Market News 10 May 2021

I have just completed my third research trip in the Far North and there's plenty to be optimistic about as you look around.

I hope when I get back and see some of the detail in the latest employment data (see ETO below) I'll discover that the Far North is enjoying some of the most rapid increases to employment participation.

Another you'll discover below is that this newsletter seems to be entirely populated by Ever the Optimist items, which frankly I am pleased about in a world of media that constantly tries to find negative and unnecessarily critical content.

INVESTMENT OPINION

 

Financial Stability Report – It was unsurprising that we were told there was little to fear in the financial stability stakes for New Zealand. There really hasn't been since late 2008 and early 2009.

The Reserve Bank spoke about the usual subjects of bank equity levels, lending risks, Loan to Value Ratios and the housing market but they also included some statements covering the obvious, such as:

We are also seeing the impact of low global interest rates resulting in increased risk taking

This 'development' has been happening for years and now that interest rates are below inflation (negative real returns) it is entirely logical that investors are seeking additional risk to pursue positive real returns on their savings.

To not achieve positive real returns is to accept a financial drag on one's wealth, like a modest amount of capital spending. This is acceptable for some people but offering capital (your savings) to a business either via a loan (deposits and bonds) or as equity (shares) should really be done in the pursuit of returns that exceed inflation.

It is the central banks driving interest rates lower that has resulted in the increased risk taking (asset allocation changes), making it ironic that this is one of their concerns.

The key word you should focus on is 'global'. Having interest rates very low globally means it will be very hard for single nations to break ranks and begin to increase interest rates, and certainly not a rate of change that varies from said global stance. To do so could become very disruptive to currency pricing and trade outcomes which might lead to an accusation of sparking financial instability!

Another thing to remember is that influence of interest rates as a monetary policy tool is being crowded out by other macro prudential levers (such as LVR settings, deposit guarantees and perhaps Debt to Income ratios) and disturbingly the Minister of Finance seems to think he should have a say too.

There isn't a politician in the house that could avoid the fear of upsetting the voters and thus none could offer the independent thinking that has so benefited our central bank, and by extension financial stability in the past.

Courtesy is the reason Adrian Orr didn't describe the Minister of Finance as the new greatest threat to financial stability in NZ.

Equity held by our banks is increasing again, bad debts are declining, and the risk profile held by the banks is also declining (less lending in the highest risk sectors) so you have little to fear with respect to the stability of the NZ financial system.

EVER THE OPTIMIST

Unemployment has surprised the Reserve Bank and declined to 4.70% and, to compound the success, the participation rate of employed has increased too.

This follows a good previous quarter for employment and is very promising evidence that anxious economists need not be concerned about broad economic prospects and that the Minister of Finance can reduce the scale of free money he might having been budgeting on spending.

ETO II – Vaccinations

Global Data:

Vaccinations delivered – 1.25 billion

Total (recorded) Corona Virus cases – 156 million

Active Cases – 19 million (stabilizing)

Daily rate of new cases – 7-800,000

People in serious condition – 109,000

Daily Deaths – about 14,000

Investment Opportunities

Sky City Bond – Skycity has announced the issue of a 6 year bond maturing 21 May 2027.

A minimum interest rate of 3.0% has been established with the final rate set on Friday 14 May.

The bonds will be listed on the NZX under the code SKC050.

No brokerage will be charged to clients.

Please contact us no later than 5pm Thursday 13 May if you would like to purchase the bonds (there is potential for scaling where investors receive fewer bonds than sought).

Bank Share Offer? – One very possible outcome from the review by Westpac Banking Group into what they'll do with Westpac New Zealand is to simultaneously list it on the NZX and offer all the shares for sale to new investors, thus becoming one of the largest IPO's to come to market in many years.

Initially most had reacted to WBC threats to exit NZ banking as either a negotiating tactic with the central bank, or an opportunity for another bank to buy a large chunk of additional market share.

It is unlikely that the Reserve Bank, or the Commerce Commission, would allow a steep decline in competition if ANZ, BNZ (NAB) or ASB (CBA) offered to buy WBC NZ.

