Chris Lee & Partners Ltd

Market News 28 June 2021

Westpac Group has decided to retain its 100% ownership of Westpac NZ.

This review was so prompt that it was either a negotiating tactic with our central bank, in response to new regulatory tensions, or it is a lesson to our government for what a serious review really looks like, and the tight time frames involved.

INVESTMENT OPINION

Bank equity – speaking of the banks;

Increasing bank equity to satisfy our central bank governor should be a simple exercise based on this new information:

‘The banking sector has made more money than ever thanks to the housing boom’.

So, one part of government (financial stability) will be pleased, whilst other parts of government will be mortified.

Welcome to the difficulty of balancing two eggs on a dessert spoon.

Meanwhile, in the US, the bank regulator confirms that following stress tests their banks have been given a clean bill of health (financial integrity etc) and thus have been approved to return to paying dividends and/or stock buybacks on market.

Investment Threats – I often find myself staring into space wondering about issues that influence investment markets and ways to navigate them in future, because everything about our pending returns will happen in the future.

Last week I was pondering what some of the greatest threats are to that investment performance and I concluded that ‘’extrapolation’’ and ‘’confirmation bias’’ were two of them.

I removed fraud and incompetence from the mix hoping that all licensed financial advisers would help clients avoid these two threats.

Some of you will be familiar with the risks associated with confirmation bias, being the behaviour of finding it easiest to spot evidence that supports your primary belief and to be clouded from recognising the importance of contrary evidence.

We all do this, and typically we all feel good about doing it because it suits our selfish needs to justify our strongest views. We clearly hope to be right, which unhelpfully plays into our egos and not into actual outcomes.

When we are correct, even though the chances of success may well have only been 50:50, it reinforces our brilliance and we become even more confident that we are on the right track. After one moment of success we think we are now a 75% chance of being correct even though at best the odds still lie between 50:50 (try flipping a coin) and maybe 60:40.

If the odds of accuracy are any higher, such as 80:20 then the scenario has already been priced into financial markets because it is visible to more than half the observers.

How many of you own shares in Meridian Energy, or Contact Energy and convinced yourselves in April that BlackRock was definitely going to pressure the share price lower when they sold down much of their holding from the Renewable Energy fund?

Many believers sold shares ahead of this date in the belief they would buy them back cheaper. The share price fell in the lead up and those calculating the index agreed change was coming, providing ‘’confirmation bias’’ to the early movers.

Yet when the time came the share price began to increase. Rather than fall to $5.00 Contact Energy’s share price rose to $7.

The share prices were clearly considered fair, or cheap, and large investors stepped in to the market to buy all of the shares (demand increased), removing the threat of a piece-meal assault on the share prices, which we had seen in January when the funds originally purchased the shareholdings.

In 2019 the NZX itself was one of the most unloved companies in the market. Some companies were moving their listing to Australia (ASX), some were being taken over and removed from the bourse and nobody seemed to be listing new companies.

Analysts and critics issued a rolling maul of assessments that implied the business was a dead man walking. This formed a repetitive sequence of confirmation bias for those who disliked the NZX as a business.

The share price felt very heavy at about $1.00.

Yet, if you looked at all the facts you discovered the following:

Their managed fund business (SuperLife and Smart Shares), with its recurring fees, was growing at nearly $100 million per month;

Their bond market activity was constantly expanding under the new ease created within the Financial Markets Conduct Act;

New people were employed to convince some of New Zealand’s impressive but scarcely known businesses, such as DGL (recently listed), to consider listing on the NZX to improve their access to capital for growth;

Covid 19 removed value for many businesses but it reinforced the value of NZX to companies for raising capital (even though the NZX share price fell again at this time);

The new CEO to the NZX (Mark Peterson) cut some costs that weren’t driving growth in the business, and removed some items that he felt didn’t belong in the strategy (capital efficiency);

The global trend by investors to migrate from active management to passive management through Exchange Traded Funds (Smart Shares locally) was now a dominant theme; and

Sharesies was launched and opened the door to hundreds of thousands of genuinely new investors to market participation.

Share market investors had been blinded by confirmation bias that the NZX had few redeeming features, but by early 2020 their error was being uncovered. Covid19 provided a temporary respite (in error) but since then the NZX share price has well and truly changed (increased) to reflect the points above, and the ongoing profits the business is making.

Looking backwards, through the share price chart, it’s actually now a surprise that the market took so long to clean the confirmation bias off its glasses and see the facts.

Long termers will remember that many good aspects of the current NZX business were driven the previous CEO, Tim Bennett.

You don’t have to look far to spot confirmation bias, it is all around us.

Stop for a minute and think of a few things that you are certain will be true that are affecting your investment decisions today.

Interest rates are definitely going to rise, right?

The planet will not be using fossil fuels for energy by … say 2030?

New Zealand will be using 100% renewable electricity by 2035?

Driverless cars will dominant NZ taxi/Uber service by 2030?

Global population will continue to expand at the current rate?

At least help yourself by trying to think of possible rebuttals to such beliefs, such as:

If interest rates must rise, why are long term interest rates falling again in the US?

Did you realise that the world does not have sufficient alternative energy sources to remove fossil fuels from the energy mix?

100% renewable electricity in NZ is not possible, without grossly over capitalising and building more resources than we permanently require (massive enlargement of Lake Onslow!) when for a small pile of coal (although it’s a large pile of imported coal at present – Ed), or a tank of gas, we can switch electricity supply on and off within a few minutes.

Work Safe obligations in NZ would undermine my confidence in owning a business where I wasn’t in control of the vehicle (driverless) but I was responsible for all outcomes;

Why would a rational couple have more than two children given the financial imbalances in place at present globally, seen immediately through the cost of accommodation?

