Chris Lee & Partners Ltd

Market News 27 June 2022

The US Supreme Court has dealt a very serious blow to the climate change cause.

In 1973 Jane Roe won a right for all women in the US Supreme Court (federal law); being the liberty of choice; the right of control over their own bodies (in privacy).

The opposing state law was written in 1854, 119 years prior; not a time when women were treated evenly and long before women gained the right to vote.

It looks entirely to me logical that in 1973 the Supreme Court trumped (unfortunate pun) state law with the constitution, in favour of Jane Roe. It would have seemed to the majority at the time that the US constitution was maturing with society.

Disturbingly, last Friday, the US Supreme Court overturned the 1973 Roe vs Wade (Dallas, District Attorney) judgment and in doing so has brought unfairness back, removing an element of liberty.

What other important forms of liberty might the US Supreme Court now try to remove?

Today's Supreme Court has judged that women do not have the same rights as men.

This is the type of governance I'd expect from the Taliban.

In my view, the judges involved today have tarnished the integrity of the US Supreme Court, and themselves, relative to the skill applied by those on the bench in the 1970's.

Do you recall me describing the world's respect for the US dollar being linked to the importance of central bank independence and the rule of law? Well, some will view this judgment as undermining the quality of US law.

So, what is the link that I make to the climate and our environment?

For the world to succeed with its ambitious goals to change the way we use and maintain our planet, we all need to be in the fight together for effective change, otherwise we will fail.

Yes, we will make improvements, but we will fail to reach the goals.

Here in New Zealand, you witnessed the effectiveness of ''all in it together'' with our Covid vaccination roll out.

The US is the world's largest economy, and they are large volume consumers (products and energy).

The US Supreme Court has just declared that 50% of the population have fewer rights than the others.

It is very hard to imagine a suppressed person (with less liberty), anywhere in the world, following political leadership that asks them to go without, relative to other people, for the benefit of all people.

Our lives are shorter than the climate related strategies. Selfishness already undermines delivery. Poor governance undermines the situation further by fueling the selfishness.

We always knew humans were imperfect, but we surely hoped we were on a pathway of progressive improvement, not destruction.

The US is not the leader it once was.

INVESTMENT OPINION

Leadership – Good leadership exists, just not in politics it seems.

This item probably belongs under Ever The Optimist:

A Russian Editor awarded a Nobel Peace Prize for championing freedom of speech (Dmitry Muratov) has, following the Russian invasion of Ukraine, donated his prize money to charity to help Ukraine. He also sold his medal for US$103.5 million (!!) and will donate these funds too.

This sale further discloses the generosity from others for supporting Ukraine because the previous highest price for the sale of a Nobel prize was US$4.76m. Some generous soul has US$100 million spare to support Dmitry Muratov's actions.

It is consoling to know that the majority of humankind show more humanity than the minority.

With thanks to Bloomberg for bringing this item to my attention.

Wallboard – Our government's response to the tension around wallboard supply for buildings was to appoint a task force to address the shortage.

The government seems to have plenty of difficulty coordinating some of its own obligations; do they really have the resources to address supply and demand matters in the private sector?

I think politicians are reacting far too readily to 'protest via social media'.

Current public information has me believing that the supply problem will be resolved by October, a modest four months from now, through production, importation and inventory control.

I'd rather not spend taxpayer money on a task force that will be redundant by November.

I have a mate in the soft toys business and his inventory is running a little short. I guess he should prepare for a call soon from some cabinet minister wishing to announce a task force into soft toy shortage (the children are up in arms!)

Central Bank Integrity - Last week I was concerned that the central bank's effectiveness was diluted by unnecessary additions to its policy targets agreement.

This week they cannot see the conflict of interest in asking a business that they regulate to provide a person to join their board of directors.

This would be like me asking our (then) adolescent children to set and monitor the rules for the family home.

Actually, the Reserve Bank can see that conflicts will exist because are they reported as saying that they have taken steps to manage such conflicts.

Surely it is not appropriate to claim that one can simultaneously act in a governance role for both the gate keeper and the poacher.

Even if the person concerned was of utmost integrity, they would be forced to excuse themselves from some of the most important decisions and thus their value would be diluted or lost.

Why would the central bank want this problem, and obvious cause for criticism?

It is clearly hard enough to manage central banking without own goals like this item.

Colombia – Colombia's latest woes are a reminder to the so-called wealthy nations about what happens if they sleepwalk into a weak financial position (high debt levels, low international reserves, weak economic prospects).

The change of government seems to have delivered promises to do the unaffordable and reduce its strongest economic activity (oil and gas industry) and increase the financial contributions to those with the greatest need.

Financial markets are concerned about this double deterioration in the financial prospects, witnessed by a 4.00% increase in interest rates relative to the US benchmark and a conclusion of an inevitable default on debt obligations.

Colombian government bonds, in US dollars, had been trading at 36 cents in the dollar and have now fallen to 3.5 cents in the dollar.

The value of the Colombian Peso and its share market are also in decline.

If a nation persistently spends more than it earns and repetitively develops poor policy, eventually their day of reckoning will arrive, and cause great harm to its population.

Trusts – I wonder if the next round of winding up trusts is underway.

Anti Money Laundering law launched the first round of wind ups as the depth of inquiry was ramped up.

The new Trusts Act 2019 initiated the second round of wind ups as many users discovered they no longer had a purpose to operate a trust nor wished to meet the new regulatory obligations.

Inland Revenue (IRD) has now introduced a third round of pressure by increasing its interrogation of trusts and has increased the reporting obligations, especially as they relate to beneficiaries.

I was told that IRD is also looking back into the financial history of trusts and levying additional taxes when they discover such obligations.

Trusts that have not been operated appropriately (like a well governed small business) will be revealed during this period of interrogation.

Lastly, and just as significantly, lawyers and accountants are now resigning as independent trustees en masse.