Our smaller banks do not have the financial capacity to buy WBC NZ, in the same way that a whitebait doesn't attempt to eat a whale.

Kiwibank also looks too small to me but is a chance if its owners (NZ government via ACC, NZ Post and NZ Super) were prepared to add a lot more capital. It would become far more likely if WBCNZ was listed on the NZX and Kiwibank bought 51% allowing the public to participate also but without control.

Frankly it would make most sense to me if Kiwibank bought WBCNZ, merged the entities and listed 49% on the NZX for public investment.

This and the arrival of government guarantee on bank term deposits would finally remove the moral hazard of customers thinking the government guarantees Kiwibank and it opens the bank up to far more options for raising new capital for growth

The Hon. Jim Anderton (RIP) is long gone. His baby (Kiwibank) that many rejected before it started has become a success (of sorts - Ed) but it has the capacity to become a very strong player if the government allows it to expand and to simultaneously invite public investment.

You may recall that Westpac is the banker that arranges payments for the NZ government. It feels like a nice concept to migrate that payment facility into a bank that the government owns, or we could become the owners of!

Maybe after Kiwibank buys WBC NZ the government could add a little value for investors by extending the service agreement for government payment processing.

The banking, financing and payments playing field was changing rapidly prior to Covid19 but since then change has accelerated markedly. It is not a place for the faint hearted, witnessed in part by WBC proposing to exit NZ, so it is surely not the place for the government to be investing.

The government agrees with the progressive removal of cheques as a form of payment from the banking ecosystem (government departments don't accept this form of payment), and they'd like cash use to decline (crime linkages). So, in five years' time will you be only using EFTPOS, online banking and a credit card for payments, or, might you be using VISA or PAYPAL backed payments systems, or maybe stored value within a family of retailers?

Imagine a flybuys style card or application on your phone that TradeMe could credit from asset sales, and refunds and discount vouchers from retailers and reward schemes like Airpoints could be credited to.

Major retailers could then accept payment for groceries, energy or everyday items from these credits.

The emergence of central bank digital currency globally onto the payments playing field could open up enormous payment movements without the need for bank involvement. If real time (immediate) settlement becomes possible between a customer and say The Warehouse (WHS) why couldn't WHS be offered a settlement facility with the Reserve Bank for a NZ digital currency?

Then, along with other major retailers such as Air NZ, New World, Countdown, Z Energy, Trustpower, etc why wouldn't they offer consumers an integrated payment portal to use within this community, linked of course to sales benefits instead of bank fees?

Do you remember Facebook was trying to launch such a scheme, at their sole control, with their version of a cryptocurrency; LIBRA?

Then there's Bitcoin, for its disciples.

There's no doubting, it's becoming harder to 'be a bank'.

So if the government will not allow Kiwibank to buy WBC NZ, and WBC sells it to the public, will it still be called Westpac in NZ?

Surely.

It makes no sense otherwise. The name is an enormous part of the value (brand).

If WBC wants to exit NZ in terms of financial commitment and regulatory obligations it rather implies that they would need to license or franchise the use of the Westpac brand.

What might that cost?

In theory a lot, but how would that make sense to new investors; paying away an annual license fee from the current profit margin, which WBC describes as insufficient to tolerate continuing to operate within the NZ market themselves!

It is all very interesting and seems likely to lead to a rather large shift in NZ banking and may yet lead to one of the biggest share floats in NZ for a very long time. (Hence the position here within the newsletter).

Then if WBC succeeds with an IPO and brand licensing, would NAB immediately follow by selling BNZ and CBA possibly quit ASB?

Or might a Chinese bank claim the opportunity to dramatically expand their beach head in NZ?

So many permutations and mental gymnastics to consider.

I think I'll just wait for the facts.

Kevin Writes – Z Energy

 

Z Energy's profit announcement last week should have pleased its shareholders although there has been a muted response from investors with only a modest lift in Z's share price.