The Chinese have been encouraged now to have three, but they seem to be sticking with plans for one.

The US birth rate has fallen six years in a row, now at 55.8 births per 1,000 women between 15-44 years of age, to the lowest ratio since 1909. Why would this increase given current financial, health and environmental settings?

This leads on rather nicely to the second major threat I thought about for investment returns; the folly of extrapolation.

The Oxford Concise Dictionary (Google? – Ed) defines Extrapolation as:

The action of estimating or concluding something by assuming that existing trends will continue or a current method will remain applicable.

I don’t mind the term ‘estimating’ at all. This is a very relevant behaviour for investors, looking into the future and trying to make decisions, now.

The trouble I have is with the ‘assumption’ part.

Assuming that existing trends will continue or a current method will remain applicable is where the trouble is to be found.

Wanting to believe in patterns is understandable, if you start with 1, and you gain another one each day, it seems logical to assume you’ll have 365 by year’s end.

However, risk and reward don’t follow such patterns, yet a huge proportion of the forecasts presented to you as investors are based in relatively simple extrapolation and the reliability of the factor used degrades with time, sometimes by the day.

Think about what you were told about housing prices in 2019 (up, up, up)… then during Covid19 (down, down, down)… and now (up, up, up).

Financial markets have methods and trends, until they don’t.

I am certain I have spoken previously about Long Term Capital Management, who became one of the world’s largest hedge funds (leveraged investors) in the 1990’s with enormous investment positions based on methodical financial deductions.

In 1998 methods changed and by 1999 LTCM was gone (if you’re a reader – When Genius Failed – Roger Lowenstein)

While I think you should respect some short term extrapolation because it is based on reasonably reliable data; Resene paint sales for 2022 will likely follow a similar pattern to 2021, but each algebraic move into the future (n+2, n+3, n+4…) makes the extrapolated forecasts less and less reliable (harmed by volatility and inaccuracies).

The NZ Initiative had a tongue in cheek look at the explosion of orange cone use in NZ. They took an estimated growth rate, extrapolated this into the future and predicted that all roads in NZ will be covered by orange cones by January 2025, and we will thereby all be safer on the roads! (And the death toll will decline? – Ed)

So, too much simple extrapolation is a threat to good investment decision making for you.

If you find yourself believing long term extrapolation and then only attaching supportive analysis and headlines to that belief, it is time to be more wary about your investment decisions.

Bank Bonds – When the BNZ recently issued $500 million of 5 year bonds at 1.884% some investors were surprised that the bank could borrow so much money at ‘such a low return’.

I assured them that the pricing was fair (at benchmark +0.60%), based on competitive tension, and frankly I was pleased the bank made the bond offer in New Zealand for us to access.

To reinforce the price and the risk of not seeing such bonds offered locally, the ANZ borrowed US$1 billion issuing bonds internationally at much the same price (+0.61%) including foreign exchange costs to bring the money back to use in NZ.

None of us like the rewards relative to inflation, but they are competitive.

Unintended Consequences – Did you see the TV item last week about the lack of rental properties in holiday centres such as Wanaka?

The rental agent confirmed that a huge number of family holiday homes, previously available for short term use by the likes of ski field staff, have been removed from the market.

The reasons given: risks associated with the new tenancy laws, and presumably costs to upgrade a property, that weren’t warranted by the temporary tenancies (assuming you could get the tenant to leave).

EVER THE OPTIMIST

LEGO has joined the efforts to recycle plastic and is to produce a series of blocks made from recycled bottles.

NZ should contact the company and offer to build them a manufacturing unit in Southland and supply it with NZ’s plastic bottle waste.

ETO II

It’s hard to believe, and is a huge credit to the management, that Qantas has said it is likely to report an underlying profit from operations over the past year.

It presumably excludes depreciation on furloughed aircraft but any measured profit from the airline industry is an outstanding result in the year that followed the emergence of Covid19.

ETO III – Vaccinations

Global Data:

Vaccinations doses delivered – 2.90 billion jabs

Some well populated countries are now rising above 60% for the first jab (UK, Canada, Chile) and many in Europe are well above 50%.

Large nations above 45% for the second jab include – Chile, UK, US, Hungary, and clearly Canada will join them in a couple of weeks.

60% vaccination is not the target for rapid herd immunity, but it closes the gap significantly and thus reduces the scale of ongoing pressure on health systems, and thus any future need for closures to economies.

Total (recorded) Corona Virus cases – 181 million

Active Cases – 11.5 million

Daily rate of new cases – 400,000

People in serious condition – 81,000

Daily Deaths – about 8,000

Investment Opportunities

Kiwi Property Group – KPG is ‘considering’ offering a new 7-year bond (‘green’), which they expect to ‘offer’ next week.

It will be fast moving, as they all are now. On previous deals KPG has paid the brokerage costs.

The interest rate will need to be above 2.50% to be competitive.

We expect the bond to be essentially the same structure as other KPG bonds (senior, secured, semiannual interest).

We have a list open for investors wishing to participate in this pending offer.

TRAVEL

Edward will also be in Nelson on July 8 and July 9.

Edward will also be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD).

David Colman will be in Palmerston North on 30 June.

Johnny will be in Christchurch on 22 July.

If you would like to make an appointment, please contact our office.

Mike Warrington

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Market News 21 June 2021

I see the United States of America is trying to win the rights to the 2027 Rugby World Cup.

The NZ Rugby Union should put all its weight behind making sure this happens.

