Market News 28 November 2022

David Colman writes:

Last week’s RBNZ announcement would have came as little surprise to our readers with its forecasts of economic clouds getting darker. Inflation remains high.

The RBNZ announced an OCR increase of 75 basis points (it did consider a 100 basis point increase) to 4.25% and repeated a number of the bank’s conclusions that the CPI is too high, employment is beyond a maximum sustainable level, and that near-term inflation expectations have risen.

Tourism was noted as on the rebound which was one of the few silver linings. The forecast is for 2 million tourists next year though Covid remains a threat to this figure.

Household spending was noted to be resilient although many households will not be experiencing higher interest rates if they have not had their mortgage rate reset in the last 6 months to a year.

Recent homebuyers will be affected more than those that bought years ago.

It seems some mortgage holders are drinking the rum instead of battening down the hatches as they sail full speed into a maelstrom.

The RBNZ now predicts the OCR may peak at 5.50% next year (this would be 125 basis points higher than today) and that reduced demand may lead to a contraction of the New Zealand economy (a recession) from mid 2023.

New Zealand‘s short term interest rates have increased at a much faster pace than long term rates which has resulted in an increasingly, inverted yield curve (long term government bonds offer a lower rate than short term) which has often been an early indicator of recessions in the past.

We are strangely in an odd moment where the central bank is screaming at us that it will raise rates at the same time it predicts a recession (albeit mild) when interest rates often fall, and are certainly more likely to fall from rates at higher levels. Uncertainties regarding which way and how hard the RBNZ will pull its OCR lever in the medium term are substantial but ultimately it will keep increasing rates, or simply keep them the same, until inflation is heading towards the 1% to 3% target range.

2023 is shaping up to be another fascinating but fitful year.

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Interest rates are impossible to predict with certainty (see above) so a degree of laddering is often utilised when establishing the fixed interest portion of a portfolio.

Typically this involves a variety of bonds and term deposits that mature over many years allowing investors to have funds become available regularly either for reinvestment or to pay for expenses if needed. It also helps with interest rate risk by keeping a lid on the value of investments repaid in a year where interest rates may be more or less favourable than other years. The goal is to achieve a higher average rate of return over time.

Another way to spread interest rate risk can be to have a small allocation to those bonds that reset on an annual basis. These bonds will follow interest rates both up and down unlike most bonds that are fixed for a term of 5 to 10 years.

There are a number of annually reset bonds on the New Zealand debt market with two such bonds issued by Infratil (IFTHA & IFTHC) that are reset annually. If underlying interest rates climb between the reset dates then the annual rate of return increases, if underlying interest rates fall then the annual rate of return decreases.

IFTHA was issued at a time when interest rates were higher but margins were lower and is reset annually at a margin of 1.50% plus the 1 year swap rate and is perpetual (IFTHA have no maturity date). These bonds tend to trade at a significant discount (73c) to par value partly due to there being no expectations for Infratil to repay the bonds at any time in the future. IFTHA was last reset on 15 November to a rate of 6.45% per annum and is next reset on 15 November 2023. The discount these are trading at, 73c in the dollar, lifts the effective cash return to above 8.50% at present.

IFTHC bonds were issued when interest rates were low but with a higher margin than IFTHA of 2.50% and have a maturity date of 15 December 2029. IFTHC currently have an interest rate of 4.19% and are next reset on 15 December this year. Based on the 1 year swap rate, which is currently above 5.0%, the new rate may be reset at 7.50%p.a. or more. These bonds tend to trade close to par as they have a known maturity date and will tend to have an interest rate that reflects market conditions when it resets annually.

Another reset security is Quayside Holdings Perpetual Preference Shares (QHLHA) which are reset every 3 years based on a margin of 1.70% plus the 3 year swap rate, next reset on 13 March 2023. The 3 year swap rate has moved above 5.0% in recent days which may mean an interest rate set next year may be well above 6.7% although it is four months before the rate is next reset and much can change between now and then. Quayside Holdings is an extremely strong investment, and has a put option to the Tauranga City Council. Quayside Holdings owns 54% of Port of Tauranga.