Z returned to profitability for the year ended 31 March 2021, announced a final dividend of 14 cents per share and signaled 19 to 23 cents per share for the year ahead. If achieved this would produce a very heathy dividend yield based on Z's current share price.

Perhaps investors are not yet convinced that Z's improvement is sustainable or that fuel volumes and margins will return to pre-Covid levels any time soon.

Certainly, recovery in Z's Jet Fuel business seems some way off despite the opening of the Trans-Tasman travel bubble.

Travel numbers have been low to date although snow and the Australian June/July school holidays should grow these numbers, provided, of course, Covid is kept under control.

Also suppressing Z's share price is probably an element of investors being a little peeved with the management and governance decisions that led to Z's demise in the first place.

The rapid growth of unmanned and no-frills petrol retailers like Gull, Waitomo and NPD over the past decade has put a lot of pressure on the mainstream petrol companies to cut their prices to remain competitive.

While the growth of the fuel discounters has been a thorn in the side for the big petrol companies, consumers should be grateful for their presence.

When Z bought Shell's fuel distribution business in 2010 they abandoned Shell's 'first mover' on price strategy and margins at the pump quickly increased.

The other big fuel companies were happy to take Z's lead and hold their prices also and the resulting margin expansion led to a very profitable period for the major fuel companies, mostly at the expense of consumers.

When the competition finally arrived, Z decided not to compete on price believing its customers would stick with them based on loyalty and convenience.

This error of judgement proved costly for its business and together with the Covid related disruptions which followed it has been a very challenging few years for Z and its stakeholders.

To its credit Z now has a plan and seems to be executing well, and despite its recent wobbles it is still NZ's largest fuel distributor.

Z's improvement includes $50m of structural cost savings, successfully growing its digital payments platform, and raising some equity to pay down debt which has shored up its balance sheet.

Reduced volumes and margins, due to Covid, have yet to cause the retail site closures many expected but Z believes this might be still to come.

With volumes down and capacity up you would expect some casualties and Z now seems better positioned to handle further sector disruption.

The recent Government inquiry into the fuel industry has resulted in new regulations which are likely to benefit Z, not disadvantage it, as many had predicted.

Long ago the major fuel companies invested heavily in infrastructure and made a commitment to service retail, commercial, industrial, aviation and marine customers throughout NZ, not just 'cherry pick' the best locations and sites.

This infrastructure included storage facilities and it seems the recently passed Fuel Industry Act will provide the framework for the majors to achieve more appropriate returns on these assets.

While it's still early days Z deserves some credit for turning things around during very difficult trading conditions.

TRAVEL

Edward will be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July 8 & July 9.

Johnny will be in Christchurch in May 20 and again in June. He will also visit Tauranga on 12 May.

Kevin will be in Timaru in mid-June, date to be confirmed soon.

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

Mike Warrington 


Market News 3 May 2021

May already, and my thirteenth May in the office.

Quick spot test - how many years have passed since the Global Financial Crisis that shook the financial system with the impact of an 8+ earthquake?

12.5 years!

It's already 13 months since the Covid disruption to finances.

Conclusion – Look forward and get busy.

INVESTMENT OPINION

 

Art or Science – Last week I had a client ask me if investment was an art or a science.

I felt like a politician as I offered my response by saying - both!

I explained to them, and now share with you here, that in my experience the best investors get the science right first, forming a robust foundation, and thereby tilt the probable outcomes in their favour.

Essentially, they are trying to neutralise as many downside risks as possible, leaving open more of the 'probable' upside rewards.

We’ve spoken a lot about the importance of investment rules, starting with asset allocation (influence of volatility), geography, business themes, and the use of financial advice with specific investment selection (risk versus reward scenarios by investment item).

This is part of the science.

Then the art begins as a lot of mental energy is spent on the forward looking 'if' and 'what if' scenarios.

For me 'if' relates to scenarios that I can readily define as a possible problem or threat.  I am spending most of my time looking for downside risks that threaten lost value, not reasons that might drive rewards higher (markets seldom have a problem spotting exciting opportunities to win, which probably means risk/reward is lopsided toward being overpriced).