Then spend a lot of time and money developing its marketing plan… www.allblacks.com, @allblacks, #allblacks

INVESTMENT OPINION

New Taxes – Tax working groups of recent years remind us that a population is willing to pay tax if its collection appears shallow and broad. I would add that simplicity demonstrably helps (think GST).

I think the current government is complicating matters and it will be detrimental to IRD (need more staff), to productivity (additional cost) and to the disadvantaged (the clever will successfully manipulate complex rules).

The new property taxes are already leading to discussions about exceptions to the headline (non-deductibility of interest). They will not be simple.

The new tax on vehicles (fossil fuels) will have unintended consequences.

Initially it will drive a huge sales increase for fossil fuel vehicles prior to January 2022 (good for investors in Colonial Motors and Turners Auctions, and the chance of a special dividend in early 2022?), and then also by extending the average life of the NZ vehicle fleet.

If one can't afford an EV, or use one for their vehicle purpose, then extending the life of an old vehicle has financial benefits.

The irony of the second point above is that this may be better for the planet (reduced mining) than trying to subsidise electric vehicles!

The manufacture of new EV cars is increasing, but it will not deliver sufficient numbers to us in the time frame that our government hopes, nor will EV pricing fall as fast as politicians are guessing. This makes ambitious EV targets impossible to achieve.

The G7, with its dominant economic influence, agrees to set policies that increase the use of zero emission vehicles, but they chose not to define a rate of change between now and 2030 and this consumer setting will influence global demand, which will map directly to the production schedules of the car manufacturers. New Zealand's preferences will not be considered at the board tables of the car manufacturers.

Being a small country is one of New Zealand's good fortunes, but it also makes us a price and product taker, not maker; we don't get to set the global rules.

For fun, when considering our level of global influence, I looked up some numbers – NZ GDP is roughly US$205 billion, but Toyota's annual revenue is US$275 billion.

This should put in perspective our influence in the vehicle marketplace. Toyota has more global influence on this matter than NZ.

Toyota cares about the planet, which can be witnessed in their early move to hybrid engines and ongoing assessment of global energy resources. Toyota is very capable of expanding its EV production, and will if forced, but they are focused on hybrid and think the political rush to EV is an error.

Toyota's lens is far longer than that of our government (all voices).

I view all of this (new taxes on cars in NZ) as complicating the NZ tax policy, which is a negative outcome and likely to direct more wealth in the direction of the few.

Almost frustratingly, our job is to help investors to dance out of tune with the new government policy to extract any possible financial gains from the situation. (short term special dividends referred to above?).

I'd bet that Toyota's annual revenue will rise faster than NZ GDP over the coming decade (not investment advice to buy Toyota!).

I would feel better about the government increasing the budget provided to the Crown Research Institutes with specific projects to assist industries with improving carbon and climate related outcomes (measurable).

China – Is China being 'Game stopped'?

If a collective of smaller investors can, against all expectations, drive up the share price of a business that others thought would fail (Gamestop), can a similar political collective change the supply/demand dynamics of global commodities?

OPEC I hear you say.

Now, in the face of China trying to artificially suppress the Australian economy, the price of iron ore needed for steel making has doubled and since President Xi Jinping has forced Chinese commodity users to reduce demand, the price has…. gone up again.

''Go on, have three children''. No thanks.

''Stop buying iron ore from Australia''. If we do, we might lose supply access for those projects you are insisting on (there's a shortage of renewable energy in China, for example).

While China is trying to reduce such demand, the rest of the world seems to be directing a portion of the trillions in fiscal spending into new infrastructure projects. (Are you referring to the cycle bridge – Ed)

Hey wait, Mr Xi, maybe this global fiscal push strategy has something to do with the rising price of iron ore?

Or maybe other political leaders disagree with China's tactic of having state media declare they will 'send Australia into a wintry economic period by wiping $81 billion from their economy' and others are placing additional buy orders with Australian miners?

The UK has just signed a new trade agreement with Australia, in what looks like a record time for a negotiation and with what seem to only be modest restrictions.

Maybe the market noticed that even though China claimed steel recycling would assist with up to 50% of their future needs (this doesn't seem credible) China's iron ore inventories are still falling.

Then, just to rub salt into the wound, another major producer (Brazil) is reducing production at present to solve problems in the sector.

So, in a classic example of 'talk is cheap' the Chinese dictatorship is learning that issuing verbal threats has less influence on market dynamics than actual business.

I think political leaders would do well if they backed away from yelling political philosophy at each other or using artificial and thus temporary forces and get back to trade agreements based on more reasonable expectations.

The rising iron ore price makes me pleased for Australia, which by one degree of separation is good for New Zealand.

Subsidy removal – Even though most governments are directing huge sums into additional fiscal spending, to have it flow as widely as possible across an economy, it is nice to read about the removal of some of the pure subsidies (no performance measure) from the Covid19 era.

In the UK, the Chancellor of the Exchequer (Rishi Sunak), has rejected business demands that the government extend the subsidies for furloughed workers.

Good on him.

At this point, 15 months after Covid impacts began, and 50% of the way into their vaccination programme, the businesses were simply trying it on. If they haven't reformed their business strategies to succeed without subsidies, then they should no longer be in business (or the board and executive team should have been changed).

Running a business based on a dependence on taxpayer subsidies is the very definition of unproductive and unnecessary within the economy. (Tiwai Point did you say? – Ed)

Don't get me started.

The German's must still be laughing at the rest of us with our bulk subsidy methods, given their more admirable financial support strategies that are dependent on regularly disclosed revenue from business.

Genuine businessmen in Germany would strive to get away from such subsidies because to see them as a revenue item should result in anger from directors because it flags corporate failure risk, not good political negotiations.

If we don't remove unconditional taxpayer subsidies, we will hold back the next transformations that our young and clever are trying to develop.

