Chris Lee & Partners Ltd

Market News 30 October 2017

I don’t really want to introduce a ‘Brick Bat’ category to Market News but on this occasion, I’ll highlight the fact that Vital Healthcare Property Trust has not offered an online voting channel for its unit holders.

This is very poor form in today’s financial markets and technical landscape.

Investment Opinion

Volatility – Some weeks back I speculated that Warren Buffett maybe be partly responsible for the ongoing decline in volatility of financial markets.

Financial market volatility is setting new all-time lows during 2017, well below 10%, where 12-15% has been more typical over the past five years and 20% prior to that.

I surmised that the investing public is sufficiently aware of the US$1m bet between Buffett (passive, value investor) and the hedge fund manager (active investor) that the outcome of that bet is contributing to the growth in use of Exchange Traded Funds (ETF).

Warren Buffett declared that a passive, low fee, investment strategy would beat the active, high fee, investment strategy.

Buffett won the bet after the hedge fund manager conceded at year nine of the agreed ten-year term.

The public knows that Buffett’s investing success is not from investing in the average, but, the public also seem to recognise that as a whole they are the ‘average investor’ and thus keeping fees down is an important and easy starting position.

So, this fee reducing strategy of investing larger proportions of savings into ETFs has been reducing the variability of decision making about where to invest this cash; the asset selection is defined within the sub index of the ETF(s) chosen.

I’d like to think that these investors use their cash holdings and fixed interest assets (not hard to self-manage) as the counterbalance for the desired level of risk being taken elsewhere via ETF – should cash be 10% of wealth or 50% (at the time one asks this question)?

I also pondered that the rising use of robots to instruct trading may have reduced the human error element from markets.

Maybe the public has widely read the book Flash Boys and learned that some businesses are ripping people off by using very fast computers (robots) to front-run their market orders and have responded by handing their money to the likes of Vanguard and BlackRock (ETF) to minimise this additional theft (sorry, transaction expense).

Given my various theories about why ETFs and the increased used of robots was reducing market volatility I was pleased to read about the Nobel prize in economics being awarded to Professor Richard Thaler of the University of Chicago for his ‘so simple its logical’ finding that humans are irrational.

Thaler showed how ‘human traits, such as lack of self-control, habits, and fear of losing pushed people toward decisions that were not the most advantageous in the long term’. I would add to that list that our egos get in the way of good decisions also and we spend too long convincing ourselves we are correct (as you are doing now – Ed).

I wish I could tell you that the current journey to very low levels of market volatility, and thus lower implied risk, will be sustained, but I can’t because I don’t believe it.

Note my comment above about holding small or large volumes of cash to counter the balance of risk in various ETF funds; this is not the way most investors behave.

Most investors wish to be fully invested and then continue to feed additional savings into their ‘fully invested’ portfolios. We see this ‘non-thinking’ behaviour in Kiwisaver statistics.

Most funds receive higher fees from higher risk asset types so there is no incentive to remind investors to also accumulate cash in a bank account, or self-managed fixed interest portfolio.

As an over-arching statement, most developed nations, where ETF use is highest, have relatively high debt ratios. If another period of financial distress emerges (as opposed to just a retreat in market prices) then liquidity, via asset sales, will be demanded to regain control of some of that debt.

If I am correct and the investing public holds very little cash, then some proportion of the ETF will need to be sold in the event that banks demand debt reduction across the economy.

You can be sure this aspect will happen because when the banks lose money on bad loans their equity falls, and this obliges the banks to either raise new equity or reduce the amount loaned out (demand repayment).

This surge in demand for liquidity could be troubling to markets, depending on the scale.

My last theory (previous Market News) was about lower volatility was simply one of over-supply. Fund managers are selling a lot of financial insurance (options), with the premiums measured against market volatility (hence pressuring volatility lower).

If my speculation about this trading behaviour is correct, then at least half of these options traders may well be selling insurance (options) without receiving enough income to cope with the ‘insurance event’ (options being exercised) when the next event happens. Imagine if your car insurer reduced the premium to $10 per annum just to get some income from your business…. One day there will be a problem.

This type of options trading (additional leverage) contributed to the scale of the share market crash and interest rate collapse in October 1987 (the crash that was recently reminisced).

I seem to have drifted all over the park on this one; let me see if I can bring it back together on the coach’s whiteboard:

Always hold sufficient cash within your own portfolio to cover planned spending, emergency funds and perhaps an amount to counter-balance (reduce) the overall risk in your portfolio (as this view changes);

Minimising fees is a wise strategy;

ETF use will continue to rise and thus have an impact on market volatility;

Another period of uncomfortable market volatility will happen (we just don’t know when);

Market volatility is likely to be lower in the decade ahead (high points and low points) as ETF use and robot decision-making increase across financial markets; (will this be true for vehicle insurance once autonomous cars dominate? – Ed)

If unsure, look to the coach (financial adviser) for strategy!

Investment News

Politics – Dear Jacinda,

Thank you for taking the time to read Market News and for so promptly pledging to enact my new policy for the NZ Superannuation Fund.

Inflation – Dear Jacinda,

Last week when I touched on modest inflation tension because of the new Labour government I hadn’t reckoned on the minimum wage jumping by 31% over three years.

I am a fan of people being paid well for their work, but not of aggressive rates of change, which makes it hard for economics to keep up.

This minimum wage policy doesn’t start and end with the people currently earning $15.75 per hour. It will have a ripple effect up through the hourly pay rates in NZ.

The median hourly wage in NZ is currently about $23.50, lifting the minimum to $20 will see a large group of people justifiably asking for pay increases to at least retain a position at the new median hourly rate.

I look forward to learning about the strategies for making NZ more productive, so we can easily deliver on higher wages across the population, and avoid any short sharp inflation jolt.

In the interim I shall pay more attention to the central bank’s assessments for the Official Cash Rate.

Ports – Dear Jacinda,

I promise this will be my last open letter, today.

Thanks for the smile, following your quote about the Port of Auckland review:

‘The future of the port is not at the waterfront’.

Telecom for sale – Investors may be confronted by more investment choice in the telecommunications sector over coming months.

Until now in NZ we could invest in Spark or TeamTalk, which is a bit like night and day, but the opportunity is likely to widen with both Vodafone and Vocus considering sales from the NZ parts of their businesses.

Post the launch of its new television service Vodafone explained that their planned share market float may be delayed until early in 2018 with the election having caused several delays for them.

Vocus is the current owner of CallPlus, 2talk, Orcon, Slingshot, Flip and local fibre line provider previously called FX Networks (which used the rail corridor to install much of its nationwide fibre network).

ASX listed Vocus Group may have a market capitalisation of A$1.65 billion, but it is currently losing money and its share price has fallen 75% from a high two years ago.

To be fair, the current share price is about the same as its level in 2013, prior to a two-year run up to an all-time high in 2016.

Maybe the delay in the Vodafone IPO relates to their desire to bid on some of the Vocus assets being offered for sale?

Regardless, the supply of Vocus business assets and then an offer to the public of shares in Vodafone NZ should (conditional opinion, commonly found in financial markets commentary) place a near-term ceiling on the share price of Spark.

Mind you, I thought the resale of the Chorus shares from the underwritten Dividend Reinvestment Plan (at $3.92) might hold that share price back too, but it didn’t.