All of these investments pay interest quarterly.

Please contact us if you would like more information on these investments.

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Sky Network TV (SKT) confirmed it has implemented its $70 million capital return to shareholders.

SKT shareholders have had 1 share cancelled for every 6 shares held and will be paid $2.40 for every cancelled share on the 29 November.

This is a substantial change from May 2020 when the company scrambled to raise $157.2 million which was primarily used to pay down debt including repaying $100 million worth of bonds in March 2021.

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NZX Limited (NZX) continues to expand the scale and scope of its Smartshares fund management business with the acquisition of QuayStreet which on top of the recent purchase of the ASB Superannuation Master Trust takes Smartshares’ managed funds close to $10 billion. ANZ Investments continues to be New Zealand’s largest fund manager managing $30 billion of investor funds.

The New Zealand fund management industry seems to be consolidating into a smaller number of large players.

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Property related companies Argosy, Stride and Oceania reported half year results last week serving as a useful update on the sector. Property industry share prices have declined this year in the face of inflation and interest rate increases yet markets believe the companies are worth far less than their NTAs (Net Tangible Assets) estimates in the current climate. It may take many years before asset values seen last year are seen again.

Argosy Property Limited (ARG) results for the six months to 30 September 2022 highlights: - Net property income of $55.0 million, up 3.6%; - Net distributable income of $32.9 million; - Adjusted Funds From Operations (AFFO) of $32.0 million, up 25.7%; - Continued high occupancy of 98.9% with Weighted Average Lease Term  of 5.5 years; - $23.5 million revaluation loss resulting in a decrease in NTA per share to $1.72 from $1.74 at 31 March 2022 - Continued successful focus on sustainability and progressing green developments; and - Unchanged FY23 dividend guidance of 6.65 cents per share, a 1.5% increase on the prior year

Argosy has a diversified portfolio by location and sector with a few Government tenancies helping support the company’s earnings and dividends.

Argosy opened 8-14 Willis Street in Wellington for Statistics New Zealand in July.

Tenants have been observed to favour sustainable green rated buildings, which Argosy has increasingly looked to develop and supply.

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A combination of Stride Investment Management and Stride Property, Stride Property Group reported results for the six months to 30 September 2022, highlights being:

- Higher net rental income of $34.1m (up $3.4m or 11.2%).

- Management fee income was relatively stable at $12.0m (down $0.2m or 1.2% from HY22) with higher underlying recurring management fee income partially offsetting lower activity-based and performance fee income

- Profit before other (expense)/income and income tax at $25.3m was up 8% after allowing for the abandoned Fabric Property listing

- Portfolio devalued by $51.8 million from 31 March 2022, contributing to a loss after income tax of $53.1m (HY22: $61.5m profit after income tax)

- Higher distributable profit after current income tax of $29.3m, up 21.2%

- NTA of $2.14, down 6.1%. (NTA does not include the value of SIML’s management contracts)

- SPL’s loan to value ratio is 32%

-Distributable profit guidance for FY23 of 10.0cps to 10.5cps, and updated dividend guidance of 8.00cps combined cash dividend for SPL and SIML for FY23, down from 9.91cps.

Stride announced it has strong interest rate hedging in place which will help provide protection against interest rate fluctuations, and a stable distributable profit profile, planning to take a prudent and proactive approach to cost and capital management.

A refined dividend policy will target a total cash dividend to shareholders between 80% and 100% of SPL’s distributable profit and 25% to 75% of SIML’s distributable profit

Stride still intends to establish and list a new Stride Product when market conditions are conducive, despite the failed effort to list Fabric, a concept the market and retail investors disliked

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Oceania (OCA) results for the six months to 30 September 2022 highlights:

- Total assets increased to $2.5bn representing 12% growth since 31 March 2022. The increase includes the addition of the Remuera Rise and Bream Bay acquisitions for $57.0m with a combined 83 villas, 58 apartments and 12 premium hospital beds. - Realised gains from new sales and resales up 12% compared with the prior corresponding period, with strong development and resale margin performance. - Increased bank facility from $350m to $500m - 127 care suites delivered in Auckland and Motueka. - 519 units and care suites currently under construction across ten sites in Auckland, Hamilton, Tauranga, Blenheim and Christchurch. - Interim dividend of 1.9 cents per share (not imputed)

Oceania continues to target growth to meet demographic demand.

