the others.

Green bond yields should be lower than an alternative of identical default risk.

A green bond return (margin over risk free bonds) should reflect the 'true' probability of default for such a loan.

Theoretically the return on a non-green bond with the same default risk and terms should be higher, to reflect the lower demand to provide funding to such businesses, not willing to respect the environment to an acceptable level.

These differences will be hard to spot, doubly so in a very small market like New Zealand, but we will do our best to highlight different behaviours and returns to you.

New Zealand does have green bonds on issue, with Argosy Property's issues being the most recent ones that you'll be familiar with.

The NZX now presents such bond offers with a green colour scheme to differentiate them from the normal blue colouring on their website.

Post Script: If you agree with me that measuring 'greenness' will be difficult, just imagine the difficulty of then measuring political correctness and fair treatment of all when approaching investment decisions!

Asset Allocation – Another interesting article I read from the US recently concluded that 'no change' was required for asset allocation given the current set of financial market and economic circumstances.

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

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

'Back then' real returns were available from fixed interest investing.

Asset allocation views are always evolving, tracking the evolving risk and reward scenarios but it was interesting to read one analyst conclude 'no change' following the Covid-19 disruption.

Having 45-50% invested in shares is common in the US, Australia seems to be higher, but this level tends to make Kiwi investors uncomfortable as they retain an acute focus on past volatility events.

It may be of interest for you to know ACC's asset allocation from the 2019 Annual Report:

Fixed Interest assets – 60%

Property and Shares risks – 34%

Cash – 6%

I doubt that these ratios have changed much by mid-2020 but the current journey into negative real returns from bonds must be having some influence.

I look forward to reading ACC's next asset allocation update.

We encourage clients to continue evolving their asset allocation rules with us.

Email Fraud – We all know this is a thing.

We often don't think it will reach us, but it does. We see some examples from clients each year.

The latest example was a person who started out emailing us correctly, but subsequent replies were being sent to the client by a person who hacked into the client's email.

The email address used to look like ours was subtly different.

The messages for you are:

Be very careful when assessing what is delivered to you in an email;

Test the content with common sense. If something seems odd it probably is and you should be doubly careful;

If odd, call us by telephone to discuss. This would immediately confirm whether or not our staff issued the email (and if still odd the person here can explain themselves!);

Save our bank accounts (trust account and company account) to your trusted bank customers list. We will never change our bank accounts. If a hacker pretends to be us and presents a different bank account to you for payment IT IS A SCAM (this appears to be the method that caught out Team NZ);

It is sad to say, but you must approach most email traffic from a sceptical perspective until confirmed as normal.

Tiwai Point - so, Rio Tinto has decided to stop riding the wave of subsidies provided by the tax payer (electricity price and Covid-19 employee support).

Good.

Now New Zealand can get on with reallocating this hydro-electricity resource widely across our economy.

Surely this will now accelerate Transpower from its lethargy with respect to increasing the capacity of the grid from Roxburgh to Benmore and thus on to the North Island.

We will comment further over coming weeks.

TRAVEL

Edward will be in Albany on July 28, The Wairarapa on 6 August and Napier 13 August

David will be in Palmerston North on 22 July.

Kevin will be in Christchurch on 6 August and Ashburton on 19 August.

Please let us know now if you would like an appointment in your town.

 

Planning for the seminars we will hold in ten cities is now taking shape, with some venues confirmed. We urge clients to contact us now if they plan to attend.

The current status is:

Kapiti – Southwards Car Museum – Tuesday, August 4at 11am

Wellington – Wilton Bowling Club – Wednesday, August 5 at 11.30am

Christchurch – Burnside Bowling Club – Monday, August 10at 11.30am

Timaru – Sopheze on the Bay, Caroline Bay – Wednesday, August 12 at 1.30pm

Albany – Albany Executive Motor Inn, Corinthian Way – Tuesday August 18at 11:30am (note change of date)

Auckland - August 17 or 19 - TBA

Tauranga – Hotel Armitage - Monday, August 24 at 11am

Palmerston North – Distinction Coachman – Monday, August 31 at 11.30am

Nelson - Beachcomber Motel, Tahunanui – Monday, September 7at 11.30am

Napier – Napier Sailing Club, Ahuriri - Tuesday, September 1 at 1.30pm (please note change of date).

 

 

Thank you.

 

 

Mike Warrington 

 


Market News 6 July 2020

With a friend's wedding in the UK being cancelled I have placed you front of mind and am heading off on a research trip to Queenstown instead.

I'll let you know what I see and hear.

INVESTMENT OPINION

Central Bank or Black Hole? – It is most definitely illogical, although not impossible, for a central bank to provide almost all lending to an economy and, as Japan is attempting, for them to also own a good proportion of the economy too.