To be fair to the UK, they are about to demand employers pay 10%, then 20% of the 80% of normal income being received by furloughed workers. Businesses have known for months now that the furlough scheme ends in September, providing plenty of time for planning.

I doubt that it is a coincidence that the global shortage of skilled labour seems to be aligned with the global excess of subsidies (employment related).

US Fed Meeting – The US Federal Reserve has again reminded financial markets not to factor in large interest rate increases, or to expect them soon.

They plan to hold their overnight interest rate at 0.00%-0.25% until late 2023.

They now talk in terms of 2% average inflation over long periods, not imminent inflation over the near term.

They remind us that their goals are both 'maximum employment and price stability' without actually defining 'maximum'.

2% average inflation gives us a focal point, but today it is badly blurred by the imprecise objective of maximum employment, and I doubt that a single eye prescription will help to understand the Fed's evolving opinions.

The employment situation has far more political influence than inflation. 100% of the voting population understand employment, with far less understanding inflation. So, getting the employment outcomes right is now far more important for political stability than getting inflation right.

The other sentence that may as well have been full of bold highlights was:

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals. (bold highlights mine)

Just as we are becoming used to the theme in New Zealand, it is no longer solely about the overnight interest rate setting.

Speaking of using additional monetary tools….

Tools – The Reserve Bank of New Zealand (RBNZ) now has more tools available than Mitre 10.

The Minster of Finance has finally approved Adrian Orr's new high priority item, permission to set regulations for Debt to Income (DTI) ratios.

The governor has been on a crusade to reduce financial stability risks (a key mandate for the central bank) in New Zealand and he saw too much risk on bank balance sheets (how risk was measured by them and the true equity held by them) and on private balance sheets (huge increases in mortgages).

The need for more 'real' equity to be held on bank balance sheets (less use of complex bonds that may look like a duck, but don't walk or quack like one) has been addressed and the new simpler, stricter, capital rules are about to be announced.

However, more column inches (scrolling depth? – Ed) will now be occupied by the subject of DTI, covering the influences that politicians prefer (restrict investors) and the central bank governor demands (increase financial stability).

The current fuss on this subject surprises me because approval of my early car and home loans centred around what the bank manager believed I could afford to borrow, based on a direct relationship between the debt, my income and risks to my income changing.

I like the potential for the Reserve Bank, and thus banks, to set tougher constraints on investor use of debt, especially in the unproductive space of residential property (so too should the Productivity Commissioner).

New DTI regulations are another resistor for the aggression of residential real estate investors, but it will not solve the house price problem nor improve access to homes for those with very little equity.

Those with the most equity will still appear to be modest risk borrowers to the banks, but it is nice to see cash flow becoming a more important part of the approval process.

I hope Adrian Orr also considers different DTI ratios between interest only mortgages and those with capital repayment tables (declining risk and thus beneficial to financial stability).

For investors, I think this has very little impact on those holding shares in retirement village operators. We are still short of houses in NZ so the more they can build the more those with real equity (retired) can downsize their accommodation, migrate toward preferred services and release capital for spending.

Demographics and housing supply problems still make the retirement villages a highly desirable part of our economy and property scene.

EVER THE OPTIMIST

NZ Company Rocket Lab has been contracted to deliver a project to Mars in 2024.

This fabulous business story is becoming universal.

Maybe our councils and central government should reflect on how far ahead businesses plan when they make strategic decisions, the evidence required and then actually delivering.

ETO II

Even with the borders still heavily restricted Air NZ has reached a point they like to call 'revive' and presented staff with a small bonus plus returned wages to normal settings (they had been cut during 'survive' mode).

ETO III – Vaccinations

Global Data:

Good news, another vaccine has been added to the market: Novavax has released a vaccine with 90% effectiveness, after trials including 30,000 people (are trial numbers going to overtake NZ vaccination numbers? – Ed)

Supply and choice are no longer an issue for global vaccination, just administration and opinion!

Vaccinations doses delivered – 2.60 billion jabs

Total (recorded) Corona Virus cases – 179 million

Active Cases – 11.5 million (declining)

Daily rate of new cases – 350,000

People in serious condition – 82,000

Daily Deaths – about 8,000

Hospitals are celebrating. The highly contagious nature of Covid19 is its greatest threat, and particularly to our health systems, which when overwhelmed cannot help those whose lives are at greatest risk.

That is changing.

US hospitals are now beginning to report zero cases being cared for. Boston Medical Centre had 229 Covid19 patients one year ago, but today they have zero. Others are reporting the same situation.

Investment Opportunities

Precinct – Holders of Precinct Properties will be approached soon with the opportunity to purchase a few additional shares via a placement, at a modest discount ($1.52 per share).

TRAVEL

Edward will be in Nelson on July 8 and July 9.

Edward will also be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD)

Kevin will be in Christchurch on 6 July.

David Colman will be in Palmerston North on 30 June

Johnny will be in Christchurch in mid to late July.

If you would like to make an appointment, please contact our office.

Mike Warrington 

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Market News 14 June 2021

It won’t please the ESG crowd (see below) but it is nonetheless another anecdote that economic activity continues to improve:

Sky City Entertainment Group (SKC) announced to the NZX that stronger than expected trading (including Sky City Malta, which may require a research trip – Ed) means they will comfortably meet financial covenants set with bankers and thus will pay a dividend in September.

INVESTMENT OPINION

Blue Green ESG – Do you still find the ‘planet saving’ and ‘good behaviour’ investment scene hard to understand?

Green?

Green is now being linked to land-based investment that is environment and climate friendly.

Blue?

Blue is being linked to water-based investment that is environment friendly, especially as it relates to the ocean.