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The recent collapse of multiple cryptocurrency-related outfits including 3 Arrows Capital, Celsius, FTX and Alameda, let alone the crash in crypto values, are reminders that new technology remains a space that requires careful navigation.

For every success there can be many more failures with many digital assets, related platforms, and technology sector personalities, in their infancy compared to traditional asset classes, global exchanges and established company CEOs.

Even established institutions such as the Australian Securities Exchange (ASX) learnt that new technology does not always provide a practicable solution after it failed to find an effective distributed ledger technology (DLT) alternative to its aging CHESS (Clearing House Electronic Subregister System) after spending $250 million, spread over many years, on the now abandoned effort.



Chris will be in Christchurch on Tuesday November 29 (pm) and 30 (am) with available times at 9am, 11.15 and 11.45 on Wednesday.

Chris will be in Cromwell on Thursday December 1, available at the Harvest Hotel at 9.15 and 12 noon.

Edward Lee will be in Wellington on Wednesday 30 November at the ANZ centre on Featherston Street and has one appointment left.

Chris will be in Taupo Dec 4-16 and could meet by arrangement.

Anyone wanting an appointment is welcome to contact us.

David Colman

Chris Lee & Partners

Market News 21 November 2022

Johnny Lee writes:

Infratil and Ryman have both reported to market, with more than a few interesting points being raised for investors to consider.

Infratil reported a modest increase in earnings, with every major investment contributing positively, other than Manawa (formerly Trustpower).

Even RetireAustralia saw a rebound in profit, as it moves ahead with acquiring development sites to continue expansion. RetireAustralia has spent most of the year under review, as Infratil considers its future within the organization.  One imagines this will not require another year of review.

Manawa's result was impacted by two major problems – lower generation and lower pricing – leading to a drop in dividend at a time when capital expenditure is likely to soar. Manawa is one of Infratil's oldest investments, and has long formed part of its cash-generative core business.

CDC, the data centre arm, is anticipating an extremely busy year, with construction beginning across its expansive development ambitions. This is clearly a very high conviction investment for Infratil, as it looks to build on the huge success it has already enjoyed from this sector.

Vodafone has now paid for itself, with cash distributions received now equal to the amount Infratil initially paid. Vodafone's next journey will be its rebrand to One NZ next year.

Longroad and Gurin continue to expand their respective development pipelines, with Longroad planning a significant amount of construction over the next year.

Lastly the diagnostic imaging arm enjoyed an increase in earnings, but the full year forecast was lowered, primarily due to ongoing COVID impacts.

Overall, the company enjoyed a strong half, with a slightly higher dividend and a busy six months ahead of their full year result.

Ryman's half year result was in line with its peers, seeing continued demand and sales, but negative revaluations impacting the headline reported figure when compared to the half year result from last year. The share price saw a modest decline, continuing a torrid twelve months for the company's owners.

Occupancy was marginally lower, a trend that needs to be reversed, but the growth in cash receipts will be encouraging to shareholders, as the dividend was able to be maintained from these earnings.

Property valuations have been, and will continue to be, a common theme across the market. Readers will recall that some companies, such as Seeka and The Warehouse, have been joining a global trend of ''sale and leasebacks'', where companies elect to sell their properties and agree to become a long-term tenant, shifting the risk of property revaluations to the new owner.

Ryman, of course, does not operate such a model (for good reason) and its existing approach has been enormously successful over the long-term on the back of long-term positive revaluation gains. Its land bank and development pipeline are both immense, giving the company a clear roadmap for the next decade of growth, and considerable flexibility if demand profiles and asset prices necessitate a change.

Despite the declining share price, Ryman will be comfortable that a period of higher interest rates and diminishing asset values is able to be managed and endured. The fall in share price this year is logical, and shared amongst its peers in the sector.