China and Russia may well be sitting concluding that we capitalists and democracy lovers are gradually coming around to communism after all with a Trojan Horse called a central bank and an unwanted virus.

Originally, I had hoped that New Zealand and Australia would choose not to play, refusing to offer these centralised ownership and lending facilities, and progressively see the wealth of our economy advance relative to other nations.

It took many years before nations followed the Japanese central bank's example of borrow and buy everything but just like jumping into a pool fully clothed, once the second and third people jump in the rest have joined within seconds.

Maybe central banks see themselves as the financial equivalent of the Waikoropupu Springs, the source of the monetary stream, and if they simply increase the flow banks will steer the additional funds into productive parts of the economy.

When this didn't happen, because banks rightly refused to loosen their tried and tested risk measurement practices, frustrated government representatives and central bankers moved 'downstream' and established business relationships with actual borrowers and equity capital users.

So, a central bank lends directly to a business; no conflict of interest to see here, right?

At this stage I am pleased that our Commerce Commission hasn't sought Resource Management Act approval to build a new electricity lines business in Auckland, launch a new media business and develop a second international airport in Wellington.

Given our central bank's lead with involvement 'in' the economy can you not imagine a more active Commerce Commission too? (with Xi Jinping as a commissioner – Ed)

Dr Bryce Wilkinson explained recently that borrowing to buy everything is not financially neutral but judging by client calls our readers' already know this – 'who is going to pay this back?' is the question you all rightly ask.

The next question should be – is it inappropriate that the tax payer owns all of these assets? (loans, bonds and shares)

And finally – isn't it a symptom of a wider economic sickness if this artificial support is required in such scale?

Even the well governed Australian economy, including the impressive services provided by its central bank is having experts like retired Treasurer Peter Costello calmly predicting that Australia's government debt will soon reach one trillion dollars!

I have progressively become blasé about each column on the abacus as my industry experience grows.

In the 1980's armed with my first thousand dollars the excitement of leaving hundreds behind was fun. At the same time my new job involved assisting clients with hundreds of thousands of dollars, 'unnecessary at this point', parked in call accounts.

This was something for a saver to aspire to.

Millions were, for the most part, a thing of business not personal account. Billions weren't referred to.

When billions reached my lexicon for some of our business activities in the 1990's it seemed enormous, for a while, but until recently rising another thousand-fold to the point of trillions wasn't expected to happen during my career.

Economies weren't growing fast enough.

Now the value of Apple, Microsoft and Amazon exceed one trillion and the US government operates in tens of trillions of debt. Other nations are in a hurry to print their way to join the trillion club as soon as possible, erroneously thinking they will lose relevance if they only talk in billions at high level meetings.

We are not hearing about early descriptions for how to slow, then remove this vast cash injection into capital markets. At this point the direct opposite is happening; central banks continue to out-headline each other with ever larger promises of additional cash being added to the global system.

Yes, regardless of the supplier the flood of cash has a global impact; unwanted US dollars quickly leave the US in pursuit of the best possible risk adjusted returns.

Perhaps the New Zealand central bank should allow the yield on NZ government bonds to rise back up to about 1.00%, from 0.50%, so other international investors would be more willing to lend money to our government (relative value) reducing the need for our Reserve Bank to print money and buy our own bonds (artificial).

Are grossly inflated central bank balance sheets really a new viable leg in the monetary policy tool belt or are they Black Holes that will create an inescapable vacuum that mere mortals cannot unwind in an orderly manner?

I see the Reserve Bank has re-titled its monetary policy efforts. They are no longer called Official Cash Rate reviews, acknowledging that this is becoming a smaller part of the committee's discussions.

The title has appropriately become Monetary Policy Review.

Will it become a Black Hole Review in the future and require an astrophysicist be appointed to the committee?

I genuinely do not think I will witness an answer to my Black Hole question during the balance of my career, which implies that the future impact is unimaginable, at this point.

Refer again to Kevin Gloag's recent article to understand what this means for investors near term.

Big New Flag – Related to the monetary manipulation by central banks described above an obvious flag now exists for investors to watch out for in the years ahead; the point when central banks begin to sell their ocean of bonds back to the free market.

Surely central banks will want to reduce the scale of their bond holdings prior to any attempts to increase official overnight interest rates.

Why would they begin to press interest rates higher prior to such bond sales, they would be causing instant damage to the taxpayer wealth (higher interest rates deliver lower bond values).

The central banks would of course be front running themselves with the ultimate in insider information and it would draw no political flack at all.

Don't interpret this as a warning of rising interest rates. This particular flag hasn't even been designed yet, let alone run a public campaign for its acceptance (bring back Laser Eyed Kiwi – Ed).