ESG?

Firstly, let’s unpack the acronym: Environmental, Social, Governance.

The acronym is used to label investments that meet one or more of these objectives.

They are non-financial elements, anchored in sustainability and ethics, that investors are increasingly choosing to use when assessing an investment opportunity. ESG is becoming a binary influence (yes/no) before the investor moves on to address risk and reward (a grey scale).

The intent of the ESG playing field is unquestionably good but it remains unclear to me to the extent that ‘we’ need to learn a lot more about measurement yet so we can bring return expectations closer to ESG performance.

Poor ESG performance needs to result in a higher cost of funds.

Demand for ESG may be binary but performance will not be (how green, how blue, how ethical) so investors need more clarity about how we are to assess ESG performance.

The ANZ kindly invited us along to a major capital markets event last week with presentations from senior representatives from all quarters including the Minister of Finance, the central bank, borrowers, investment managers (lenders) and bankers who originate capital markets transactions.

The dominant theme of the day was ESG and how capital markets are trying to do their bit to improve the behaviour of those using investor money.

Unlike the unmeasured ‘we are green’ marketing flags used about 10 years ago ‘this time is different’.

Businesses seeking equity or debt investors are leading their slide shows with evidence about ESG credentials and stumbling without certainty into areas where they can display performance measurement as it relates to their business type.

They are genuinely keen to prove that they are treating ESG seriously, and this element of their effort deserves respect.

However, I think we need more development on measurement so directors and senior management can be held accountable upon review.

All of the investment managers are taking the new filter seriously and have added ESG to the contents of their research brief. There’s a rapidly rising menu of managed funds promising to be ESG focused but as one on stage said ‘I think ESG labelled funds will become redundant because all funds now carry this objective’.

This alone is sufficient evidence for why ‘this time is different’.

Regulators, bankers and investment managers are aligned in their intention to apply pressure to businesses and activities that demands ongoing improvement with respect to sustainability and ethical outcomes.

Once measurement is better defined that pressure will become unrelenting.

This doesn’t mean that businesses supplying products or services that may seem imperfect in an ESG world (think oil) won’t attract investors, they will because the world needs them, but they must display to regulators and investors that they are on a path of continuous improvement in the way that they do their business.

I had one concern. Investors are price takers at the moment, not price makers.

The pressure on business will increase once investors can set conditional pricing if they are to buy shares or bonds and support the entity asking to use their money. An important aspect of setting a price (reward for risk) and any penalties for failure to perform is ESG measurement.

If a property investment company seeks ‘green’ funding support via bond issues, or a sustainability linked loan from a bank, it may secure this debt with its best performing buildings. ‘Best’ may mean lowest energy use, but how will we measure what is best, or what is an agreeable reduction in the period ahead?

Financial markets do not yet offer you, the investor, a different reward based on ESG performance, and I think this is necessary, soon.

Proclaiming ESG status will always happen at the prospecting stage. We need rewards to alter based on ESG performance against measurable goals; your reward will increase (cost to business rises) for underperformance and as a double-edged sword the reward will decline if outperformance is achieved (lower cost to business).

This price influence will be powerful, especially when aligned with the government pricing of carbon (credits for the good, and costs for the bad).

The G7 are in agreement with the need for measurement stating after their recent meeting in London: ‘support for moving towards mandatory climate related financial disclosures that provide consistent and decision-useful information for market participants, that are based on the Task Force for Climate-related Financial Disclosures (TCFD) framework, and in line with domestic regulatory frameworks’.

For the moment you are not investing in ESG for relative returns, and you are not doing so because you’ll actually see climate change outcomes, but because you are demanding higher standards and this will lead producers and consumers to evolve the way they operate, for the better.

As it happens NZ has very few ‘’bad’’ investment opportunities so there is no need to weed out the baddies from your portfolio. However, I look forward to seeing how our local investments will describe ESG improvement targets and then report on them.

Retirement Villages – If you are an investor in the NZX listed retirement village operators, and you are concerned about the recent proposal from the Retirement Commissioner that the Retirement Villages Act 2003 needs reviewing, I think you can relax.

Comments from residents whom I know make me wonder if the corporate entities should find a way to offer more influence to the residents committees. There are some very capable people living in these villages, and it seems a wasted resource not to use them, in my view.

However, the dislikes that these residents describe to me are some weak operational matters, not the cost of the service being provided.

The weekly costs and relatively high real estate margins when units are sold are well known to residents and yet this does not stop them from signing agreements and moving in.

I think there is too much hindsight occupying the mind of the Retirement Commissioner and the property market critics as they vent their frustration that the retirement village operator profits from the change in NZ property values.

If the resident had been that unhappy about the financial element, looking forward, then they could have taken the roughly 30% cash difference between the sale of their community home and the purchase of a Licence to Occupy in a village and purchased shares in that village operator (subject of course to seeking advice from a financial adviser!).

If a mistake was made by the unhappy critics, was it that the village pricing is high, or that those people didn’t seek financial advice?

The retirement village businesses have been an excellent supplier of additional ‘homes’ in our communities precisely when NZ has been failing so badly at building more homes. I don’t think we should be looking for ways to restrict that supply, rather we should be trying to make it easier for them to increase the scale of the services they provide.

I think the Housing Minister should be thanking the sector, not criticizing it or making it harder to operate.

Given that so many of the village residents that I know are so happy with their circumstances, and seldom discuss the wealth factor of who owns the underlying property, maybe it is their beneficiaries who are sponsoring the criticisms?

Through experience, I concur with one request that the commissioner raises; that retirement villages be obliged to buyback a licence to occupy by a certain date (6 months), regardless of whether or not a new resident has been found.