Would you rather invest in Spark or Vodafone?

Now is a good time to move those thoughts around the whiteboard.

Takeovers – We keep losing companies off the NZX, so it will be nice if Vodafone does ultimately bring themselves to list on the NZX.

The Opus takeover looks likely to succeed and thus see their departure from the NZX in late November.

On Thursday Singaporean interests confirmed a takeover offer for recently listed Fliways Group (transport business) at a price of $1.22 per share.

Fliways has only been listed on the NZX since 2015, as the beginnings of an exit strategy for the then private owners. Now it is a chance to depart the NZX after a very short shelf life.

It’s nice to discover that we have many good businesses available to investors in NZ but it would be a shame if we kept losing some of the best ones without newer businesses arriving onto the public markets at the same time.

Immediately after writing this paragraph a new transport business announced that it was joining the NZX via a backdoor listing (through a small shelf company).

Transport Investments Ltd from New Plymouth, value at approximately $200 million, introduces a new freight business to investors.

Friends – Good friends, especially those trusted friends from senior school and university, will often feature in one’s decisions about who to involve in influential decisions.

Consistent with this thinking, we would be wise to maintain an interest in the actions of Liu He, who is clearly a good friend to China’s President Xi Jinping.

Liu has emerged from the 19th Party Congress with the task of masterminding China’s economic reform for the next five years, making him one of the most influential confidants to President Xi.

Liu is well educated and has two degrees from well-respected US colleges.

When Liu speaks, we should listen.

Ever The Optimist – Global behemoth, Apple, buys into local NZ firm (spun out of Auckland University) PowerbyProxi (a wireless power transfer business).

According to the story Samsung was already a shareholder, so that’s two corporate giants who need involvement with a NZ originated business.

Nice.

Well done to the PowerbyProxi team for their successes.

ETO II – Considering all the headline angst about global trade, the Baltic Dry Index of shipping prices across 23 different routes confirms that trade has been improving for the past 12 months.

After setting an all time low of 290 the index is now back to its upper quartile pricing with the index at 1,580.

Ships appear to be full and on the move.

Investment Opportunities

For businesses wishing to issue new bonds to retail investors now is the season if you wish to complete the offers prior to Christmas.

Expect plenty of activity over the next two, or three weeks.

Christchurch City Holdings – has confirmed their intention to issue two tranches of NZX listed bonds to the public; hopefully one tranche so then another by 2019.

CCHL has a strong ‘A+’ credit rating and an easy to understand business, which one can review on their website: https://www.cchl.co.nz/

We have a CCH bond list which anyone can join as we await more information.

Property For Industry – has confirmed that it is considering an offer of bonds to the public.

The term of the bonds will be seven years. The yield will need to exceed 4.00% to be competitive.

We have a list and all investors are welcome to join it if they wish participate in this offer.

China Construction Bank– held a presentation to investors and whilst nothing was announced we hope they follow in the footsteps of Bank of China and issue bonds into the NZ market, including access for retail investors.

CCB has a strong ‘A’ credit rating from Standard & Poor’s.

Trustpower – we would like to believe that TPW will offer a new bond for investors holding the maturing TPW130 bond (15 December 2017) and for new investors.

I think we will start a list.

Vodafone – has also announced its intention to list Vodafone NZ on the NZX.

The latest headlines imply this might be a deal for 2018.

We have a mail list for investors wishing to hear more about this proposed offer, when it finally reaches the market.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (New Issues) email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

Edward will be in Taupo on Wednesday November 8.  He will then be in the Wairarapa on Monday November 20 and in Auckland on Thursday 30 November.

Chris will be in Christchurch on November 21 and 22, at the Airport Gateway Lodge, Roydvale Ave.

Kevin will be in Ashburton on November 23.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

 

 

Michael Warrington

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Market News 23 October 2017

I know now’s not the time for me to be introducing new policy to government for

consideration, but reading that the NZ Super Fund paid 9% ($1.2 billion) of the

total corporate tax collected in NZ last year got me thinking.

The National Government stopped putting money into the Super Fund, preferring

to spend available money on other more pressing financial commitments. They

preferred not to increase debt unnecessarily to continue contributing to the fund.

Maybe now they could introduce a new policy, of allowing the Super Fund to

retain and reinvest the tax it would otherwise pay to the government.

The government is, after all, trying to accumulate enough money to prepare for

the rising cost of super in the future, which will require putting away a few more

acorns today.

Shall I start a letter?

Dear Jacinda…. Or should that be Winston?

Investment Opinion

Politics – There you have it, the NZ government has been formed.

By any measure you’d have to acknowledge that Jacinda Adern has delivered a

remarkable outcome for the NZ Labour Party. Amongst the frequent references

to policy over the past two weeks it is also clear that personality counts.

A Labour led government just in time for Labour weekend.

Coincidence?

The hype stirred up by the NZ media as they awaited the outcome of the coalition

negotiations was understandable from a local perspective. However, from our

perspective to you as investors there are three more influential political situations

that warrant deeper observation, namely;

The election of the next Chairperson of the US Federal Reserve Board;

The communist party Congress in China and President’s Xi’s increasing power

grab; and

The outcome of negotiations in Germany, to form their next government.

Shortly we will learn about the policies that the new government wishes to put in

place and then we can assess the impact on the NZ economy and possible

outcomes for investors.

One of President Xi’s quotes, from his three hour speech (good grief), would

resonate well with our new government; ‘Housing is for living, not punting’.

I don’t expect to see many local drivers for change in the current structure of your

portfolio, unless you have a large portfolio of residential properties that we are

unaware of.

The NZ dollar slipped in value by a larger than normal daily amount (2 cents) but

in my view this volatility will quickly settle down to reflect trade flows and interest

rate differentials.

‘Do not adjust your set, normal transmission will resume shortly’.

The large scale of the National Party as an opposition in the NZ parliament may

result in a relatively slow rate of change for policy and management of

government departments.

This is probably a good thing as a moderating force but it will also remind

investors that both sides of parliament in NZ are moderate policy makers.

So, beyond our shores, let’s see just how far Xi Jinping’s ego has taken him with

his pursuit of power and try to understand the medium term impact this will have

in China, our second largest trading partner.

Then immediately thereafter, we must understand the near term impact of

President Trump’s next choice of Chairperson for the US Federal Reserve Board

because this will undoubtedly have an impact on your investment portfolio.

Stay tuned.

Investment News

Inflation – There may be a flicker of hope for fixed interest investors, hoping to

see a lift in interest rates.

Headline CPI last quarter was higher than forecast (+0.5% and +0.70% for non-

tradeable inputs).

The central bank will not change tack on a single data point, nor prior to

identifying both a new governor and a new Policy Targets Agreement with

government, but a lift in CPI would warrant some attention.

A generalised expectation is that a Labour led government will spend more freely

and thus add some upward pressure to inflation.

Surely the intention to press the building industry harder, if that’s possible, and

restrict access to foreign employees will have an inflationary impact on pricing

from that sector; something that affects us all.

If CPI does begin to follow a more robust path the long unwanted annual reset

securities, such as Infratil IFTHA and ASB perpetual preference shares, might

come back into vogue.