Independent trustee obligations are now more codified than in the past, increasing the liability risks, and the reaction from professionals has been to resign.

Typically, these independent trustees were not being paid; they received other business from the entity so agreed to act as part of the relationship. Now, you couldn't pay them enough to accept the role and most ''family trusts'' don't want to pay either.

This will pose a serious problem for those where the trust deed defines the obligation to have an independent trustee.

Yet again, the message to people operating a trust is to test if they have a genuine purpose for operating a trust.

The costs, obligations, and liabilities are rising; are they beginning to exceed the benefits?

I explained to a lawyer recently about the ongoing failure of government to make it obligatory for all entities, including trusts, to be registered (in the same way as a company is) and then the public information could be shared when required under each legislative obligation.

Whilst she agreed with the benefits, she lamented that NZ is just not that well enough organised at a governance level and she would first prefer to see an obligation for a central register for recording everyone's Last Will & Testament!

Everybody dies, but not everyone operates a trust!

If you are operating a trust, you should again be testing if you have a good purpose for the trust and that you are prepared for the new regulatory and administrative pressures coming your way.

Bitcoin – One of many examples of stress testing that is occurring in financial markets at present.

If you are a Bitcoin enthusiast, the problem with half price Bitcoin two weeks ago (US$30,000 pricing versus the high of US$60,000) is that it almost halved again over the following two weeks.

The excitable non-believers are now suggesting that they expect it to halve yet again to trade below US$10,000, which would be an 80% decline from the peak.

Why not?

This guess at a reasonable price is as good as anyone else's.

Crypto-enthusiasts won't have enjoyed reading that the Bank for International Settlements (BIS) annual report concludes that the future of monetary systems will be built around Central Bank Digital Currencies, and not crypto-currencies.

Whilst the BIS accepts that new technology and tokenization will play a role in digital currency development it is centralisation that will enhance confidence (vital requirement of money), not fragmentation as seen in crypto-currency attempts.

The greatest legacy of Bitcoin may well become that it forced banking globally to enhance its service offering to business and the public, and in theory to simultaneously reduce its cost.

Bitcoin no longer needs to survive for this development to occur (global digital payments services, that reduce costs of service).

I think Bitcoin will survive but it will be more clearly recognised as the scarcity based commodity that many always thought it was, and not a unit of payment.

Forcing an upgrade to global banking is something for Satoshi Nakamoto to truly be proud of.

Show Me The Money – Watching sport, and observing the sponsor labels can be quite instructive as to which sectors of the economy are doing well.

Last week when I was ''watching race cars going around a circle'' (My wife's description of Formula 1) I found myself focusing on the sponsors for a few minutes.

Nothing was surprising me, probably because I had seen them all so often, but the themes began to assemble for strong businesses, being:

Oil – Aramco, BP, Shell, Petronas, Castrol, Mobil

I know that motor racing uses a lot of their product, but the presence and scale of the sponsorship makes it clear they are providing both oil and vast sums of cash to the teams.

Aramco (Saudi's) in particular has its brand everywhere.

Technology dominates too – Oracle, Microsoft, Amazon, AMD, Citrix, Snapdragon, Crowdstrike.

This category makes sense too given the enormous amounts of data processing and storage businesses use at the frontier of development.

All teams had banking sponsorship, presumably to support the complex array of payment obligations all over the globe – UBS and Banco Santander seemed to have pole position here (pun intended).

The next most obvious sponsors were, I thought, those that wish to sell a product to viewers only and are not a requirement of the race team. Essentially, they are premium brands wanting to be associated with the pinnacle of the sport.

They included – Rolex, IWC, TAG Heuer, Puma, Rayban etc (a variety of fashion houses).

The other sponsors that looked like unnecessary products for a race team to use, and thus I assumed have far too much cash to share, were:

ByBit and Binance – two cryptocurrency trading platforms! (I wonder if they'll be back next year?);

BWT – aka Better Water Treatment, an Austrian company. It's interesting to see a water industry business making so much money that they feel like supporting a Formula 1 racing team! (No jokes about 3 Waters nonsense in NZ please).

There are definitely some very successful businesses out there, earning a lot of money.

I'll keep an eye out for the likes of Mainfreight, EROAD, Fonterra, Zespri and Fisher & Paykel Healthcare on the international sponsorship scene (smile).

Ever The Optimist

Speaking of Fonterra, I see they are already increasing the milk payout forecasts, now up to a central price expectation of $9.50 per kgMS with private analysts willing to use $10.00 in their forecasts.

Thank you yet again to our farmers (all primary industries), who consistently keep their eye on the prize for this nation.

Investment Opportunities

ANZ Bank – has confirmed its offer of a perpetual preference share (Additional Tier 1 capital item) with a planned opening date of 4 July 2022 (next Monday).

The close is 7 July, so even subordinated bonds have joined the ''Fast Moving'' issuance process.

The Product Disclosure Statement and Terms Sheet are available on the Current Investments page of our website.

Now is the time to make your decision about participation in this offer.

The first possible (optional) redemption date is 6 years, but investors are reminded of the importance of the term perpetual for these securities. The option for repayment rests with the ANZ bank, not investors.

The strength of ANZ bank results in these securities having a BBB standalone credit rating.

Current market conditions (Australian market for similar securities being issued by Westpac) implies a return well above 7.00% for the first fixed rate period.

By way of comparison, you may recall that Kiwibank (KWBHA) was the first to issue such a Tier 1 security in NZ after the Reserve Bank amended the regulations for what constitutes as capital on a bank balance sheet.

Westpac is issuing similar securities in Australia at present which will help provide a steer on necessary rewards for the ANZ offer in NZ.

I expect the ANZ to offer a very large volume of these perpetual preference shares, for the following reasons:

Their total capital has declined over the past six months (about $300m);

Yet, their total assets have increased (+$6,500m); and

They appear to be about 1.00% lower in capital (Total and Tier 1) than their preference (based on recent data).