Lower asset prices represent both a risk and an opportunity, especially for long-term, well-capitalised players like Ryman and Summerset. While the share price remains in a downward spiral as land and property values decline, there remains a strong demand for its product as more developments come online.

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Our horticulture sector took a turn for the worse last week as both Seeka and T&G Global provided updates to the market, both followed by share price declines.

Seeka reported a large downgrade in earnings guidance, following a late shipping season and poor fruit quality across the industry. In August, Seeka made the decision to suspend its dividend, despite an increase in revenue and profit. At the time, the board justified the decision by stating that it foresaw a period of uncertainty in the near-term.

T&G Global reported an even sharper downgrade in guidance, now expecting a modest loss for the year. It blamed a poor apple harvest, leading to consumers turning away from their apples and leading to an oversupply of rapidly deteriorating fruit.

The horticulture sector continues to struggle with staffing issues, with more reports of rotting fruit and vegetables as farmers struggle to attract workers. Part of the problem being encountered is the geographical discrepancies in our national labour supply, with the Otago region reporting virtually zero unemployment, compared to the Northland region, where both the participation rate is low and the unemployment rate is (relatively) high.

Migration data from last week shows that the number of people coming to our shores to work is slowly rising, offering hope for those sectors that are seemingly unable to find staff elsewhere.

Long-term investors in the horticulture sector will be well aware of the risks involved – weather, disease, labour supply, commodity prices, logistics, exchange rates – and will be accustomed to the cycle of good years and bad years as an investment. As such, a one-off reported loss will not necessarily spell doom for the companies in question or signal poor management.

An ongoing trend of poor results, especially when peers are seeing a different trend, would be such an indication.

Both Seeka and T&G Global report their financial results in February.

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One group of shareholders that will be hearing alarm bells are those holders of My Food Bag.

The company reported its result on Friday, showing far fewer deliveries, lower revenue and a significantly lower profit. The share price hit fresh lows immediately after, as large sellers finally began quitting the company, and the absence of buyers was laid bare. Some buying interest later emerged, but market observers would have noted that the interest was a large number of very small buyers, a pattern typically associated with retail traders.

On the positive side, the dividend of 3 cents was maintained, bringing the total for the year to 7 cents, or a dividend yield of near 20% gross. The company provided an explicit warning that next year's dividend would be lower, barring a recovery in market conditions.

As a company that relies heavily on recurring revenue, the steep fall in deliveries is a very negative sign, and one that must be addressed urgently. The company does note that sales of the Bargain Box brand actually grew, as some customers pivoted towards the cheaper product, rather than abandoning the company altogether. The company has been resistant to the idea of positioning itself as ''the cheap option'', knowing that such a perception is difficult to reverse.

The company's report makes considerable effort to highlight that there has been growth if one specifically compares the 2023 half year result to the 2020 half year result. While this is factually correct, the recent change in economic conditions make such a comparison less useful, unless one takes the stance that a return to 2020 conditions is imminent.

My Food Bag must learn to better adapt to this environment. The news that customers are changing to lower value (and lower margin) product is absolutely preferable to simply abandoning the service altogether. However, the company notes that as overall numbers are declining, the benefits of economies of scale are reversing, and cross-selling opportunities are becoming more difficult.

Could the company be of interest to a larger competitor, seeking an established business in New Zealand? Perhaps, although such a competitor is likely facing the same trends. Merger and acquisition activity has been muted as of late, and the days of borrowing cheap debt to fund long-term loss-making ventures are passing.

The report puts forward its strategy for reversing the trends seen over the last six months, including supply chain improvements, and targeting new customer types, including vegans. However, the outlook is blunt in this respect, forecasting further declines in earnings and lower deliveries in the short-term.

The company's value has declined heavily over the last eighteen months, from near $450 million last year, to nearer $120 million now. This decline may lead to a corresponding reduction in analyst coverage and fund manager interest, as it leaves indices and funds exit the company.

Inflation and rising interest rates have claimed many casualties around the globe so far. My Food Bag will need to be clever to avoid such a fate.

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A brief update for Contact Energy shareholders, as the company hosted an Annual Shareholder Meeting last week, which included an address from both the Chairman and CEO.