The retirement village does, as discussed, benefit from the equity returns from ownership of the property and with that comes risks; one of those risks is a lack of occupancy (tenancy). The business can solve this problem by making sure the product and its pricing meets with market demand.

None of this financial risk (finding a new occupant) can, or should be, the responsibility of the estate of the prior occupant.

If retirement village directors thought about it they could make a marketing opportunity out of a pledge to return capital to a person’s estate no later than six months after their passing.

I don’t think this issue needs a lot of angst and could well present a useful opportunity for the whole sector to mature gracefully (excuse the demographic pun).

Meridian Energy – I see Meridian Energy is considering exiting its assets in Australia.

Is this another example of a Kiwi business recognising potential failure in another market?

Not long-sighted enough to stick to their knitting in NZ and allocate spare capital to much longer-term planning for this nation’s requirements?

Maybe they want to become vertically integrated and manufacture electric vehicles in NZ, and supply the power. (sorry about him – Ed).

I’ll give them the benefit of the doubt; they temporarily became a bit short-sighted and now see better returns on capital invested back in NZ again.

Evidence of Cash Excess – There is rising evidence that the oceans of extra money that have been injected into economies are not being used effectively.

Even though investors are recoiling at the appallingly low interest rates on bank term deposits and investing their savings elsewhere, our banks still have too much cash and the Reserve Bank is being forced to remove the surplus from the system each day.

In the US the Federal Reserve is removing almost US$500 billion cash from the system each day (funds not required by the banks). Might it reach $1 Trillion and start to make a mockery of the scale of additional funding that has been supplied to the market through the various bond buying programmes?

$1 Trillion in, $1 Trillion out, and the only difference is between the duration of the bonds issued (years) and the cash removed from the system (days and months).

It’s beginning to look as though central banks have issued the largest cheap derivative (interest rate swap) ever to the banking system:

If you hold a view that longer term interest rates may rise, sell your (overpriced?) long-term government bonds to the central bank and park the unwanted cash raised with… the central bank.

If it transpires that long term interest rates do begin to decline again, either buy some bonds issued by government to support the massive spending programmes or buy some bonds back from the central bank when tapering (keen to reduce the scale of their bond portfolios!).

For the rest of my career, it looks as though there will be two major suppliers of government bonds (high spending governments, and central banks) and one buyer (the savings community).

The savings community (fund managers, banks etc) will become expert in analysing how to profit from the preferred market conditions of the central banks.

It really is yield curve control. No free markets here, and the Reserve Bank confirmed last week that they too were ‘turning Japanese’ and will use their bond buying programme as a monetary policy tool from now on.

Sometimes they will move the Official Cash Rate to send short term interest rate signals and other times they will buy or sell bonds to send signals about their targeted long term interest rates.

It is artificial and I don’t need to know whether it will work or not for helping the economy, but I can assure you that banks and savers/investors will profit from it at the taxpayers’ expense.

I don’t like it, but it’s here to stay in financial markets for longer than me.

EVER THE OPTIMIST

The G7 nations seem to have agreed to proposal for a minimum corporate tax rate of 15%, and that governments can measure it against sales within their jurisdiction and not ‘reported profits’.

It’s a long journey from G7, to G20 agreement and then 139 members of the OECD but it does appear that some sanity is emerging across global governance to insist that everyone contributes fairly.

Recall that tax experts observe that if a tax is fair (shallow and widely spread) you stand a greater chance of it being paid.

Surely businesses such as the technology companies that assign their profits to low tax jurisdictions understand that after the mammoth level of financial support provided by governments last year it must be ‘repaid’ by the global population.

If they don’t make steps to increase the volume of tax paid, and its dispersion, they can be certain that governments will tear their fiefdoms down.

ETO II – Vaccinations

Global Data:

Vaccinations doses delivered – 2.35 billion jabs

Frustratingly, if you live in NZ you can roll your sleeve back down and wait another while.

The G7 have strongly declared they will support a strategy of ending Covid19 by December 2022 and supply massive volumes of vaccines to the world’s poorest nations.

There’s a challenge for NZ; we’d better beat December 2022 for our vaccine rollout!!

Total (recorded) Corona Virus cases – 176 million

Active Cases – 12 million (declining)

Daily rate of new cases – 400,000

People in serious condition – 85,000 (declining)

Daily Deaths – about 10,000

Hawaii is helping to define how some regions will move on from border restrictions and to encourage >70% vaccination coverage. The state government has defined 70% vaccination as the point when they will lift all border restrictions (quarantine or prior testing) and remove the policy of mask use indoors.

Hawaii has also proved that rewards help. When they offered free entry based on evidence of vaccination the website crashed based on the high level of participation!

Investment Opportunities

Infratil Bond – Thank you to all who participated in this bond offer (6 years at 3.60%).

Infratil confirms that the offer is fully allocated.

Now we wait for the next borrower to approach the market with a bond offer. We are expecting several during the second half of the year.

TRAVEL

Edward will be in Napier on 24 June and 25 June and in Nelson on 8 July and 9 July.

Edward will also be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD)

Johnny will be in Christchurch on 17 June.

Kevin will be in Christchurch on 6 July.

David Colman will be in Palmerston North on 30 June

If you would like to make an appointment, please contact our office.

Mike Warrington 

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Market News 7 June 2021

Only three weeks since the Budget and one week since I questioned whether or not the government could deliver on its infrastructure spending promises and they have started cancelling roading projects.

Confused?

INVESTMENT OPINION

How hard to forecast? – I was reminded of this headline (below) from 25 June 2020 in the immediate aftermath of Covid19 lock downs:

‘FMA expresses concern about the frothiness of the share market’.