To add 1.00% to Tier 1 capital ratio the ANZ could issue as much as NZ$1 billion of these new perpetual preference shares (calculated against current risk weighted assets of $106 billion).

Whilst one can never say never, the potential for scarcity and scaling is a little lower on this offer than some recent bond offers.

Don't forget to seek out financial advice for this complex investment product.

Across the Tasman, the Australian Securities and Investments Commission has established new Design and Distribution Obligations and these rules have resulted in Westpac declaring that retail investor could not participate in their subordinated offer without accessing financial advice.

It doesn't feel like a stretch to suggest that the NZ Financial Markets Authority will copy this additional protection for retail investors here.

 

Travel

Chris will be in Christchurch on Tuesday and Wednesday July 5 (pm) and 6 (am) at the Airport Gateway and welcomes requests for appointments.

 

Michael will visit Tauranga on 11 July and Hamilton on 12 July.

Please let us know if you'd like an appointment.

 

 

Michael Warrington

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Market News 20 June 2022

Here’s an anecdote about how bloated our government and its departments appear to have become (my main economic concern) and how poor they are with messaging.

We are monitoring a neighbour’s house and mail whilst they enjoy open borders to visit their children and grandchildren.

They are retired (Gold Card, National Super).

Last week they received a five-page letter to explain that they wouldn’t be receiving the winter energy payments because they are outside New Zealand at present.

The action is fine, and it is logical.

The letter (which they ask us to open) is the inappropriate part, written with this tone: ‘we have discovered that you’re not in NZ because Customs told us so, and this means you are not entitled to the money… etc’. (bad citizens)

The balance of the content includes an unnecessarily voluminous pre-amble and post-amble, with disclaimers and processes for correcting information or complaining.

I don’t even want to think about how many people, days and whiteboard markers were used during the development of this one government process.

It is real mail, in a real envelope, which arrived late.

I am pleased about information sharing between government departments (more would be good to reduce actual fraud) but this communication could have been sent by email (machine automated), been short, polite and effective.

‘Switched off whilst you are out of the country and switched on automatically once you return’.

More information could have been offered via links to helpful websites.

Trees could have been saved. Government workload could have been reduced. Respect and productivity could have been gained, not lost.

I know, I said I had retired from my role as President for the Day, sorry.

Actually, I am considering becoming a visual pollution officer in my next life, such is the volume of pointless signs erected in public now.

INVESTMENT OPINION

US Inflation data – The most recent US inflation data (10 days ago) was worse than expected (+8.6% p.a.), which didn’t go down well for financial markets that had been living in hope that evidence would begin to emerge revealing some small declines for the inflation pressure.

To be told the opposite was true shattered that hope.

Hope is never a good strategy.

The US share market experienced significant declines (2-3% per day, for several days) as investors discounted the newly revealed threat and interest rates on all terms jumped sharply as markets calculated the need for more aggression from the most influential central bank, US Federal Reserve.

Until I corrected a spelling error above, after typing too fast, I had typed Feral Reserve; this would be the name for the central bank(s) of El Salvador, Turkey, Argentina, Russia and maybe Brazil.

I digress.

The US Federal Reserve had already moved market expectations toward rate increases of +0.50% in scale, being double the more normal rate of 0.25% but in the end the immediate inflation pressure resulted in strategy change and an increase of 0.75% last week.

This ‘’biggest move in 30 years’’ didn’t surprise markets on the day because ‘’they’’ had already discounted the need for it into market pricing. Essentially all the Chairman Powell did was agree with the market; he had been disagreeing with the market until early 2022.

The more aggressive tightening of monetary policy, by front loading the interest rate increases (bigger changes, sooner), has actually soothed market concerns (a little) in that the Fed was previously running a risk of losing control of inflation.

Todays Fed Funds rate is a range of 1.50%-1.75%. The Fed expects to now increase this to 3.25%-3.50% by the end of 2022, which implies to me another move of +0.75% and two of +0.50%.

The current terminal point for interest rate hikes is 4.00% by 2023, and presumably this means in the first half of the year, so up to another three increases of +0.25% as the Fed begins to slow the application of monetary tension.

Long term interest rates, using the 10-year US Treasury as the example, quickly moved from 3.00% to 3.50% which is a very aggressive change over a short period for a long duration interest rate (roughly 5% swing in value in less than a week).

After the +0.75% increase the 10 year Treasury yield declined to 3.30% but some are debating the potential for this bond return to reach 4.00% by 2023.

As you have become familiar, when the world’s largest economy moves the smaller economies such as New Zealand always follow.

NZ investors planning to buy bonds last Monday (such as the new ASB Bank bond) received an interest rate reward that was 0.50% higher than they were expecting by the Wednesday.

The debate now, based on a new setting of hope, is that the high scale of the current inflation pressure is temporary (the spikes always are) and they will recede back below 4.00% (the hope part).

I am grateful to an old industry contact who supplied me with a chart, reminding me of the very strong correlation between the oil price and inflation. This will make sense to you given the world’s reliance on energy, and the involvement in energy in most things that we do or consume. (the inflation measure is the Consumer Price Index).

The price of oil matters. Make it one of your target news items.

Oil producers do not want to suffocate the global economy, or drive consumers too quickly to alternative forms of energy, because this reduces sales.

I am inclined to agree with expert economists who now think a recession is unavoidable.

Higher debt costs, higher energy costs, lower consumption levels and less confidence doesn’t deliver economic growth or higher profits.

These pressures should reduce the demand for oil, and thus hopefully reduce the price of oil and the pass-through to inflation (pricing of goods).

A sustained decline in the price of oil will help to signal lower inflation pressures, but not cheaper prices for goods; new product and service pricing is now baked into the economy.