'If' the government were to restrict or cancel mining licenses how would that impact the future of NZ Oil & Gas business?

If the Minister of Finance interferes with the operation of the central bank and adds irrational pressure to bank management obligations what might that mean to banking services and returns in NZ (remember Westpac is considering leaving NZ)?

If the Reserve Bank of NZ were to reduce the capital requirements of non-bank deposit takers, in response to the proposed deposit guarantees, what would that mean for the competitiveness of banks with lending?

'What if' is really just one's guesses about what might come out of the dark, from behind you, and completely disrupt the playing field.

Most of us felt we had reasonably good portfolios in early 2020 but almost none of us discussed the 'what if' risk of a pandemic emerging.  The steepest decline in the values of both shares and bonds was evidence that 'most' were shocked by the news event.

There have been other serious health threats over recent years but none that grabbed the world's attention, and forced response, as Covid19 has since the Spanish Flu 100 years ago.

Factoring in 1:100 risk scenarios under the 'what if' risk category seldom gains much traction with an investment decision.

Regulatory interference and losing an excellent chief executive too soon are far greater risks to the performance of an investment.

So, spend a lot of time on getting the science (foundations) correct then spend some time wondering how a selection of 'if' and 'what if' scenarios might impact your investment performance.

At your best you'll pre-define the way you'd react to certain unpleasant risks, should they emerge.

As ever, we are happy to help.

Tesla – has done as I suspected and become a Bitcoin trader, not a supporter of some new method of settling vehicle purchases; Tesla has already sold some of the Bitcoin purchased just a few months ago to collect some profits.

I'm not denying that Telsa made some money from the action, I am saying that it is evidence of poor management via a loss of focus on their real goal 'to accelerate the advent of sustainable transport by bringing compelling mass-market electric cars to market as soon as possible'.

Now the company describes Bitcoin as part of its capital-raising strategy, naively assuming the value of Bitcoin will only rise.

Again, it is a car company, not a cryptocurrency speculator.

Elon Musk must be perplexed then by the German who made a lot of money on Bitcoin and has used his profits to help finance a political party that proposes to ban the use of Bitcoin as a settlement method (gross unproductive waste of electricity)!

That's a nice segue to the next item . . .

Green Energy Supply – Demand for uranium (U3O8) is rising and whilst you might not like the idea it would appear that 'we' can't dislike both coal and nuclear energy simultaneously and hope to meet the global climate-related goals.

Some countries of the world are shying away from nuclear as a fuel for electricity generation (think Germany, Japan, NZ) but not China. They seem to need it in large scale if they are to meet their global climate change commitments, which demands a significant reduction in the use of coal.

Nuclear energy was without friends recently as a source of reliable, non carbon-emitting, energy but so poor is our effort with reducing carbon emissions that it seems China is recognising the need to increase the nuclear option.

I can imagine they'll operate such power plants with better discipline than others (Russia) and I can only hope they have better plans for storing waste material than dumping it in someone else's back yard.

China (presumably President Xi) recently approved the construction of five new nuclear power units to be built by 2026.  Being China, you can probably safely bet that they'll be delivered on time.

China's longer-term plan, out to 2035, is to build 3-4x as many nuclear power units on top of their current portfolio, but even this only represents 10% of the nation's electricity use (with or without Bitcoin mining? – ed).

The article I read concluded: If we assume reactors take 5 years to build, on current technology China will need to approve 10-12 new reactors per year between now

and 2030.

If you'll excuse the pun, the fund management industry is becoming energised about the renewed demand for uranium and the rising price.

The uranium mining industry is tuned in to such developments and is quickly re-opening dormant or suspended mining operations (Cameco – Cigar Lake, Paladin – Langer Heinrich in Namibia).  The interesting one in this group is Cameco because Canada had been actively reducing its mining volumes over the past five years but this has now been reversed and strong increases are expected.