We don’t want a rapid change to inflation because this would simply erode the

real interest rates that you receive (nominal interest rate less inflation) but just

enough of a threat to get the central bank onto a more hawkish stance for

monetary policy.

The central bank probably now has enough to change its stance.

An initial move of the Official Cash Rate (OCR) from the current 1.75% up to

2.00% would at least put the overnight interest rate in NZ at a neutral point with

inflation (zero real interest rate return).

Thereafter the central bank can debate the positive real return that they’d like to

see in the economy for short, near risk free, terms (one day).

CASHA – Credit Agricole has announced the repayment of its Perpetual Deeply

Subordinated Notes (CASHA) will occur on 19 December 2017.

The word that springs to mind is ‘relieved’.

My relief may perplex the French but the world is often perplexed by the French

so the complex nature of the relationship is maintained.

Credit Agricole arrived opportunistically in 2007 to issue these subordinated Tier

1 securities when they observed how successful Rabobank had been with its

issue of the same type of securities ($900 million RBOHA at a credit margin of

+0.76%, repaid just last week).

On reflection, we investors and advisers did not negotiate hard enough with

Rabobank when pricing the RBOHA’s, to achieve a higher credit margin.

Mind you, there is no doubting that a $900 million deal, the largest non-

government bond issue in NZ history, was sufficient volume to declare that the

price was considered fair at the time.

Unlike many investors I never took issue with the low interest rates each year on

RBOHA because the annually reset interest rate was precisely what was

described in the prospectus and interest rate resets are very normal for some

investment securities, just as fixed rate securities are normal.

It was the global and local economic conditions that resulted in a stark fall in

interest rates (Global Financial Crisis, earthquakes etc), including those paid by

RBOHA, not an ad hoc decision by Rabobank executives.

Fixed Interest investors should always have a mixture of short, medium and long

term investments in their portfolio as part of a diverse mixture that helps to

defend against unexpected sharp changes in interest rates. RBOHA was a short-

term interest rate behaviour product, which did its job.

With the benefit of hindsight fixed rate long term investments have performed

better than short term, ever changing, fixed interest investments.

Those of you who have known us a long time may recall our relatively strident

view in 2008 and 2009 to buy ‘strong, long, and liquid’ fixed interest investments.

This advice reflected the rapidly weakening market for interest rates at the time,

and the knowledge that most investors already held plenty of short term, or

resettable securities.

The Credit Agricole notes are an interesting corollary to RBOHA in that they were

fixed rate and long-term in design, with two five-year periods of fixed rate returns

(10.0355 and 5.04%). The announced repayment allows us to now calculate a

7.52% average running return (I’ll cover actually returns lower down) over the

past 10 years, which is a pretty good result (almost enough for all the angst –

Ed).

Yes, that’s true.

After the 2011 crisis in Europe CASHA investors were justifiably concerned about

the survival of European banks, not yet sure whether to believe the European

Central Bank would do ‘whatever it takes’ to solve a landscape full of financial

problems.

CASHA securities fell in price to about 40 cents in the dollar during the intensity

of concern during 2011 and early 2012.

Those who were brave enough, now known to be wise enough, to buy CASHA

securities during these subsequent years of price discounting have been royally

rewarded for their confidence.

To simplify my math a person who bought the securities in 2012 at 50 cents in

the dollar has received in excess of a 30% p.a. for five years (5.04% coupon

interest payments plus the 50 cent capital gain relative to repayment at 100 cents

in the dollar).

The CASHA Notes spent two years around 80 cents in the dollar and buyers at

this price gained returns of approximately 13-15% p.a.

That is still an impressive return alongside the very bullish share markets of the

period.

Most holders though started at $1.00, collected 10.035% and 5.04% and were

repaid $1.00.

I suspect this group will be pleased, as we are, to see CASHA repaid on the

expected schedule and can now move on to a new investment that is likely to

cause a little less heartache.

The era of these ‘old’ regulation subordinated bank securities is gradually

drawing to a close.

These bonds have treated investors well.

ANZ is likely to repay its ANBHA securities in April 2018. Rabobank are near

certain to repay their RCSHA securities in 2019. This would leave only ASB to

announce a repayment of its original ASBPA and ASBPB perpetual securities.

We hope that ASB sees the moral integrity value of doing what investors

expected and repaying these securities when they no longer serve a purpose as

equity on the bank’s balance sheet.

If they do not, it will harm ASB’s ability to ask investors to consider investment in

any new subordinated bank capital securities.

What a profound irony that would be if the markets anxiety and potential upset

that was brewing against the French, via Credit Agricole, actually belonged at the

front door of a seemingly reliable NZ based bank.

Am I lobbying just a little on behalf of our clients?

Of course I am. I want to see our ASB clients repaid.

I also want to see our clients be willing to invest again with ASB, just as they will

for BNZ, ANZ, Rabobank and Kiwibank, all of which have treated investors well

within the subordinated securities market.

To Credit Agricole, thank you for the issue and the repayment of CASHA

securities on schedule. (annual updates would have been nice – Ed).

More Care Please – The European bank regulators are trying to avoid a new

accumulation of bad debts on bank balance sheets, on top of the already large

pile of bad debts from the past.

The new obligations, starting January 1 2018, will give lenders two years to set

aside funds to cover 100 percent of the value of their newly classified non-

performing unsecured debt and seven years to cover all secured bad debt.

They deem that if collateral for secured loans cannot be effectively claimed within

seven years then it probably never will be and those loans must be then deemed

as unsecured loans, and probably written off anyway.

No longer can non-performing loans be put in a quiet corner under the sign ‘hope

for better’.

This development is consistent with the ongoing improvement to equity on bank

balance sheets and this latest move will make bad loans prohibitively expensive

to get wrong.

This won’t help expand the provision of credit within the economy but it should

ensure that frivolous lending, driven by sales incentives, doesn’t occur again.

House Price Change – I read a recent article in the Sydney Morning Herald

about the long-term change in residential real estate prices in Australia, as

compared to other countries.

The lift in values was big (6,556%) and averaged 3% per annum over and above

inflation over 55 years. This won’t surprise most of you.

The kernel of most value to me was the reference to a data-point from a Bank of

International Settlement report:

A key finding of the BIS report is that there is a lag between changes in interest

rates and movements in house prices, and it can take up to five years for

changes in borrowing costs to have a major impact on prices.

Five years!

We are only one year into the macro-prudential tools rolled out by the Reserve

Bank of NZ so we may not see their full impact until 2021.

If the RBNZ is thinking of increasing the risk weighting for banks lending to

people with multiple investment properties, and perhaps debt to income ratios,

it had better get on with it otherwise we won’t see much behaviour change across

the current electoral cycle.

Ever The Optimist – Zespri has announced higher payments per tray for 2018

with the Gold variety setting the highest price at $9.73.

However, the environmentalists will be pleased to see that Organic Green variety

attracts $8.24 per tray relative to Green at $6.23.

The will of the consumer is clearly widening and affecting price.

ETO II – The Port of Tauranga reported a strong increase in freight volumes

(total trade up 15%).

This will please their shareholders (the share price is coincidentally up 15% for

the year) but should also please New Zealanders widely given the message this

sends about export successes.

Investment Opportunities

Christchurch City Holdings – has confirmed their intention to issue two

tranches of NZX listed bonds to the public; hopefully one tranche so then another

by 2019.