An appropriate government strategy to help suppress inflation would be to support all efforts to increase the supply of renewable energy to an economy and to simultaneously stop printing money (QE) and over-spending (Fiscal) which provides artificial financial support to the economy.

It is past time that we re-discover the natural supply and demand levels of our economy.

Your level of confidence in these desirable government strategies will align with your view about when central banks will maneuver inflation back within the 1-3% target range!

The ‘’hope’’ strategy believes this will be in 2024.

Minimise the influence of ‘’hope’’ within your investment strategy.

RBNZ – After a move to being more credible (market perspective) from the US Federal Reserve, we witnessed the opposite from our central bank with more and more commentary on matters that are completely unrelated to inflation and monetary policy.

I think Adrian Orr, governor of the Reserve Bank of NZ should begin lobbying the government to remove GDP, employment and Treaty of Waitangi objectives from central bank policy targets agreement; They are proving to be an unhelpful distraction from the most important role of financial and price stability.

Adrian Orr didn’t invite these distractions; they have all been introduced by politicians (Minister of Finance).

Adrian Orr’s recent speech filled with metaphors and delivering against national obligations to Maori was the first time I joined the growing chorus of critics of the governor. Adrian is a very clever man, but he has been drawn too far into the field of politics here and thus too far away from the vital obligations of the central bank.

Financial stability and price stability should be the only remit for a central bank.

As we are learning this year, or being reminded, it is far too important to get the stability outcomes correct to muddy the thinking with woolly ambitions for economic activity and employment outcomes, or preferences for specific groups of people.

Right now, you can see that the political move of pumping cash into the economy to ‘’assist employment and business’’ has been part of the problem driving disruptive inflation around the world, so this action is directly in conflict with the central bank’s obligation of stability.

Pumping surplus cash into the economy was, and always will be, a political decision (vote catching). Meeting obligations to specific community groups is the responsibility of government. These actions and obligations differ enormously from ensuring that we have stable banking system and setting a price for money (interest rates), which is the reason central banks were made independent of the parliament in the first place and must remain so.

The parliamentary creep that occurred when it added employment goals to the central bank remit needs to be removed, reinforcing the extremely important independence of the central bank.

One of the great attractions of the US Dollar to the world is the independence of the central bank alongside the rule of law.

It is hard enough to hold the value of the NZ dollar up, given our minute influence in global economics, but I’d rather we didn’t undermine the value further by reducing the independence of our central bank. Financial markets will notice this trend!

We borrow too much money from the world to undermine their confidence and thus willingness to lend to us.

Governments don’t broadcast the fact that they benefit from inflation (taxes on income and sales rise as a result) so the central bank should be kept well removed from setting policies that might encourage some desirable and rising level of economic activity, that presses for higher inflation.

If the central bank achieves stability and thus confidence in the payments systems and pricing levels, economic activity will occur based on the potential of our economy (without artificial incentives).

Taking a woolly, difficult to debate, approach to tackling the current inflation battle will result in failure, which I think we would observe through inflation results that refuse to settle back into the 1-3% target range.

Sadly, I do not expect the current government to address, let alone respond, to this idea of increasing central bank independence between now and the next election.

Accordingly, as always, New Zealand inflation is affected more by the actions of other countries than our own central bank, which in my view has one arm tied behind its back at present as it contemplates how to assist with political goals.

Saudi Arabia – An oil story.

Golfers around the world are criticising the new Saudi controlled golf business based on dislike for the political situation. I understand that.

Critics would prefer that the new business venture (golf) didn’t succeed and draw top golfers away from the PGA. They rightly point out some unpleasant Saudi actions.

Saudi Arabia is not a democracy and is not interested in the views of most outsiders. We will not influence the way they run their country or organise its affairs.

Saudi Arabia might argue that they are maintaining a dignified silence about the many undesirable actions carried out by other nations.

Access to Saudi oil has held influence over the politics of other nations for decades now, not the other way around.

The world’s surge toward more climate and planet friendly policies is important, but we cannot switch off the use of fossil fuel as an energy source so we must work with the suppliers.

The price of oil tells us this.

Saudi Arabia is one of the world’s largest suppliers of oil.

The price of oil has been the driver of this nation’s wealth in the past, and this is doubly true today; Saudi Arabia’s wealth is ballooning.

With enormous wealth, and future oil reserves comes political influence on a global scale. We need to work with that fact.

Pretending that ‘we’ can isolate Saudi Arabia is naïve.

Somehow ‘we’ must find ways to interact with the nation as they use their vast wealth to consume and to dominate, as they surely will.

China is one our largest trade relationships, yet there is much to dislike and little control to exert.

Australia is another of our major trading partners, yet they actively choose to send criminals ‘’back’’ to New Zealand.

Putin’s behaviour is evidence that much what is said in friendly communications is ignored in the true light of financial or military power.

This is why good diplomats are so valuable (Please do not send Trevor Mallard to Saudi Arabia! - Ed).

Housing - The Singaporean government has stated that it will increase the supply of land for private homes by 26% relative to the prior plan for the period of June to December 2022.

The government land sale plan will now provide for 3,505 residences (up from 2,785).

Unlike here in New Zealand, something tells me that Singapore will deliver exactly 3,505 new homes during the period and builders will have time-based obligations to build the dwellings on the land or be penalised for failure.

It won’t surprise you that this decision was based on data about resilient demand for homes and a declining inventory of available homes.

They make it sound so simple.

Asset Allocation – After regularly being asked by clients about how asset allocation works, and then promising I would write a simplified piece on the subject (in January!) I have finally finished the item.

Clients who receive a financial advice service from us can find the item loaded on the private client page of our website.

Thanks for your patience.

Ever The Optimist

After such a difficult time for airlines they have a good quality problem to resolve with more demand they can satisfy with current staff and aircraft!