The Tauhara geothermal development remains on track for completion in 2023, but has encountered significant budget overruns. Modest increases in capacity will mitigate a small proportion of these overruns.

The Chairman notes that once this development is active, the company intends to decommission the gas-powered station in Stratford, as part of its decarbonisation goals. Wind, solar and battery storage are likely to remain the focus going forward.

The number of broadband customers continues to grow, as cross-selling opportunities prove effective at ''bundling'' customers together. Trustpower's retail arm – now owned by Mercury – pursued the same strategy to some success.

Long stretches of the speech were aimed at the proposed Lake Onslow battery scheme, as the electricity industry starts to weigh in on the merits of the project. It is clear that such a project could have implications for the entire industry, context that is important to recall as the debate continues.

Part of this is simply the unknowns behind how it would operate, how much it would cost and how long it would take. The electricity sector plans its developments and future production many years in advance, based on assumptions around both future demand and future supply. Having variables introduced can change the economics of these developments.

Others argue that it is a horrendously inefficient solution, politically flashy but ultimately poor value for money, solving a relatively minor problem in an unintelligent way.

The completion of Tauhara and shuttering of Stratford will represent a significant change for Contact Energy over the next two years. From there, solar is likely to emerge as a focal point.

Many variables exist, including demand for things like electric cars and rooftop solar. The challenge will be to navigate these changes in a way that enhances shareholder value, while maintaining the standards expected of corporate citizens.



Chris will be in Christchurch on Tuesday November 29 (pm) and 30 (am) and in Cromwell on Thursday December 1 (am).

Edward Lee will be in Wellington on Wednesday 30 November at the Regus on Featherston Street.

David Colman will be in Whangarei on Monday 28 November.

Anyone wanting an appointment is welcome to contact us.

Johnny Lee

Chris Lee & Partners Limited

Market News 14 November 2022


Johnny Lee writes:

Two rare pieces of good news gave investors cheer late last week, one with global impact with the other more localised.

US inflation data arrived first, showing a much more modest rise than expected in consumer prices for the month of October. 

For context, markets responded by repricing expectations from a 0.75% increase in the Fed Funds Rate in December to a 0.50% increase. Inflation remains an issue, and this is not the end of interest rate hikes. Nevertheless, such a change was enough to see the Dow Jones rally 1,000 points. The market seems desperate for good news and was pleased to take this as a first step.

One of the sectors seeing the largest price adjustments in the US has been second-hand motor vehicles, a market that re-priced sharply higher during the supply chain crisis after COVID and the resulting impact on shipping rates. As financing has become more expensive, the American consumer is electing to own its cars for longer. In this instance at least, rising interest rates are impacting consumer prices.

The concept of a ''soft landing'' has been long pursued by central banks, where economic risks are managed without triggering severe economic pain. While market pricing suggests the risk of recession remains, this single data point will be a welcome relief to hoping to see the impact of all the recent rate rises.

The other piece of good news came from listed retailer The Warehouse, which continues to see foot traffic and sales increase in the post-COVID environment.

While the decline in profit margin is less than ideal, it is perhaps more of a reflection of the changing nature of its products towards lower margin goods, following its expansion into grocery products. The strategy - undercutting supermarkets to get the masses through the doors - appears to be working.

Online sales are beginning to moderate, itself a double-edged sword. Online shoppers tend to be more disciplined in their consumption, seeking specific items and naught else. However, online retailing also carries the benefit of efficiency - 24 hour service, no need for prime locations and parking, and none of the staffing difficulties normally associated with frontline retail.

The fact that consumers are still happily spending means the forecasted slowdown in discretionary consumption is yet to reach our shores. Avoiding it entirely seems unlikely. However, the retail sector will be pleased that consumers, for now, are still keeping the wheels of our economy turning.

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The Mainfreight juggernaut continues to grow, as the company reported it had eclipsed 3 billion in half year revenue for the first time (in 2020, revenue at the half was $1.6 billion). The dividend soared, as the company reports new business gains greatly outweighing the declines in shipping freight rates.