CCHL has a strong ‘A+’ credit rating and an easy to understand business, which

one can review on their website: https://www.cchl.co.nz/

We have a CCH bond list which anyone can join as we await more information.

China Construction Bank– held a presentation to investors last week and whilst

nothing was announced we hope they follow in the footsteps of Bank of China

and issue bonds into the NZ market, including access for retail investors.

CCB has a strong ‘A’ credit rating from Standard & Poor’s.

Property For Industry – announced an intention to ‘consider an offer’ of bonds

to the public.

Since their rights issue raising additional equity the company has remained silent

on the potential for a bond offer.

We have a list and all investors are welcome to join it if they wish to hear more

from us if the potential offer is proceeds.

Vodafone – has also announced its intention to list Vodafone NZ on the NZX.

This possible offer must be moving closer following the launch of their new

television service, incorporating access to Sky TV suite of channels, but it does

appear that 2018 timing is more likely.

We have a mail list for investors wishing to hear more about this proposed offer.

The fastest way to hear about new investment offers is to join our

‘Investment Opportunities’ (New Issues) email group, which can be done

via our website or by emailing a request to us to be added to this list.

Travel

Chris will be in Christchurch on October 24 and 25.

Edward will be in Hawke’s Bay on Tuesday November 7 and Taupo on Wednesday

November 8. He will then be in the Wairarapa on Monday November 20 and in

Auckland on Thursday 30 November.

Kevin will be in Ashburton on November 23.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please

drop us an email and we will retain it and get back to you once dates are

booked. Alternatively visit the "request an appointment" page of our website.

Michael Warrington

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Market News 16 October 2017

After such a long, and strong, rise in share prices are you feeling flush with cash?

If so, you might be pleased to learn that an oversupply of private jets has seen their prices fall by a third.

Clearly some people have missed out on the gravy train recently.

Investment Opinion

BREXIT – on the subject of politics, unresolved locally, it’s possible that New Zealand will benefit from BREXIT if both the UK and the European Union decide to fight for pole position in free trade negotiations with us.

You’ve got to love genuine competition, especially in a world (led by Trump) that is showing signs of retreating from competitiveness.

BREXIT is clearly going to take a while yet, with politicians delaying progress, just as we are experiencing locally.

Politics II – There is another example of the importance of trying to be careful about the politics of governing a country; the sharp change in approach in Turkey from President Erdogan is unsettling important political relationships.

Turkey’s swing toward relationships with Iran and Russia is disrupting its strong prior relationships with old Western allies, including the US.

The US has accused Turkish banks of aiding money laundering for Iranian entities. President Erdogan has responded by supporting the banks.

Turkey would be unwise to see themselves removed from trusted global banking networks. This would not serve their people well.

It was only two years ago that Turkey was bidding to join the European Union.

Financial markets in Turkey are beginning to experience significant price declines, which indicates to me that capital once dominated by Western providers is withdrawing from the Turkish market.

I’ve always held a view that rapid change is unwise when working with issues that involve politics.

FMA tightrope – The Financial Markets Authority, within its quest to increase public confidence in financial markets, is simultaneously trying to set tighter regulatory standards around market pricing and to encourage more institutions to participate, so as to help add depth to the market.

More depth, and diversity, in market participants should indeed add to the quality of market pricing, but will the new rules encourage this?

The latest news item was about the wholesale market for setting short term interest rates each day (30-180 day terms), which through extension have an impact on setting interest rates for mortgages and floating interest rate corporate debts or derivatives.

I think the FMA has bitten off more than they can chew and will not be successful with both of their goals (tighter rules and regulations plus more participation for market depth).

The tighter rules and regulations approach is consistent with trying to increase public confidence in the outcome, thus trying to avoid scandals like those endured overseas with rate setting or foreign exchange trading. However, the tighter rules will also reduce participation, in my opinion, not increase it.

One of their descriptions was quoted as:

‘FMA said it expects banks to think about how they can record contextual evidence that will show what the purpose of any trading activity was, at the time it took place. It says banks should have a clear trading strategy and should record its explanations for varying from that strategy. The regulator may conduct spot checks.’

Thinking back to my previous roles that involved trading or price making in financial markets, I would have reduced my activity if I had a new obligation for recording ‘evidence of purpose and context’ around every transaction.

Sometimes the risks being managed by a financial markets trader (which differs from a fund manager) are changing by the second, influenced by multiple purposes and changing context, so I smile at the prospect of a regulator asking for a tight new process to be followed.

Banks will look at improving their processes and will aim to behave well in price setting roles for financial markets but I don’t see other institutions becoming involved, so I don’t see the market expansion that the FMA seeks.

These short terms only have modest financial leverage for smaller market participants, unlike the banks with balance sheets in the tens of billions, so the smaller market participants will focus their attention and regulatory workload on risks where they can make greater financial gains.

To put this in perspective; do you think about the risk and reward of your 90 day bank deposits more than the changes occurring with your shares?

Ongoing improvements to financial market integrity are to be applauded, but NZ is a very small market and no amount of polite encouragement will change its depth.

Share Prices – It’s a little repetitive to say, especially to those who believe in the hypothesis of perfectly efficient markets, but markets are imperfect and often the mistakes they make are significant in scale.

Sometimes the participant making the error is the investment entity and the error, once disclosed, is larger than the shareholders or board members hoped was possible.

Sometimes the error is, well, illegal, and once disclosed is immediately damaging from a financial perspective and from an integrity perspective; both result in collapses to share prices.

Last week Kobe Steel disclosed they had used false data for aluminium and copper products (Volkswagen and emissions – same, same) so its share price fell by 40%.

A perfectly efficient market would have factored in this risk a little more or progressively made comparative reviews about the product relative to market norms and investigated risks to profit further.

Kobe Steel shareholders may argue they couldn’t access such information, and perhaps that is the case, but the inability to reduce this risk with a higher volume of knowledge should have reduced the height to which the share price reached.

This leads to another of the ‘sometimes’; often the investor accepts too many assumptions and becomes emotionally attached to an optimistic expectation about the investment.

This results in the ‘market’ accepting a share price that all recognise as optimistic, or in the upper quartile of justifiable valuations; until, suddenly it is not.

Another example from the retail sector in the US, where you’d expect investors to now be well aware of the ‘Amazon Affect’ on retail competition, clothing retailer J.JILL announced that sales would be 3-5% lower and earnings would be down.

3-5% lower, yet the share price fell by 52% the next day.

There is something imperfect about that situation.

One commentator on the Kobe Steel story dragged in the value of diversity though (one of Markowitz’s recommendations for investing) by disclosing that their investment in Japan was via an Exchange Traded Fund and thus the loss for them attributable to Kobe Steel’s behaviour was only 0.15%.

The argument for the value of diversity should be unquestioned, but the theory regarding perfectly informed markets is clearly a sham.

I have a view that within a portfolio of reasonably broad diversity one must also try to back a few of the most athletic looking thoroughbreds to at least try and increase your odds of outrunning the pack.

The only way to further protect your emotions from harm, and to minimise negative financial impacts, is to try and stick to a well-defined investment policy (set of investment rules).

If you have this in place, then when you are hit by an unpleasant financial loss, and it is when not if, then you will be able to rationalise the presence of the investment in your portfolio and its impact on your financial position.