ETO II

Rocket Lab is helping NASA to go back to the moon.

This is still one of the coolest stories to come out of little old New Zealand.

Yes, our agriculture and primary industries sectors are making more money for the country (thank you for all the hard work) but you can’t help but be excited about watching Rocket Lab progress from a student with an idea and a passion to reach it’s current position on a trajectory ‘’to the moon’’.

Investment Opportunities

ASB Bank – completed its offer of 5-year bonds issuing $750m and the interest rate was set at 5.524%.

Investors are benefiting from the sharp increases in interests, that are nicely aligned with the interest rate sets on recent bond offers.

These yields are now available on the secondary market if you have more bonds to buy for your portfolios. Just call and we’ll be happy to assist you.

Thank you to all who participated in the offer through Chris Lee & Partners.

Vector – Capital Notes rollover was completed, and the interest rate was set at 6.23% for the next five years to 15 June 2027.

Downer (Works) – reset the interest rates on its perpetual notes at 8.14% (The benchmark reached 4.09% and the 4.05% credit margin was added).

Investors who claimed a dislike for resettable securities as interest rates declined will find a new love for them now and rediscover the benefit of their presence in a portfolio.

Bank Tier II Bonds – It will be nice to see the next Tier II subordinated bank offer in NZ because the implied interest rate for the initial 5-year period should be about 7.00% based on last week’s market conditions.

ASB Bank completed an issue of Tier II subordinated securities in the US (US$600 million, close to NZ$1 billion) with a credit margin that implies the yield noted above.

It would have been nice if they had issued these securities here in NZ, however, we may not have been able to provide the volume and the speed required by the bank.

LGFA – The Local Government Funding Agency issued more bonds to top up its funding requirements for councils, raising $160 million across three maturities (2025, 2028, 2031).

Interest rates have moved so far, so quickly, that investors can now easily access very strong bonds such as those issued by LGFA at yields between 4.00% - 5.00%.

Strong bonds should appeal to investors during periods of disruption, such as current financial market conditions.

 

Travel

Johnny will be in Christchurch on Wednesday, June 22.

Chris will be in Christchurch on Tuesday and Wednesday July 5 (pm) and 6 (am) at the Airport Gateway and welcomes requests for appointments.

 

Michael plans to visit Auckland on 30 June, Tauranga on 11 July and Hamilton on 12 July.

Please let us know if you’d like an appointment.

 

 

Michael Warrington

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Market News 13 June 2022

Ports of Auckland has staggeringly written off $65 million from its now cancelled plans to automate more of the port.

My question is:

Would Ports of Auckland have made a better decision if they were privately owned and publicly listed, than being 100% owned and influenced by Auckland Council politicians?

If you listen closely, I suspect you'll be able to hear an opinion from Brian Gaynor!

INVESTMENT OPINION

RBA – The Reserve Bank of Australia has finally joined many other central banks in acknowledging that inflation pressures are worse than they thought, and they are likely to last longer than hoped.

Janet Yellen belatedly acknowledged the same situation for the US when she stated that she and Jerome Powell had erred when they predicted that inflation pressures would be transitory, when in fact they have been sustained and compounding.

Friday's inflation data in the US was again higher than everyone hoped for (+8.6% Year on Year) extinguishing hopes for the beginning of a decline from the currently high inflation pressures.

Now, Japan and Europe remain as the two most significant non-believers in the sustainability of inflation.

The RBA increased its official cash rate by +0.50% from 0.35% to 0.85%. The move was significant, and a surprise to most analysts, although frankly their expectations were led by the central bank's constantly robust style.

I can sympathise with the Australian analysts with this forecasting error because throughout my career the RBA has been a model of calm, resolute, monetary policy management.

It would seem that the RBA's recent error was when they tried to reinforce market expectations by boldly declaring that the Australian cash rate would remain at 0.10% for three whole years.

Central bank wording in public statements is very important.

Analysts compare the addition and removal of single words within statements supporting such regular reviews. Central Banks know this and choose their words carefully, trying to steer the markets understanding of the situation beyond a simple interest rate.

However, it's hard enough to forecast tomorrow, or next month, let alone market pricing three years into the future. The RBA's error was in trying to extrapolate its verbal influence beyond its visual capacity.

The RBA managed to hold Australia's cash rate at 0.10% for only 17 months and markets had been telling them it was unsustainable from the 12th month and other central banks broke ranks after 14 months.

That's 3-6 months when the Australian central bank failed to recognize that it had grown blinkers that were bigger than a Melbourne Cup winner and the absence of peripheral vision was compounding their short-sightedness and they rejected the need for interest rate increases, until now.

They are underway, and they will quickly reset their overnight cash rate up to the proximity of the rates of the US and a little below New Zealand.

The only statement that I thought the RBA governor could have avoided was a late, backside covering, comment that he still felt inflation would be lower in Australia than elsewhere and that he felt it would fall back inside the 2-3% range by next year!

Why stick your neck out again when you are acknowledging an error in the past strategy?

I hope Dr Lowe is correct. We all do. Price stability is important, but inflation was hard enough to forecast when the world was operating smoothly and right now it is failing to operate at all across some jurisdictions.

I remain intrigued by the RBA's willingness to break away from the typical 0.25% interest rate level stopping points.

They moved as low as 0.10%, perhaps declaring that they did not see 0.00% or negative interest rates as credible settings (a tick from me) and their next two moves were to 0.35% and to 0.85%. The +0.25% and +0.50% increases were common with history, but not the final interest rate level.

Why might that be?

I like it.

I once discussed here the potential for central banks to reduce the scale of cash rate movements to eighths (0.125%) or tenths (0.10%) and to thus increase their potential for maneuvering more often and sending signals with less need for lengthy commentary.

I think the RBA has introduced this option for themselves, which should be good for them in future, and if this is the case it makes very clear the message that they intended from the +0.50% increase last week; it's as big a move as they ever hope to use in the current monetary policy landscape.