The notion of selling central bank held bonds and then increasing interest rates probably doesn't happen in the next decade, sadly, so all of your current fixed interest investments will likely have matured and been repaid prior to any change in policy.

Mind you, I'd be more than a little wary about buying 20-30 year bonds at today's yields. Given that interest rates are structurally a combination of inflation plus a marginal reward for risks it is improbable that they will stay below inflation for such extended periods of time.

Deflation is a chance, sure, but this idea isn't sustainable with so much money being spread around.

Fortunately you cannot access such a long duration in the NZ bond market so you're not forced to contemplate such valuation risks, nor convexity risks (a term for the bored to look up – Ed)

It is a risk for the younger investor to watch out for once it finally arrives on the horizon.

It will bring quite the change to investment rules.

Yields – Did you observe how quickly our market yields travelled from stable, to fearful and back to bullish?

In February, prior to Covid19 disruption yields on most senior corporate bonds yielded between 2.50% - 3.00% alongside returns on bank deposits, (yields on subordinated bonds were near to 4.00%).

In the midst of the Covid19 sponsored financial fear all bond yields rose sharply; senior bond yields reached 3%-4% (5% for Wellington Airport) and subordinated bond yields increased to 5% - 7%.

Sky TV senior bonds traded at 50% as some forecast a reading of the last rites.

By May bond yields were settling back to the old February levels.

Now, in June, the yields are:

Senior corporate bonds: 1.50% - 2.10%

Subordinated bonds: 3.00% - 3.75% (excludes troubled entities such as NZ Refining); and

Sky TV raised new equity and now its bonds trade at 4.50% (Price $1.01 again) with nine months remaining until maturity having again become reassured about repayment.

Bank term deposit rates are below 2.00% and heading lower in my view.

Regular readers may remember my excitement when bond yields rose well above returns on bank term deposits, but sadly this opportunity only lasted a matter of weeks.

I think this situation is indicative of what to expect from the period ahead of us (balance of 2020), meaning that the market will continue to demand quick decisions from participants.

Working from the foundation of an investment plan, with financial advice, will help you to make quick decisions when called upon.

No Guidance – in the world of 'Continuous Disclosure' obligations from companies to stock exchanges the most common announcement is 'no guidance offered'.

I'm not sure whether businesses are saying 'sorry we do not know' or they are using the Covid19 aegis to avoid publishing information they'd rather didn't reach competitors until the last possible moment (formal reporting obligations).

This reduction of information increases risk for investors, which should in turn should see us demanding higher returns (lower purchase prices).

The fact that this expectation (lower prices) is not happening is another behaviour change that can be linked back to 0% interest rates as the opportunity cost; a lack of disclosure is tolerable when 0% return is the alternative.

Piloted by Private Equity – Typically our longest lasting airlines have been government owned, or controlled, providing a link to both economic importance and to deep pockets when conditions became financially challenging.

You can see this clearly right now in our region:

Singapore Airlines, Qantas and Air New Zealand all have robust support and will continue into the future.

By contrast Virgin Australia was placed into Administration barely four weeks after Covid19 lockdown began.

Now it seems that Virgin Australia will return to the sky under Private Equity ownership which will deliver aggressive management style to the airline business. (Bain Capital was announced as the successful buyer shortly after writing this note).

I am no fan of providing equity or debt funding to private equity businesses but in this case there may be a silver lining for consumers because Virgin Australia will place immediate price pressure on the likes of Qantas and Air NZ with respect to airfares.

This is something all consumers need to see to minimise the near monopoly position the two home airlines would otherwise have.

It doesn't represent a new 'worry' for Air NZ shareholders in my view. We already have plenty to worry about! I am certain that Greg Foran and the Air NZ board will be closely tuned into the influence of the Virgin Australia future business model.

EVER THE OPTIMIST

The NZ government is going to try 'virtual APEC'.

ZOOM for leaders is a novel idea, but I suspect the novelty will wear off and its greatest value will be confirmation that face to face is a better way for society to interact.

Investment Opportunities

Sky City – Share Purchase Plan (SPP) was completed last week at $2.50, raising the additional $50m sought by the company from its retail investors.

SKC is now re-financed with an additional $230 million, sufficient for the foreseeable period of Covid-19 disrupted activity.

Who shall be next?

We typically broadcast news of these offers by email to our INVESTMENT OPPORTUNITIES group, if the public can participate.

If you are not already on this list, and wish to be, please add yourself via this link: https://www.chrislee.co.nz/newsletters

Be sure to check the 'Investment Opportunities' box is ticked.

Thank you.

TRAVEL

David Colman will be in Palmerston North on July 22.

Edward will be in Auckland (Remuera) on July 27 and Albany on July 28

Please let us know now if you would like an appointment in your town.

Thank you.

Mike Warrington


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