I’ll give you two real examples:

I invested in ERoad on day one during its Initial Public Offering at $3.00 and this price subsequently fell in half for various reasons including slower progress and a loss of faith from investors. However, I understood the evolving information and I knew why I had invested; these reasons had not changed, so I remain as a shareholder.

By contrast, I intensely dislike that I lost some money investing in Wynyard shares because I was not a fan of the story, they clashed with my investment policy and I didn’t admire the management.

When they failed I wasn’t shocked.

Regular readers may recall me criticising Wynyard’s naivety with respect to how to manage a fresh capital raising.

This investment outside my own investment policy thinking was inexcusable really (I guess you are hoping that Mrs Warrington doesn’t read Market News – Ed).

The answer to your obvious question is – greed and a misguided view about my trading prowess.

You can all be certain that share prices will move around on you, and be equally certain that they will move down as well as up.

A growing number of commentators and analysts are publicly expressing their concerns about the probability of a decline in share market pricing. Without wanting to declare this camp as correct I do agree that investors would be wise to address these opinions, conclude that risks are elevated and to respond to that risk level within their own portfolios.

In a nutshell this paragraph is another reminder to all investors that they should have a well-defined investment policy and, with only mild bias, you should be engaged with a financial adviser.

Investment decisions – following on from the above, I came across a relevant article that addresses the difference between good advice and effective advice.

I hope the author will be OK with me directing your attention to them too and re-presenting their very ‘effective’ points to you:

Good advice is preaching to your clients to stay the course.

Effective advice is building portfolios that are durable and behaviourally aware enough to help clients stick to their plan.

Good advice is to buy low and sell high.

Effective advice is to create a rules-based system that forces you to sell a little bit of what has worked and buy a little bit of what hasn’t.

Good advice is to ignore the noise.

Effective advice is to create a comprehensive investment plan, which focuses exclusively on those things that are within your control.

Good advice is giving people tactics they can apply right now.

Effective advice is building people systems they can apply over and over again to different situations.

Good advice is telling people to save more money.

Effective advice is helping people automate their finances so they don’t even need to think about saving money.

Good advice is telling investors to think and act for the long-term.

Effective advice takes into account the fact that people don’t live their everyday lives in the long-term.

Good advice is to do nothing most of the time when it comes to your portfolio.

Effective advice is helping people do less harm than they would do otherwise by implementing behavioural release valves.

Good advice is theoretical and unemotional.

Effective advice is practical and takes into account human nature and behaviour.

Good advice offers optimal solutions.

Effective advice withholds judgment and takes into account a client’s personality, current situation, and circumstances.

Good advice is universal.

Effective advice is personal.

Good advice takes into account the historical evidence.

Effective advice marries an evidence-based approach with a deep understanding of the human element involved.

Good advice tells you how to succeed.

Effective advice shows you how to succeed.

Good advice looks for the best ideas.

Effective advice looks to destroy the worst ideas.

Good advice incorporates the best in academic research.

Effective advice incorporates academic research with real-world experiences.

Good advice finds the best investment strategy.

Effective advice finds the best investment strategy for you personally.

Good advice is intelligent.

Effective advice is easy to understand.

With credit to: Author – Ben Carlson

http://awealthofcommonsense.com/2017/10/good-advice-vs-effective-advice/

Investment News

Integrity – I see the Financial Markets Authority has laid new insider trading charges relating to a staff member at a different business.

I record this paragraph simply to applaud their ongoing attention to this matter and to hope that monitoring trading (against CSNs) and share price behaviour around news releases is stress tested for the potential for people benefitting from inside information (not yet disclosed to the market).

Once the FMA gets a few more convictions under its belt for this behaviour I would hope to see less suspicious share price movements in future.

Ever The Optimist – The price of butter has hit an all-time high (retail distribution pricing), which is good both for dairy farmers and my waistline because I can no longer afford to spread it to the edges of the toast.

ETO II – It’s a fair distance from NZ, however, reading that German industrial production jumped the most in six years after a summer lull is useful news given the political and employment disruptions occurring in Europe.

ETO III – It seems a little unfair to claim a win from other’s misfortune, but a poor grape season in Europe might allow NZ winemakers to sell more product in 2018.

ETO IV – We knew tourism growth was happening but it is nice to read about businesses securing value.

Cardrona Alpine Resort reports that it set a new record for sales in 2017 (not yet closed!), after the previous record set only in 2016.

Investment Opportunities

 

Auckland Int. Airport bonds – AIAL completed its issue of 6-year senior bonds last week, issuing $100 million with an interest rate set at 3.64% p.a.

Demand for the bonds was high enough to result in scaling of the issue.

The bonds will begin trading this week, so if any investors missed out on the offer and wish to purchase these bonds they are welcome to contact us and we will assist.

Bank of China bonds – also completed a successful issue of $150 million bonds with a 5-year term at an interest rate of 4.09% p.a.

These bonds will begin trading this week if you missed out but would like to add these bonds to your portfolio.

Christchurch City Holdings – we observe that we have also been invited to a results presentation for CCHL and this may result in an approach to capital markets for debt funding support.

This would be consistent with the region’s funding needs, payment of robust dividends to the Christchurch City Council and the latter’s reluctance to offer shares in its various entities.

CCHL has a strong ‘A+’ credit rating.

We have a CCH bond list which anyone can join as we await more information.

Property For Industry – announced an intention to ‘consider an offer’ of bonds to the public.

We have started a list and all investors are welcome to join it if they wish to hear more from us if the potential offer is proceeds.

Vodafone – has also announced its intention to list Vodafone NZ on the NZX.

We have a mail list for investors wishing to hear more about this proposed offer.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

Chris will be in Christchurch on October 24 and 25.

Kevin will be in Invercargill on 19 October and Christchurch on 26 October.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

 

 