Yes, central banks have used larger cash rate movements in the past, especially during the calamity that was the Global Financial Crisis (GFC), but that was then, and this is now, and the times are so different.

By the way, for the sake of relativities, in the white-hot heat of the GFC the RBA slashed its overnight cash rate to an all-time low of…. 3.25% a substantial 2.40% higher than we sit today in Australia with financial risks scarcely comparable to those presented during the GFC chasm between late 2008 and early 2009.

You know, or want to believe, that ''things are different this time'' if you are to believe that a high point of 2.50% will be sufficient to confront the contemporary inflation pressures.

I can now imagine, and indeed hope, that the RBA will move quickly to a cash rate of say 1.85% (2 moves of +0.50%), then perhaps 2.10%, then 2.35% and then maybe 2.45%, increasing in +0.10% increments if they begin to observe inflation settling in the way they hope will occur.

Movements of 0.10% should remove 0.125% from the strategic rule book for the central bank because such a difference would require more words to explain, not less.

The most obvious item that plays into the hands of the central banks for lower nominal interest rates (seldom breaking into positive real return levels relative to inflation) is the now high levels of debt that exist within our Western economies.

Higher levels of debt feel the cost of interest rate changes more keenly than we did in the past, so our consumption behaviour should change (reduce) sooner in response to interest rate signals (increases).

This seems to be an appropriate time to remind investors ''not to fight the Fed''; meaning do not freely make new investment decisions that are diametrically opposed to the stated intentions of the central bank(s), where the US Federal Reserve has the most influence, followed by the central banks in the other jurisdictions where you choose to invest.

Typically, the signals we hunt for to assist our decision making are hard to see and sometimes hard to interpret. Signals from the central banks are not hard to see.

Apple Pay – Plans to enter the Buy Now, Pay Later (BNPL) industry and they stand a better chance of actually making sure that people ''pay later'' because most Apple products users will not want to be shut out of the other services provided by the company.

Slowly but surely the Apple tractor beam is drawing its users further into the Apple Universe (inescapable Black hole? – Ed)

Google Pay will be right behind them.

Unsurprisingly governments are taking steps to place BNPL under financial services regulations and in related news are placing crypto currencies under financial markets regulations.

The banks seem to be making it easier for these businesses to push further into the short-term finance space. Maybe the loan defaults were too high, and the banks are happy to leave it behind?

The BNPL businesses certainly felt the influence of poor form from the borrowers (consumers) with very high levels of non-repayment, but I think Apple may well have the answer to that risk through the leverage it has over it customers.

BNPL also faced another risk; borrowing long term (plus some equity capital) to lend short term (3 months). Based off a normally shaped yield curve this implies borrowing at a higher benchmark rate (long term) to lender off a lower benchmark rate (short term).

The only opportunity to profit from this situation is to take more risk via the quality of the borrower and some of that additional reward is used up within market pricing i.e. the lender doesn't actually receive all of the reward required for the risk taken!

You may recall Afterpay's recent loss reported at US$350 million, against its business that was purchased at US$39 billion. For the non-mathematicians that is a 0.90% loss, or almost a 3% loss based on current estimates for the value of the business now!

The situation is not sustainable unless BNPL and retailers find a way to apply more leverage over the consumer if they fail to pay.

Everyone older than 40 years of age has the idea for them, don't release the goods until they are actually paid for!

Apple can still compete though as they have other forms of leverage over behaviour that don't involve blocking delivery of the service. So does VISA and Mastercard, albeit only offering half the finance period relative to Apple.

Meanwhile, banks, with the best credit behaviour databases will focus on secured lending and extracting slightly wider profit margins by borrowing shorter term and lending for longer terms and being expert at managing the margin duration risks.

Coincidentally, on that point, as I write, SBS Bank (Based in Invercargill) is pleased to report a 9% increase in profits for the past year and I'd predict a higher profit next year given the rapid changes occurring to the New Zealand yield curve.

It feels far more comfortable to consider ''buying'' Apple, or SBS, or VISA than any of the BNPL businesses.

To be clear, this is not a recommendation, it is just one of my many observations about how the chess pieces are being moved on the board.

Infratil – through its subsidiary Longroad Energy will be pleased with the US President's latest push to encourage more solar power generation.

Biden has lifted tariffs on more solar panel supplies, reducing costs to the generation building businesses.

This helps to crystalise gains from IFT's strategic plan of investing at the frontier of consumer and regulatory preference.

Crypto – Amongst all the bad crypto news, here's a good news item for the sector, even if it's not as good as they may hope when they consider the ramifications.

International payment service SWIFT is experimenting with decentralized technologies (read Blockchain) to allow interconnection of payment between Central Bank Digital Currencies and fiat money.

Once SWIFT achieves this development it stands to reason that the world's central banks and thus banks, could connect a Bitcoin payment with any CBDC, which by extension means any fiat currency.

Before Bitcoin disciples get too excited though they must have also observed that it draws the anonymous into the world of the disclosed and regulated.

It is the only way to ensure reliable long-term futures for independent crypto currencies.

It is also how the world's governments and central banks will ensure that crypto ''currencies'' are defined as commodities and not currencies.

It would see the term crypto currency drop from use and see each item referred to by its own brand, such as Bitcoin.

Ever The Optimist

Tax collection (gross sums) is increasing, being of some assistance to the central bank and its hopes to suppress local inflation, albeit not a form of tension that the public enjoys.

ETO II

Global freight costs appear to be continuing to decline.

It's a 'fingers crossed' ETO item because further declines would indicate a relief valve for some of the inflation pressures we are experiencing.

Investment Opportunities

ASB Bank – has launched a new 5-year senior bond offer (maturing 21 June 2027).

Based on market conditions as I write (today 13 June) the interest rate would exceed 5.00%p.a..