Belief, internally at least, seems to be extremely high. Insiders are spending millions buying their own company's shares, despite the relatively high share price. At a time when many listed companies are pausing investments in the face of uncertainty, Mainfreight is barrelling ahead with its plans to increase capacity and service levels. The outlook is bullish, forecasting continued growth across all regions and all sectors.

Mainfreight's result announcements have always been unique due to their very modest approach to success. The company described the 66% increase in net profit as ''satisfactory'' but with “more work to do”. It is beyond doubt that this culture is an enormous part of the company's success.

Another of our major growth stocks saw a sharp increase in share price on Friday, albeit for a very different reason.

EBOS rallied over 10%, before moderating slightly, following the announcement that it would be included in an MSCI Global Small Cap index. It was to replace Synlait Milk, which in turn saw a share price decline.

Inclusion in these indices may seem meaningless to the casual observer, but it absolutely does lead to increased net buying. Part of this is due to the exchange traded funds which track these indices. The iShares World Small Cap Fund, which has $2.4b US under management, is one such fund.

Of course, when these funds leave such an index, perhaps due to methodology changes, growth in other companies or a new listing, the impact reverses. 

For EBOS, the share price rise equates to about $700 million of company valuation.

Not bad for a day's work.

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The world of cryptocurrencies was thrown further into disarray last week, following the collapse of the second largest cryptoexchange – FTX - and a feared contagion amongst the sector. The company's billionaire (as at time of writing) founder and owner has since resigned, as the company declared bankruptcy.

Adoption of cryptocurrencies across New Zealand, thankfully, remains low. Recent data suggests only about 10% of New Zealanders have exposure to the sector, below the global average of nearly 15%. This was expected to climb, with the world's largest cryptocurrency exchange provider – Binance – now seeking approvals to expand into New Zealand.

Ironically, one redeeming factor for New Zealand investors of cryptocurrency this year has been the relative underperformance of the New Zealand Dollar. While this may do little to cushion those staring at losses of almost 60% of total value, silver linings are fairly difficult to come by at the moment.

For advocates of cryptocurrency, these wild swings do nothing to convince the masses that it is the path of the future. Indeed, one must wonder what future economic textbooks will say of this period of time, when over a trillion of global wealth was invested into, stored, then lost in Bitcoin. Is this a period of madness, fuelled by greed and naivety? Or merely a speedbump on its path to riches?

Several related parties to FTX have since announced they are halting withdrawals for customers, a worrying trend and one that threatens to spiral beyond control if confidence deteriorates. While confidence plays a role in asset pricing generally, it plays a particularly powerful role in the pricing of virtual assets. Those hoping that their value would be underpinned by their finite nature may soon be discovering the weakness of this argument.

Part of the unravelling of this sector is revealing just how intertwined many of the products are, including cryptocurrencies which invest in other cryptocurrencies. Many of the so-called ''cryptobillionaires'' are also revealing themselves to have very little real wealth behind the digital assets, unable or unwilling to help the millions of people depositing funds into their platforms.

I accept there are absolute diehard believers in the world of cryptocurrency who will disagree with these words. Their online presence is difficult to escape. I only hope that, if there are indeed 500,000 New Zealanders electing to invest in this sector, that the story ends more happily than I fear.

While these market ructions were occurring, a rout of a different sort is playing out in the US technology sector.

Meta, the parent company of Facebook, has announced it is laying off 13% of its staff, cutting 11,000 jobs as its share price continues to fluctuate. It enjoyed a brief share price bounce following the news of the layoffs, as investors interpreted the move as an acknowledgement from CEO Mark Zuckerberg that the company needed to change its course.

Across the (virtual) road, Twitter announced it had cut ''approximately 50%'' of its workforce, as owner Elon Musk began to stamp his mark on his newest acquisition.

Within days, there were reports that laid off staff were being asked to return to work.

Concerns are now being raised – publicly, by the new CEO, via Tweet – that advertisers are considering abandoning the platform, seemingly fearful of being tainted by the company and its users. Advertisers have a fairly diverse range of social media platforms to target now, and competition for advertising dollars remains intense.