The share market is now 38% higher than when the FMA expressed this concern.

I deduce two things from this:

A reminder about how difficult it is to make financial decisions; and

Regulators shouldn’t even try to express such opinions.

The FMA has nothing to gain from voicing market pricing opinions so they should leave it to those whom they have licensed as competent to do so.

To be fair, it’s entirely possible that the journalist amplified Rob Everett’s response, which may have been a simple raise of his eyebrows in response to the question.

Massive Spending Continues - If recent headlines about inflation and withdrawing from the provision of financial support post Covid19 were a concern for you, they shouldn’t be.

President Biden is proposing a budget for the year ahead of US$6 Trillion dollars, rising to US$8.3 Trillion over the decade ahead.

The budgets imply annual deficits at a minimum of US$1.3 Trillion.

US$1 Trillion is roughly equivalent to US$2,850 per person in the US, so the proposed deficits look like they average a debt increase of US$3,700 per person, per annum.

This places a huge burden on the economy to increase its performance, and/or upon those earning the most to increase the ratio of tax paid to the government.

Annual GDP in the US is about $21.5 Trillion, so at some point the US government needs to collect an additional 6% of this number in revenue to stop the budget deficits proposed, let alone begin any repayment schedule.

I doubt repayment planning is on anyone’s agenda (sadly – Ed).

The alternative, and the one they must be shooting for, is to collect similar tax ratios from a much larger economy.

Last year US tax revenue was listed as being US$3.71 trillion. The other implied US$1 Trillion of revenue must come from other sources (Budget of $6 Trillion, less $3.7 Trillion tax, and less the acknowledged $1.3 Trillion deficit).

US$3.7 Trillion of tax revenue is about 17.25% as an average tax ratio.

You may recall Biden joining calls for a minimum tax rate of 15% on foreign earnings and 21% for domestic corporate tax rates in their attempt to defend the tax base.

To remove the budget deficit based on current tax ratios they need the US economy to grow to about US$29 Trillion, being a 35% increase in the size of the economy.

That is a heroic assumption for the decade ahead.

I am struggling to name any deserving heroes on the current economic playing field.

Now, I didn’t draw your attention here for a serviette tutorial about the implausible US economic plans. I did so to remind you that this king tide of money, via fiscal spending is not going away, it is getting larger.

The US government is doubling down on its financial commitments and to some extent its political commitments.

Donald Trump was belligerent and patriotic but also highly unusual.

Biden may prove to be even more belligerent and patriotic, but he looks a lot more conventional which is likely to mean the US is taken far more seriously as they flex their over-sized economic muscles.

This is the key point for investors; do not plan your investing on the basis that financial support will be removed during the decade ahead.

Central government will frown upon central banks that speak too firmly about higher interest rates given that debt levels are rising so far (proportion of the economy) that higher interest rates would become a lever of financial instability, which is contrary to a key part of a central bank’s mandate.

Good businesses will know how, or will learn how, to succeed under these conditions of plentiful cash flow. Normal analysis means one must be on the lookout for bad businesses, that do not cope.

The tide that was lifting all boats (business values) was the decline of interest rates toward zero. Now we will begin to discover which businesses cannot make sufficient money even when the debt costs are so low (Warren Buffett – only when the tide goes out… - Ed).

I do hope that New Zealand doesn’t follow the US lead of such rampant spending. We simply don’t have their capacity, a mere cork in the global economic ocean. Our total population is less than 24 of the 50 states in the US, and two of its cities (New York, greater Los Angeles).

Over the past 10 years the population of Texas grew by almost our entire population.

We should just keep our head down and paddle our own boat with more refined steering and less horsepower.

Aussie, Aussie, Aussie– Over recent weeks the Australian share market has risen to new highs whilst the NZ market has been receding.

What’s up?

Well, in my view the share prices of NZ’s high cash flow utility type businesses benefited from interest rates falling to zero, but that conveyor belt of relative value has stopped; it’s all about business performance now.

Global demand for Australia’s natural resources is increasing again and buyers are paying higher prices for them.

And, just maybe, the Australian government’s rather forthright approach is more supportive of its economic expansion than we are experiencing from our government at present.

Rather than limiting immigration, as NZ is proposing, Australia is debating strategically targeting who they want to attract to their economy (young, skilled) and offering to pay them more money.

I am certain this will result in an increase in the young New Zealanders that we lose across the Tasman to this Australian push to employ.

This is what financial markets do, distill all discoverable information to reveal the best possible returns on investing capital.

Increasingly the investment of that capital also demands higher standards of Environmental, Social and Governance processes (ESG).

The market knows that Australia has a lot to do to improve its impact on the climate (think 66% electricity from fossil fuels) yet the Australian market is up, at new highs.

Australia must be doing something right, economically speaking.

Tiwai Point – Rio Tinto, through its subsidiary Pacific Aluminium, has announced the write off of $223 million of residual value in the Tiwai Point smelter business.

This is consistent with the intended closure of the business based on the current electricity supply agreement with Meridian Energy, set for December 2024.

It also increases the heat of the spotlight on Transpower to ensure the national grid can carry Manapouri’s generation capacity further North than Roxburgh by late 2023, giving time for network testing to be done.

I hope our Inland Revenue Commissioner measures any tax deduction claim from Pacific Aluminium against actual taxes paid in NZ (revenue transferred to Australia?).

Demographics Matter – Demographics should be an important part of an investors’ investment selection process.

It is not a fast-changing influence, but it has the power of the tide, i.e. unstoppable.

Investing in the retirement sector seems to be an easier investment choice because even a poorly governed business stands a chance of finding new customers over the decade ahead and a well governed business should benefit from high customer demand and higher profit margins.