The offer is open now, and closes on Wednesday 15 June, so if you wish to invest it is urgent that you contact us immediately with a request for a firm allocation.

Clients pay normal brokerage on these transactions.

Travel

Edward will be in Wellington on June 17.

Johnny will be in Tauranga on Wednesday, June 15 and Christchurch on Wednesday, June 22.

David Colman will be in New Plymouth on 20 June.

 

Michael plans to visit Auckland on 30 June, Tauranga on 11 July and Hamilton on 12 July.

Please let us know if you'd like an appointment.

 

 

Michael Warrington

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Market News 6 June 2022

This is a call to small business owners for help, please. Feel free to forward this request to other small business owners.

Are you willing to help Cameron Bagrie (a friend and past workmate who helps me) to develop a high-quality ongoing survey about credit conditions in New Zealand?

It will be simple and quick – 5 short questions.

Using his expertise, he operates a business called Chaperon https://www.chaperon.co.nz/ to help businesses navigate some of their banking requirements.

Cameron is very concerned about the difficulties businesses are having accessing bank credit to run their businesses and wants to broaden the knowledge through real user input.

Agreeing to assist him is easy, just email Cam – info@chaperon.co.nz

I’m sure he will share results with us, and therefore you, and we’ll all be wiser as a result.

Thank you in advance.

INVESTMENT OPINION

US FED – A very important influence for investors to monitor over the second half of 2022 is the willingness of central banks to become more aggressive in their stance with confronting inflation.

Early in my career central banks were apolitical and aggressive about confronting inflation. The expressed strategy was that interest rates will be moved to a price that exceeds inflation so as to restrict it and suppress future inflation expectations.

Public expectations are the greatest threat to future inflation.

If you are convinced that inflation is 10% then you’ll increase prices in your own business and probably agree to pay $6 for a coffee.

Central banks increased the price of money (interest rate), being the opportunity cost, until producers and consumers acknowledged they would suffocate financially if they kept up the stance of tolerating higher prices.

If inflation was reported at 10% and central banks forecast a move to 12% they would shift interest rates to 14%.

As many of you experienced during that era the compounding effect of higher pricing and very high opportunity costs are unsustainable for both the economy and personal finances.

Over the past decade central bankers moved their stance and surprisingly  changed strategy from forecasting inflation and proactively setting interest rates to confront the forecast, to one of reacting to inflation once the evidence was experienced, rather than forecast.

Well, rising inflation is here.

Initially central banks offered moderated responses, not even moving interest rates to the point of being restrictive (interest rates remained below inflation).

They then lived in hope that the price disruptions were solely a result of Covid related disruptions to trade delivery and would settle down.

Then Russia decided it was a good idea to invade Ukraine, adding new disruptions to energy and food trade but equally importantly introducing new long-term disruptions to the relatively settled state of politics over recent decades.

The tone of central banks then changed to a more assertive level, and some like the Reserve Bank of New Zealand acted, increasing the current interest rates and the forecast interest rates to make their new intentions clear, but will the RBNZ become restrictive?

The current forecast of a 4.00% OCR aligns with current inflation data, if you apply a generous eye to the forecasts. If you apply a harsh eye, then the OCR is well below inflation and will not restrict inflationary expectations!

The US Federal Reserve chairman, Jerome Powell, has been called into a meeting with the US president and Treasury Secretary for a session that will undoubtedly remind Powell of the political optics of the situation!

President Biden says he embraces the concept of independence for the US Federal Reserve and wants the fight taken to inflation (what he says), but he has still called Powell in for a meeting behind closed doors (what he does).

Powell, and his fellow Fed governors are talking a big book on addressing the risk of higher inflation, but they have not yet played a strong hand.

Governments have complicated the regulatory obligations of central banks, migrating them from simple ‘bank and price stability’ mandates to ones that include more convoluted objectives relating to economic activity and employment. In doing so politics plays a greater role in central banking than it did in the past.

This political interference does not support moves to even higher interest rates until they crush inflation expectations.

You’ve already had your first helping of this scenario in NZ when the RBNZ unnecessarily described a likelihood that after reaching an OCR of 4.00% during 2023 they expect to begin reducing it in 2024!

These influences are constantly changing, and even the experts are constantly guessing (educated guesses) so investors shouldn’t feel any more, or less, concerned about their investment decision making, just keep in touch with your financial adviser and keep up the process of portfolio reviews.

Market pricing will keep you updated on the opinions of risk takers, and frankly these are more important than headlines from politicians.

Recession – I agree with the many commentaries that risks that may prompt recessions aren’t hard to find, but surely it is hard to conclude one will happen whilst we enjoy such low unemployment numbers. (Keep a close eye on this indicator for change)

Western Australia has just reported a decline in their state’s unemployment to 2.90%. They could read out the names of the unemployed and take less time than would be required for a debate about recession risks there.

WA proudly reports that no other Australian state has ever reported unemployment below 3.00%

It is, however, entirely possible that Australia’s economic strength might temporarily reinforce some economic weakness in New Zealand, if they keep pinching our staff with wages reported to be 50% higher!

Climate – The economic disruptions caused firstly by Covid and then by Russia invading Ukraine derailed the global focus of refining climate related outcomes from the way we operate.

The most vocal political cheerleaders must have been very disappointed to see the oil industry return so quickly to being the most profitable businesses on the planet.

There is a lesson here for those politicians; the world cannot yet manage without the energy supplied from the fossil fuel sector, so we need to set a gradual and achievable track for change and not demand immediate cancellation.

The price of oil would not have jumped so far, so fast, if consumers had ready alternative sources of energy.

However, amongst the temporary concerns about feeling as if one germ and many bullets have snapped us back into a world that prefers to use fossil fuels there are, and will be, glimmers of progress.