The Eli Lilly debacle - where a listed pharmaceutical company saw its share price tumble 5% after an impersonator paid to be verified as representing the company before declaring that the company would provide free insulin - shows that credibility in the platform is in danger of evaporating entirely.

The first challenge for the company, however, will be to align its desires for ''free speech'' with advertisers' concerns of the risks of lesser content moderation.

These large-scale job layoffs seem to be occurring across the technology sector in general, which has swelled in size over recent years. The pandemic drove significant investment from the major companies in the sector, and the relatively quick shift in the economic cycle is causing a rethink of these decisions.

A thought must be spared for the young people preparing to enter the workforce, especially those with dreams of entering the technology sector. With the pace of change in the world today, one imagines that young people planning a career choice today would need to think very carefully before committing to a career path. 

While some sectors - like healthcare - are reporting severe staff shortages across the board, and have done for years, others are going through very abrupt boom and bust cycles. 

Hopefully, we will see no such large-scale layoffs on our own shores.


Edward Lee will be in Auckland on Wednesday 16 November (Ellerslie) and Thursday 17 November (Auckland CBD).

David Colman will be in Whangarei on Monday 28 November.

Chris will be in Christchurch on Nov 29 (pm) and 30 (am) and in Cromwell Dec 1 (am).

Anyone wanting an appointment is welcome to contact us.

Chris Lee & Partners Limited



Market News 7 November 2022

Johnny Lee writes:

AS expected, the United States Federal Reserve has lifted interest rates again - by 0.75% - while dropping some clues for investors as to the direction of interest rates for the world's largest economy.

Markets responded positively at first, grasping onto a subtle change in language in the statement that implied that interest rate rises would slow. In a subsequent news conference, Chairman Jerome Powell clarified that further interest rate rises were indeed coming, and fears of an economic recession would not alter the path. Inflation, he argues, is the greater enemy. Predictably, share prices turned south after the conference.

Politicians in the US have begun to publicly express their disapproval with the direction Chairman Powell is taking, arguing that rising interest rates will lead to rising unemployment and lower economic growth, and damaging their chances at the polls. They are almost certainly correct. As Powell himself said, ''I wish there were a painless way to do that (lower inflation). There isn't.''

This trend towards politicisation of Central Bank actions, while perhaps politically popular, is disappointing. Central bankers, of course, are not above reproach. However, politicians demanding interest rates be lowered in order to ease pressure on households would be wise to recall the trade-off to this. One of the reasons politicians need monetary policy independence is to ensure that necessary but politically unacceptable decisions can be made.

As we approach the election next year, I expect those keen for airtime will pursue these lines further. Poll after poll shows that the cost of living remains the prevailing concern for the electorate, and a central bank hiking interest rates may be viewed as a ''free hit'', as mortgage repayments consume a growing proportion of New Zealander's disposable income.

The idea of controlling Kiwisaver contributions to weaken discretionary spending is also re-emerging, although this does create other unwelcome side-effects, while shifting the burden of inflationary pressures from one group to another. The idea is also an easier sell when investor returns are rising, rather than falling.

Another topic being raised is the impact of unemployment on inflation.

Much is also being made of commentary surrounding NAIRU – the non-accelerating inflation rate of unemployment – and whether inflation is being fuelled by constraints on our labour supply. Immigration and evolving attitudes towards work/life balance are changing our workforce.

The argument goes that businesses requiring staff must pay more when the pool of available labour is so constrained. While there remains a number of people out of work within New Zealand, many of these people lack the skills for the available jobs, or are located in the wrong part of the country to fulfil needs. One of the benefits of migration is that both of these issues are solved, by pointing skilled workers towards areas of need.

However, such public discussion has a habit of being reduced to more simplistic terms. In this case, ''low unemployment is exacerbating wage inflation'' – a fairly innocuous stance - was re-interpreted to ''jobs must be lost to control inflation'', triggering an angry response from some quarters.

The Reserve Banks focus, for now, remains to control (lower) future inflation. Rising interest rates will be the tool used to affect this. Those seeking a different outcome must be mindful of the alternative.

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NEW ZEALAND also had some data last week, highlighting that wage increases have continued their virtuous spiral upwards, as workers demand higher wages in response to rising costs.