The analysts describe China's plans as requiring an increase in demand for uranium of 65 million pounds per annum for at least the next 60 years!

The market price for uranium confirms the re-emergence of demand with spot prices rising from the lows of US$21/lb back up to US$30/lb which seems to be the level required for sustainable mining commitments.

https://www.cameco.com/invest/markets/uranium-price

Actually, this is an interesting market to observe because it displays a low level of price volatility, which likely relates to the fact that uranium does not trade on an open market for nuisance speculators like me to interfere; all transactions are negotiated agreements between the miners and the users of the resource.

I always wondered when someone would confirm that the only way the world can meet its 2030 and 2050 targets relating to carbon exhaust reductions (climate change) was to include nuclear power generation in the supply mix.

If we are to truly disinvest, removing capital from the coal miners, we need to invest in other forms of electricity generation, including nuclear energy.  Over the next decade or more, solar and wind have no show of supplying sufficient energy to replace coal, let alone oil and gas.

Remember of course that one strategy is to drive up the use of electric vehicles, thus increasing the need for additional electricity generation.

Nobody said it would be easy.

Digital Currency – These new digital payment methods won't arrive quickly, but it is clear they will arrive widely across most developed economies and are being encouraged by the Bank of International Settlements.

China seems to be determined to lead the pack with its digital Yuan constantly in the headlines, which is unquestionably 'approved' by President Xi.

The Bank of England has just announced that it has opened its Real Time Gross Settlement system to integrate with blockchain-based payment methods.  What an impressive step forward.

I am excited about what our central bank will one day create in the digital payment space for NZ and hope that it enables significant steps forward with payment efficiency, which should accelerate the velocity of money in our economy.

If we combine the efficiency of this future method of payment with widely accessible tutorials for the public then people currently concerned about the retirement of the cheque may well wonder why we kept such quaint pieces of paper in use for so long.

EVER THE OPTIMIST

There is a bubbling sense of economic optimism appearing in the headlines, growing at the rate of the vaccine rollout.

NZ has enjoyed ongoing and smoothed out optimism, having remained largely Covid free, but nations that have locked down, long term, are bursting free with far more potential energy than we ever experienced.

Vaccination is still one of the major stories for 2021, across all economic and health matters globally; the other is the flood of surplus cash being supplied.

Yes, the optimism is lopsided toward the wealthy nations who are leading the charge but before you cry 'unfair' we should acknowledge that wealthy nations will do the most business with others and be most generous in supplying the vaccine to the poorer nations.

The scale of savings that has been accumulated during the Covid period, both for security reasons and because people were locked down, is becoming enormous (one estimate was US$5.4 trillion!) and you just know people are itching to get out and consume in public again.

Maybe some of the wildly optimistic economic growth forecasts won't be wild enough?

ETO II – Vaccinations

Global Data:

Vaccinations delivered – 1.15 billion (20 million per day!)

Total (recorded) Corona Virus cases – 150 million

Active Cases – 19 million

Daily rate of new cases –9,000

People in serious condition – 110,000

Daily Deaths – about 15,000

Interesting fact – the first 100 million doses of vaccine took 61 days to inject. The latest 100 million took five days!

Israel – whilst they are now finding it difficult to rise above 60% of the total population, they have achieved 85% vaccination for those aged over 70 years.

Investment Opportunities

ASB Bank – very quickly issued a new series of 5-year bonds last week with a yield of 1.64% p.a.

These bonds sit alongside (parri passu) bank deposits in terms of risk and the return is very similar to that of bank deposits, but bonds offer the additional value of liquidity (saleable).

These bonds can now be purchased on the market if investors still wish to access this investment type (we will help).

Thank you to those who participated in this fast-moving bond offer with us.

TRAVEL

Edward will be in Wellington on Wednesday 12 May. He will be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson on 8 and 9 July.

Johnny will be in Christchurch on 20 May and again in June. He will visit Tauranga on 12 May.

David will be in Kerikeri on May 6 and Whangarei on May 7.

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

Mike Warrington 


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