Michael Warrington

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Market News 9 October 2017 I see the Europeans are complaining about the Chinese ‘dumping’ electric bicycles on Europe. Subject to quality, I have always wondered why people would complain about cheaper access to products, especially if someone else’s tax-payers are contributing toward the purchase. This appears to free up a population to spend its time being more productive in other industries, where they have a competitive advantage. More usefully, I observe that the rise in electric bikes (actually they are hybrids with pedalling involved) is larger than we may realise. It is going to become a very big part of cycling in NZ and I do hope that our tourist businesses that direct people onto our many excellent cycle trails are becoming well stocked with electric bike options. Tourists with the most money tend to be ‘mature’ and I’ll wager that the majority of this group are over proving their physical prowess by actually using manpower alone to get to the top of each hill. If supplying electric bikes is the difference between getting additional tourists onto the trails and not, then let’s be sure to supply them. I can even imagine the marketing gimmick of Meridian installing charging stations along the length of the ‘Alps to Ocean’ (Waitaki) cycle trail, then why not send them back up the Otago Rail Trail? So, there you have it Europe, stop complaining about subsidised electric bikes, buy some and start a tourist servicing business. Investment Opinion Fed Chair – President Trump says he’s going to do many things so I’m not jumping out of my own chair with impatience as Trump declares that he will select a new Chairperson to the US Federal Reserve in the next couple of weeks. Unlike many subjects where Trump can obfuscate and not actually make a decision, on the matter of the Fed Chair he must because Janet Yellen’s current term as Chairperson comes to an end in February 2018. She can however, stay on the board until 2024 if she wishes. It is a very important decision, selecting the Chairperson of the central bank in the most economically powerful nation in the world. Janet Yellen is yet to confirm if she wishes to stay on, which is a shame because it confirms the political nature of the fight for the role. It seems she’ll disclose her hand once the game is known rather than putting pressure on, either way, by stating her preferences now. Trump refuses to be specific about the names on his short list but one is beginning to stand out as very interesting; Kevin Warsh. Kevin Warsh is being summarised as having firm views about many of the actions taken by the Fed over the past seven years as being strategic errors, specifically when the Fed began its Quantitative Easing (money printing) programmes to inject additional liquidity into the economy (and the world – Ed). Janet Yellen has been pressing toward higher interest rates and a very gradual decline in the volume of bonds held by the central bank (US$4.3 trillion at present). If Kevin Warsh is selected as the Chair-Elect of the Fed, financial markets will lurch higher with medium and perhaps longer-term interest rates. ‘Lurch’ is a technical term, not found in Investopedia, for about half a percent (+0.50%). This scale of movement would shift US 10 year Treasuries back up close to 3.00% yield, which is the high point over the past five years. That’s right, you need to go back seven years to find a point when this bond was higher than 3.00%. This leads to an interesting Trivial Pursuit question: Was the lowest yield of US Treasuries set in the depths of despair during the Global Financial Crisis when the banking framework almost failed? Given my tone, most will have guessed the answer is no. The yield at that point was about 2.40%. As the US economy has continued to struggle to get back up to a meaningful growth rate, and renewed inflation risks, the yield on 10-year US treasuries have fallen to 1.49% in mid 2012, and following a lift they fell again to 1.51% in mid 2016. Almost 1.00% lower than the crisis environment yields. Today the 10-year US Treasuries yield 2.31%. This will be at the heart of Kevin Warsh’s opinion, and possible governance strategy, artificially low interest rates have simply transferred wealth to those who use leverage for investment purposes and not to the wide benefit of the economy. My guess would be that after seeing 10-year US Treasuries lift to about 3.00% yields again you would be wise to look right and consider the behaviour of the 30 year US Treasuries. Did they follow shorter terms higher by 0.50%? Or did they sit still, or worse, fall in yield heralding a serious concern about an ‘own goal’ recession? For perspective the 30-year US Treasuries yields across the same dates as above were: GFC – 2.69%; 2012 – 2.57%; and 2016 – 2.18% Today they are 2.87%. If Kevin Warsh is appointed Chair of the US Federal Reserve and the 10-year US Treasuries lift to near 3.00% and the 30-year US Treasuries do not rise above 3.00%, trouble is brewing for the US economy and more than likely the US stock market. Respected and retiring Fed board member, Syd Fisher, offered a headline on the subject of the next Chair; ‘any new head of the Federal Reserve will need to have the ‘’flexibility of mind’’ to change tack during acute periods of crisis’. One might interpret this as a message to, or about, Kevin Warsh not being too rigid in his views if he wishes to become the Chair of the Fed. If Donald Trump does not want a strong minded approach, such as that proposed by Kevin Warsh, then well performed fund manager Jeffrey Gundlach predicts that Neel Kashkari would be chosen for his support of the current framework. The Trump Administration has responded to this speculation with a statement that Kashkari is not being considered, which in the context of Trump implies that he is probably on the short-list! Gundlach predicts Janet Yellen is a nil chance to be re-elected. You may recall me saying recently, with respect to the NZ General Election ‘relax, it is unimportant from a broad investment perspective’, ‘international influences are far more important’. The strategy of the incoming Chair of the US Federal Reserve is far more important for NZ investors than who our next Prime Minister is or what we should call Winston Peters. Stay tuned. South Korea – With the squabbling going on between the US and its neighbours Canada and Mexico over trade it is nice to see that many economies in our time zone are showing signs of improvement. Snap elections aside, Japan is showing some sustainable signs of growth; Chinese Trade with NZ is rising again and it reports a five-year high on a factory activity survey; and Last week South Korea reported a 35% surge in exports with particular note for steel, semi-conductors and petro-chemical products. (I think the steel moved from Australia, through the Hyundai factory and back to NZ – Ed). ETO interject – this is true, NZ car sales hit yet another all-time record last month (+10% on previous year). Clearly Trump’s argument with Rocket Man hasn’t held South Korea back. (They’re probably exporting steel North for missile manufacture – Ed). That’s an interesting point, it doesn’t hurt South Korea to have North Korea keeping them well separated from mainland China. Australia showed signs of economic improvement last year and if they can just resolve their energy stability and self-sufficiency again they may kick in for our benefit too. Once our trade negotiators return from sewing up an agreement with Iran they could return to boost a few Asia-Pacific time zone trade agreements before returning to the UK to hook them in. Simple really. I’m surprised it creates so much angst. Investment News Electric Cars – Everyone is joining the trend, scared to miss out on being named ‘Belle of the Ball’. India has announced that it will begin replacing its government vehicle fleet (500,000 vehicles) with electric replacements and to reach a point, for the nation, where by 2030 all new vehicles are electric. They will start with 10,000 from local manufacturer Tata Motors. I think it is appropriate for governments to lead the charge in pushing up demand to help manufacturers achieve a scale that allows lower pricing for the public. It is this outcome, from the rising global trend, that will ultimately play into NZ hands with respect to our trade balance (oil use down, electricity use up). DRP – A few businesses are returning to the use of Dividend Reinvestment Programmes (DRP) to bolster equity on their balance sheets. DRP programmes are often switched off by companies when equity is not required as they have no reason to offer discounted shares to investors (2-3% price discount is common). A reasonable proportion of investors like to use DRP to both compound their returns and to access a discount which these days equates to almost 12 months pre-tax interest! Chorus (CNU) has presented the most aggressive DRP scheme that I have seen in a while; they have established a process of achieving a 100% dividend reinvestment rate by securing an underwriter for the shares not wanted by current shareholders. This is of course artificial but it suits CNU’s balance sheet and will answer a few questions for Chorus, and other companies who are undoubtedly watching: Will shareholders continue to want so much cash dividend if we dilute them with an underwriter for the balance of the shares we wish to issue? Is the market deep enough to comfortably absorb the extra CNU shares at 0-3% below market pricing (i.e. $3.80 - $3.92 for the recent tranche) being the shares that the underwriter now needs to sell? How quickly can we restore our preferred equity ratio on the balance sheet without undermining the market pricing of the assets? I have a supplementary question: How long will it take for the CNU share price to rise above $3.92 again? I like the presence of DRP schemes for investors not yet spending their cash flow but I am not a fan of artificial markets, so something tells me this 100% DRP scheme for CNU will end in the shadows and not the spotlight of centre stage. At its simplest it probably just reflects CNU’s need to establish control of its long-term funding options before they run into the expiry and repayment of government supplied funding options. For the record the natural investor demand for CNU’s DRP was 54% of its shareholders. PFI Rights – Property For Industry has expanded its portfolio by purchasing approximately $70 million worth of additional buildings. They have announced a rights issue to finance the purchase(s) – 1:10 at $1.54. David Colman has loaded an advice piece on the Private Client login area of our website for clients with PFI shares to help with their assessment of the opportunity. PFI made no further mention of the potential for a bond issue, within the press release about the rights issue. Ever The Optimist – NZ reports that Corporate Tax collection is 17% up on last year. This is great news regardless of whether it comes from better economic activity or more effective pursuit by IRD! ETO II – Patient EROAD investors will be pleased to learn of a 31% lift in US sales. EROAD (trucking data and payments) and PUSHPAY (religion focused payment service) are achieving the sales goals that many Kiwi located businesses strive for. Good on them. XERO, by contrast are proving to be very successful as a business but are still finding the US Market tough to crack. ETO III – The price of oil has increased back above US$50 for the first time in a long while. This reflects increased demand rather than a shortage of supply. Increased demand is a good economic indicator. Investment Opportunities Auckland Int. Airport – has announced its intention to offer a new six-year senior bond. This is a ‘fast moving, clients pay the brokerage’ type of bond offer and an interest rate at about 3.65%. We bid for an allocation today, so if you wish to invest please contact us immediately with your firm request. Please only join this list if you are certain that you wish to invest. There will not be sufficient time to contemplate the offer slowly. Potential investors can already access live information about the risk of lending to AIAL due to its ongoing disclosure obligations to the NZX. AIAL has a strong ‘A-’ credit rating. The latest investor information, including the annual report to June 2017, is available on their website: https://corporate.aucklandairport.co.nz/investors Christchurch City Holdings – we observe that we have also been invited to a results presentation for CCHL and this may result in an approach to capital markets for debt funding support. This would be consistent with the region’s funding needs, payment of robust dividends to the Christchurch City Council and the latter’s reluctance to offer shares in its various entities. CCHL has a strong ‘A+’ credit rating. I think we’ll start a CCH bond list which anyone can join as we await more information. Property For Industry – announced an intention to ‘consider an offer’ of bonds to the public. Details are yet to be announced but many of you will guess accurately that it is likely to be a longer term (5-8 years) and this will result in a yield well above 4.00%. We have started a list and all investors are welcome to join it if they wish to hear more from us once the offer is made. Vodafone – has also announced its intention to list Vodafone NZ on the NZX. We have a mail list for investors wishing to hear more about this proposed offer. The fastest way to hear about new investment offers is to join our ‘All New Issues’ email group, which can be done via our website or by emailing a request to us to be added to this list. Travel Chris will be in Auckland on October 16 and 17, then back in Christchurch on October 23 and 24. Kevin will be in Invercargill on 19 October and Christchurch on 26 October. Anyone wanting to make an appointment should contact us. If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked. Michael Warrington