Higher wages and high prices will result, of course, in higher nominal tax revenue, something of a boon for Governments who have long hoped to ''inflate the debt away''. The Governments Financial Statements from last month revealed that, as wage increases push workers into higher tax brackets, the nominal tax take had increased sharply.

Data from The Bank of England followed suit shortly after, as it lifted rates by 0.75%, the largest such increase in over 30 years.

The UK central bank also issued a projection that its economy is likely to enter a recession soon, that may extend until at least late 2024. With a country already suffering from severe energy inflation, it seems the worst is yet to come.

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A2 MILK'S announcement that it had received temporary discretion to import its Infant Milk Formula into the US was cheered by the market, despite the company seemingly playing down its importance. The share price rose around 5% following the announcement.

Earlier in the week, A2 had confirmed it was intending to take legal action against Care A2+, a rival milk producer in Australia, for infringing on its trademark. While it is in early stages, with luck, this action will not be unduly time consuming.

Protecting its trademark in this way, at the very least, will have the benefit of warning others from trying to leverage off what it sees as its brand, built over many years and many millions of dollars.

The approval to enter the United States is temporary – expiring January 6 2023 – but may be extended through to October 2025. As such, it is difficult to quantify the exact value of this opportunity. A2 Milk itself was careful to highlight that the opportunity may be short-lived and of little relevance to shareholders.

These short-term approvals were triggered by the US infant formula shortage earlier this year, the shortages themselves triggered by a large-scale product recall following the death of two children and an alleged link to an infant formula provider.

The approvals are temporary, partly, due to the fiercely protective dairy lobby in the United States. The four years during Donald Trump's presidency saw a sharp rise in global protectionism, a trend that has shown few signs of reversal.

Reading the announcement, an investor would be forgiven for wondering why the opportunity is being pursued. A2 was clear that the US market is highly competitive, and entering this domain would see margins fall and distribution costs increase. Clearly, this is a longer-term strategy, allowing A2 an opportunity to open doors and prove itself to a wider, wealthier audience.

A2 Milk, of course, is the same company currently combating a class action regarding its financial disclosures. Its legal team has had a busy year.

Time will tell whether A2 is able to fully harness the opportunity in front of it. The early share price response suggests very cautious optimism.

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WITH an inflationary environment so suddenly following a deflationary one, a question commonly posed asks whether the low-yielding bonds of yesteryear should be sold in favour of more recent, higher yielding issues.

While every situation is different, some truisms are worth recalling.

There is no free lunch. When bonds are sold, they are sold at a price mutually agreed by both parties. A buyer of low-yielding bonds may demand a steep discount, whereas a seller of high-yielding bonds may demand a premium.

In 2020, the Auckland Council issued bonds maturing in 2050, offering an interest rate of 2.95% per annum. After initially seeking $300 million, the Council eventually accepted bids totalling $500 million. At a time when investors were fearful of interest rates turning negative, the issue closed oversubscribed. Some of the more unscrupulous ''advisers'' elected to profit further from this demand, buying the bond for themselves and on-selling it to clients at an even lower yield, arguing that such actions were ''market forces''.

The economic cycle changed, and negative rates never eventuated. 2.95%, even from our largest council, is now well below the market average. A seller of these bonds today would reap barely 60 cents in the dollar. The seller could then elect to invest into a more recent bond, earning an interest rate of, say, 6%.

At the risk of oversimplifying the equation, a $10,000 investment earning 2.95% has become a $6,000 investment earning 6.00%. The $4,000 difference has, effectively, been transferred to the buyer of the lower yielding bonds. Although other factors will form part of an investment decision, that loss of principal is permanent.

Add brokerage - both ways - into the deal, and suddenly, the lunch is looking quite expensive indeed.

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Johnny Lee will be in Christchurch on Wednesday 9 November.

Edward Lee will be in Auckland on Wednesday 16 November (Ellerslie) and Thursday 17 November (Auckland CBD).

Anyone wanting an appointment is welcome to contact us.

Chris Lee

Chris Lee & Partners Limited

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