However, even an expertly governed business with falling demand remains on a downward glide path, which is never fun for investors. Think of coal as an example.

Recently you may have read about Australia pushing for more immigration (just not refugees – Ed), and China moving on to a new family limit of three children, not long after agreeing to two children as a policy.

This is done out of concern for economic activity within each nation.

Japan is a current example of economic difficulties under the ‘weight’ of declining, and aging, population numbers. Their population almost doubled between World War II and 2010 (128 million) but has now declined by 2 million and is forecast to fall by 20% by 2050 (although a whole generation is too far to forecast in my view).

China’s move to a three child limit so soon after increasing from one to two, is partial acknowledgement of the failure with their policy of controlling the size of the family unit. Full acknowledgement would have been to remove the policy altogether, but that is not how ‘we know best’ politicians operate even if the facts disclose the failure vividly.

I haven’t read enough to know whether the two child setting was failing for financial reasons (cost of running a family) or because it was the first opportunity for some of the Chinese population to reject a government policy, something that is otherwise difficult to do in this one-party dictatorship.

Businesses of the world may have been enthused by the increase to the child policy in China but I doubt it is a short term opportunity given the failure to create larger families under the previous increase in family limits.

When you look at global population change over the past century it becomes obvious that the scale of growth in just 100 years (2 billion to 8 billion) is the main driver of damage to the planet, not just the way we use resources.

Declining populations may not be great for business, as a generalisation, but it may be the most effective way to reduce the damage our species is doing to the planet.

Usually populations expand when resources (mostly food, oxygen, water) are in abundance and decline when the opposite occurs. Maybe humans are the same as all other species and will self-manage declines in numbers through ongoing birth rates at below 1.0x per person.

Maybe the very long-term outlook for economics is very bad indeed and climate change influences will be easily achieved beyond 2070? (just as our great grandchildren arrive on Mars)

True to form, I have strayed from the foundation of this paragraph, so I’ll try and pull it back into focus for you:

New Zealand needs to be very careful not to lose population, especially the skilled people, over the decade ahead;

It is interesting to see the Chinese population seizing the opportunity to reject a policy of its dictatorship government; and

Always ponder what is happening to the scale and behaviour of the customer base for your investment companies.

Vaccination Status – The current scale of anti-vaccination beliefs in the global population will surely drive governments and businesses to respond with new rules and rewards.

Your ‘vaccination card’ will be far more influential than your old ‘gold airpoints’ and ‘platinum Visa’ cards.

If a part of society insists on unnecessarily increasing the demands on the public health system how will governments respond to this avoidable cost and inconvenience?

Only the Emergency Department will accept your arrival on the property without an appointment?

Will General Practitioners only offer ZOOM based appointments for people without vaccination cards?

What other businesses might insist on remote or online servicing unless vaccination is confirmed? (government departments, visiting the private properties that are retirement villages, banking services, supermarkets!)

How will the insurance industry impose itself, which it surely will? No uninsured travelers on aircraft, and no travel insurance for the unvaccinated?

Tourism is definitely coming back, but not to the heights achieved by 2019, for a very long time. (probably a good thing – Ed)

These uncomfortable impositions are entirely avoidable if we treat the vaccination offer seriously and acknowledge its glaringly obvious benefits.

EVER THE OPTIMIST

Is this reason to be optimistic, or unimpressed with the quality of work by Treasury?

Three weeks after the Budget NZ is already reporting higher income, lower spending and less debt than forecast by Treasury.

I’ll take it, if it is sustained.

ETO II – Vaccinations

Global Data:

Vaccinations doses delivered – 2.1 billion jabs

The very large nations that have been the most successful with the vaccine rollout are all running into difficulties getting above 60% vaccinated; a problem that needs to be solved.

Total (recorded) Corona Virus cases – 173 million

Active Cases – 13.5 million (declining)

Daily rate of new cases – 450,000

People in serious condition – 89,000 (declining)

Daily Deaths – about 8-10,000

The vaccination science is clear, and obviously of benefit to the population.

Investment Opportunities

Infratil Bond – the Infratil new bond offer (6 years at 3.60%) was more successful than the company or lead managers expected.

To have a bond offer drowned by demand and filled within a week is not the way Infratil likes to issue bonds because it implies that some excess of value was left on the table (interest rate too high).

On this occasion I doubt shareholders are concerned because the equity in the company (and the share price) are rising faster each day than the cost of a whole year’s interest!

BNZ bond – BNZ successfully issued $550 million of its new 5-year senior bond last week, at an interest rate 1.884%.

These rank alongside term deposits with respect to their risk, but have the benefit of liquidity.

Thank you to all who participated in this placement with Chris Lee & Partners. We can buy this bond on market for investors who wish to add it to their portfolios.

Share IPO’s – They are not imminent, but the industry has its eyes focused on the plan to bring 2 Degrees and possibly Westpac NZ to the local share market.

Those tasked with bringing other mid-sized companies to the NZX, such as the recently listed DGL Group, are very focused on adding to the recent listing successes.

Secondary Market – Remember that if there are no new investment offers to choose from, or none that appeal to you, we can help you to source investments for your portfolio from the secondary market.

TRAVEL

Edward will be in Auckland on June 9 (Remuera Golf Club), June 10 (FULL) and June 11 (Wairau Park).

Edward will also be in Napier on June 24 and June 25 and in Nelson on July 8 and July 9.

Johnny will be in Christchurch on 17 June.

Kevin will be in Christchurch in early July.

David Colman will be in Lower Hutt on 16 June and Palmerston North on 30 June

If you would like to make an appointment, please contact our office.

Mike Warrington 

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