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Market News 2 October 2017

Some NZ executive incomes are enormous.

I don’t think the Fonterra Chairman, John Wilson, needed to place a label on the CEO’s income for the past year, ‘velocity payments’, because it’s clear to everyone that the CEO is indeed earning a lot of money very quickly ($8.3 million last year).

Without wanting to judge his particular employment agreement, I concluded a personal opinion on the matter of executive pay:

A person should not be able to gain a position within the group of a country’s wealthiest few based on employment alone.

If you can make it onto the NBR Rich list based on employment income alone something is askew.

My opinion is not one of envy but of risk and reward.

If a CEO has no capital at risk then the scale of their reward should be more limited than seems to be the case today.

Investment Opinion

Debt Up, Ratings Down – Here are a few news items that caught my attention with respect to the risk of high debt levels:

Russia nationalised two more banks that were on the brink of failure. The Russian government already owns banks with in excess of 50% of the nation’s assets but with this scale increasing it confirms private credit is struggling (with rising bad debts).

The Toys R Us bankruptcy, and debt default, has lifted the ‘loan default rate for risky retailers’ (whatever this definition includes) up to 7% and a move toward 10% is viewed as likely.

The previous high for this loan default measure was 5.9% in 2009 as the GFC disclosed over-leveraged business in a different era of falling sales.

Credit rating agency, Standard & Poor’s, has cut China’s sovereign credit rating from AA- to A+ (one notch) citing debt levels. Moody’s Investor Service had already cut China’s credit rating earlier in 2017.

There’s no shame in an A+ credit rating, but the agencies are concerned about ‘a steady increase in leverage on top of already high debt levels’.

I learnt that very little of China’s debt is owned by international investors so the S&P announcement will not be disruptive. However, rather than protest, as they have, Chinese officials would do well to prove that the increased credit use relates to higher growth in China.

If so, great, but if not then S&P and Moody’s concerns will be confirmed.

Speaking of credit rating downgrades, Moody’s also cut the UK’s credit rating one notch (from Aa1 to Aa2) and just like in China, the UK bureaucrats criticised the piano player.

The British government said that the credit rating downgrade ‘did not take into account the speech from the Prime Minister last Friday, in which she outlined her vision for Brexit’.

Good grief, if that’s what they hang the credit worthiness of the country on, a few words from a now unpopular Prime Minister, then their problems are worse than they realise.

I have a vision for how my children will behave but their schools would be unwise to assume it will happen all day.

Moody’s is concerned about debt levels rising again as the Brexit process slows the UK economy prior to any new trade agreements being gained. Further, that the UK government’s legislative programme will be dominated by Brexit law crowding out other progressive matters.

I am not concerned about the UK or Chinese governments defaulting on debts but the tidal change in credit ratings warrants attention because it reflects a weakening underlying financial state.

Chameleons – The banks are in the early stages of changing their colours again, a strategic colour that is.

Over the previous generation, back to the mid 1990’s, banks began expanding into all areas of the economy that they deemed ‘financial arrangements’, or similar and began to build or buy businesses in the insurance, fund management and broking sectors.

They had witnessed the high returns being made by the investment banks of the world and President Clinton gave them licence to push ahead when he removed many of the limitations from the depression era Glass Steagall Act (which separated commercial banking from investment banking).

Post Global Financial Crisis, banking regulators have been re-tightening the regulations with respect to what a bank can do and what must be done by others.

The same regulators are demanding that banks increase their equity capital for wider financial stability and making it more expensive for those banks to do business that regulators would prefer they did not do.

There have been several stories already that should come to mind for you on this subject, such as Westpac’s partial sale of BT Funds Management, the ANZ sale of E-Trade and UDC Finance and last week CBA announced the total sale of its insurance business and its ‘strategic review’ of its wealth management business.

Given the very reliable fee income that is generated by compulsory superannuation in Australia and the Kiwisaver scheme in NZ you would have thought the banks would retain these businesses, but CBA’s statement confirms that there are no sacred cows.

Then again, CBA’s allegedly unreported breach of Anti-Money Laundering obligations may result in a fine so large that they must kill one more cow than the other banks, regardless of the price of milk.

The increased equity on bank balance sheets, and the possible reduction in risk, is good news for the financial stability aspect of banking but it will reduce the gross returns to bank shareholders. That is, until the banks find other ways to increase revenue from lending (higher interest rates for higher risk borrowers) and inescapable fees for banking services.

Many investors are over-weight banking shares, often inherited from parents. These particular investors would be wise to take a close look at the banking shares ratio within their portfolio.

Customers using banks peripheral businesses might ponder how they will feel about that service being removed (sold to a different entity). How would you feel if your bank no longer operated your Kiwisaver fund?