We should encourage that progress, whilst discouraging fossil fuel use where change makes financial sense, or where ‘someone’ is willing to help bridge the financial gap whilst we make the changes to new sources of energy.

Usually the ‘someone’ is the taxpayer, but occasionally it will be a philanthropic private citizen (the sort politicians often err in criticizing).

Last week’s glimmer of hope came when Mike Cannon-Brookes (wealthy, activist shareholder) finally succeeded in forcing Australia’s largest energy company (AGL) to begin a strategy of reducing its greenhouse gas emission footprint.

AGL’s carbon emission footprint is twice that of the next largest (40.2Mt CO2-e) which is Energy Australia (18.7Mt CO2-e).

Cannon-Brookes will not profit in the short term from insisting that AGL increase costs and reduce revenue! However, he is determined that change must happen, and he is putting a lot of his money at risk to try and make it happen.

Cannon-Brookes will benefit if he can display to customers ongoing improvements, which might result in more customers, but this potential gain is the unknown financial item (risk) relative to the more certain reduction in profits faced by the company in the foreseeable years.

I guess a politician would say ‘’we have no pity for the AGL dinosaur’’ but speaking from the lectern (after arriving in a car) offers no progress with change, whereas Mike Cannon-Brookes actions are and will.

This ramble doesn’t propose any change to your portfolio, but it does remind you to be gradual with your changes and not to give up on the principle of demanding improvements from our directors and senior executives (in businesses that we own, or lend money to).

How did that happen? – Over the past few weeks I have received a variety of calls and emails asking a similar question; why did my share price fall after the company reported such a strong profit result?

One example was Turners Automotive, with record earnings and an increased dividend, but the share has declined from $4.60 (high) in January to $3.80 now, falling $0.11 immediately after the profit announcement.

Mainfreight was another to announce a strong profit result but see its share price fall $1.00.

There are many examples of these contrary movements.

The short answer is to remind investors that financial markets are always looking forward, pondering tomorrows risks and probable financial outcomes.

Profit results are backward looking; history as it were.

A genuinely good profit result is good news and it is generally understood that a share’s price should loosely reflect the value of a business, including assets held and profits being made, but you all know that market pricing is not that simple.

Looking forward, at present, the markets are concerned about the overall impact of rising interest rates and the current loss of confidence from investors, and the evapouration of intangible wealth held in the likes of goodwill and crypto currencies, meaning a reluctance to invest more capital at present, especially into the least certain risk types. 'Risk Off' as you may have read in financial media.

If investors choose to reduce their risk profiles it implies removing some of their capital from investment in shares, being lower demand profile and quite probably a simultaneous increase in supply.

Restrictions to international freight may be impacting Turners access to vehicles. Mainfreight logically says a lack of international shipping and air capacity, has proved frustrating to say the least, when trying to secure service and space for our export and import customers.

Fletcher Building is also making more money now and was buying back some of its own share with spare cash, yet they too are witnessing a lower share price.

In their case an inability to supply enough GIB to meet demand is surely lowering their potential profits in the current year.

A similar question comes in when the governor of the Reserve Bank increases interest rates (for the one-day rate), then declares that he will increase it further, but yields to investors on longer term bonds decline!

It’s the same effect, investors and financial markets participants are progressively updating their forward-looking conclusions about risk, which affect reward/pricing.

With my usual disclosure of deep bias, this situation is another reason to highlight the value of financial advice to investors.

Ever The Optimist

A statistically small, but measurable, increase has been reported in the use of public transport.

Public transport use increased in the Queenstown Lakes District with the arrival of Kevin Gloag’s gold card.

I’ve always been pleased that some of my taxes go to support this card in the community.

Investment Opportunities

Infratil – has completed the issuance of $65 million of its new 8-year bond to investors applying with new cash.

The interest rate was set at 5.93%

Thank you to those who participated in this offer through Chris Lee & Partners.

IFT190 Next – It is now the turn of rollover investors (holding the IFT190 bond maturing 15 June 2022) to act.

The rollover process is open now at the same interest rate, closing on 13 June.

This is an online process, and we are happy to help but we will need to know your ENTITLEMENT NUMBER.

Genesis Energy – GNE completed its offer of $285 million subordinated bonds (GNE070) last week.

They set their interest rate at 5.66%.

Thank you to those who participated in this offer through Chris Lee & Partners.

The success of this transaction has triggered the formal announcement that the old GNE040 subordinated bonds will be repaid on 9 June 2022, being the end of the initial 5-year period.

The repayment of the GNE040 is why the advice community think it is probable that the new GNE070 will be repaid in 2027.

BNZ – issued $650 million of their new 5-year senior bond (BNZ160), with an interest rate of 4.985%, and investors benefitting from a day when underlying (benchmark) interest rates increased.

Astute investors will notice that this return is well above the interest rate on 5-year bank deposits (4.00%) which represent the same default risk as this bond. The bond has the added advantage of liquidity (saleable).

Side story – so often when interest rates were declining the results seemed lower than anticipated and many an investor would wave their sabre at the directors or executives of the borrowing entity for poor service to investors.

The truth is that once a credit margin (risk for the borrower) is defined, the nominal interest rate becomes a function of market conditions at the moment the interest rate is being set.

In a rising interest rate environment, there is a 75% chance that investors will get a pleasant surprise with interest rate settings, as witnessed by this BNZ result.

Thank you to those who participated in this bond offer through Chris Lee & Partners.

Vector - Vector has completed the 'rollover' of its VCT080 subordinated Capital Notes.

The interest rate will be reset on 15 June and will not be lower than 5.50%.

Travel

Edward will be in Wellington on June 17.

Johnny will be in Tauranga on Wednesday, June 15 and Christchurch on Wednesday, June 22.

Michael plans to visit Auckland, Hamilton and Tauranga in the weeks ahead. Please let us know if you’d like to be contacted about an appointment.

Michael Warrington

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