Banking customers, and those investing in term deposits and bank senior bonds, have nothing to be concerned about from a risk perspective.

Scams – Well, technically not a scam but a very hard sell broking business.

A small group of Australians caught up in a boiler-room sales scheme (urging the unwary to trade financial options) has been trying to lobby the government to ban such speculative schemes.

In reality these people should be seeking financial advice before taking such risks with their savings.

This latest scheme involves immoral brokers cold calling people and encouraging them to trade in financial options (derivatives with leveraged exposure to prices on financial markets). ‘Put in some money and when (if – Ed) this happens you will win big’.

The problem for the person who has been drawn into the scheme is they have little understanding about the price movement of the product they are betting on and seldom recognise that the risk they take is magnified by the leverage they do not understand.

In a theoretical sense, there is nothing wrong with investors considering the use of financial options if they understand their risks and know how to apply those risks to their own portfolio.

Most investors, and I mean 99% of them, do not have this knowledge and thus should not be involved in financial options trading.

Presumably these sales sharks will try out the NZ public too in their efforts to fleece the unwary of money, so, be wary.

You know the principles:

Do not open up a new financial relationship based on cold calls made to you, these callers do not consider you to be a client, you are a payday for them;

Is the business, or person, calling you registered on the NZ Financial Service Providers Register? Ask for the number and look them up. If they are not on the FSPR, disengage because you have no regulatory protection;

Get financial advice from the business you already engage with;

If it seems to good to be true, it is;

If you want to have fun with them, and waste some of their valuable time, start asking them intentionally illogical questions then place your phone on speaker and carry on making the dinner etc;

Sample of an illogical question: ‘I understand that volatility plays a role in the pricing of options (this is true), what role does the volatility of political polls (irrelevant) play in the rewards I can expect?

The Australian government will not respond to the lobbying over there and neither would the NZ government if these ‘crooks’ manage to extract money out of Kiwis.

The Financial Markets Authority would be curious to learn whether or not these people are operating from a NZ registered Financial Service Provider or an international business that is not obliged to be registered in NZ to call you.

If it is a NZ entity then you can report any inappropriateness to the FMA.

I hope you are all getting better at swatting away these scams and conmen.

Your instincts are invariably correct and if you have a financial adviser, as we think you should, then check your opinion with them.

Investment News

OCR – The review of the Official Cash Rate was so boringly ‘as expected’ (unchanged) that it almost didn’t warrant this line in Market News.

Elections– Unexpectedly (by me), and possibly unnecessarily, Japan’s Prime Minister (Shinzo Abe) has announced a snap election for his country on October 22 with a full year left to run on his current term.

I can’t help but think he has made the same mistake Theresa May did in the UK by playing purely political cards.

If so, the Japanese will punish Abe for taking his eye off the far more important ball of still urgent economic reforms and the need for political stability whilst surrounded by the instability of their neighbour North Korea and the US President’s preference for governance by Twitter.

Japan is the world’s third largest economy, fourth if you bundle Europe together, making this new election as important as the German general election last week.

Gold – The lustre is inescapable.

China is reintroducing a gold standard for international payments, against oil trading agreements.

The Yuan is not yet a global settlement currency, although this development seems inevitable as their economy broadens its reach but as part of its move away from reliance on the US dollar China is to introduce an oil futures trading market in Shanghai, using gold as the payment method.

Futures contracts are an agreement between two parties wishing to buy/sell a commodity (or security) out of a date in the future, typically each quarter (March, June, September, December).

No money (or gold) changes hands today, but at the expiry of the agreement the commodity (oil in this case) must be delivered simultaneously against payment (gold in this case).

China is the world’s largest importer of oil so there is a natural position to support oil trading in Shanghai.

The US has become self sufficient with oil supply so many other oil exporters will be contemplating their options for selling oil elsewhere; Iran for example.

Have you drawn those two lines together?

Do you think Iran will mind selling oil to China and receiving gold in settlement, with both countries settling the trade away from the view of the US dollar banking system?

Maybe the ‘Shanghai Oil’ reference will quickly become as important across commodity markets as ‘West Texas Intermediate; and ‘Brent Crude’, not because China will join the other major producer regions but because they might claim such a high volume of oil trading settled against gold.

Maybe China has witnessed the emergence and acceptance of the many crypto currencies (like Bitcoin) and pondered, as I have, isn’t gold a more stable and reliable settlement option?

Should the World Gold Council establish a Distributed Ledger Technology platform for recording gold ownership and its ongoing use for payment into the future?

Gold has bounced around in a range between US$1100 - $1350 over the past four years. If it travels above US$1375 then things will get exciting for the gold bugs (and the oil market – Ed).

The price of gold will tell us about the success of this global finance development.

90% Rule – Once a takeover offer reaches the point of 90% acceptance the remaining 10% of the shareholders have no choice but to sell their shares to the buyer, this is because the law allows compulsory acquisition once a person owns 90% of a public company.

Last week the Chinese company Zhejiang Rifa Holding Group Co (ZRHG), which owns 75% of Airwork Holdings after an earlier offer, returned to the market to buy the remaining 25% of the company (at NZ$5.20 per share, a 20% premium to market pricing).

ZRHG has already secured acceptances for 15.30% of the AWK shares they do not own lifting their holding to 90.3%, so now they will compulsorily buy the balance.

The other takeover offer currently open in the market is the 100% offer by WSP (Canada) for Opus Consulting.

This offer has reached 75.3% but the market price for the shares (trading at 98% of the offer price) is indicating a high level of confidence that the Overseas Investment Commission (with its coincidental initials) will approve the takeover and that a high proportion of shareholders will accept the takeover offer.

The Opus offer runs until 27 November so shareholders still have the free option of not expressing a view on the offer, yet.

If WSP reaches 90% acceptance though the remaining shareholders will lose their ‘option’ for making a decision.

Electric Cars – are all the rage now (a good thing for the NZ economy over time).

I remember thinking that the big car manufacturers should know how to defend their turf against the many upstarts, which are likely to include physics professors (electrical specialists) and people with too much money.

I have inserted this paragraph after enjoying a laugh from a Bloomberg headline on the subject.

A person with ‘too much money’ has joined the market to make an electric car; James Dyson of vacuum cleaner fame.

The headline – ‘vacuum billionaire’s long journey to make a car that doesn't suck’.

A perfect summary of the person, the subject and the risk.

Ever The Optimist – Fulton Hogan’s recent profit report was logical to me, +8.5% in revenue, +6.50% in profit and +850 employees.

NZ is amid a large push upward for infrastructure and construction, yet so many businesses in those sectors are underperforming and disclosing management problems.

FH deserves applause for their performance and the reminder they provide to the listed businesses in their sector of what good performance looks like.

ETO II – Z Energy (ZEL) and Synlait Milk (SML) deserve compliments for delivering on strategy and becoming increasingly successful, financially speaking, as a result.

Shareholders will undoubtedly be chuffed with the performance of both companies.

ZEL has reached a point of maturity now where they expect to focus on efficiencies and to distribute larger proportions of their cash flow to investors.

SML by contrast is still in the midst of pushing ahead

ETO III - NZ forestry (logging) is enjoying a sweet spot with both China increasing its demand and the NZ domestic market also increasing its demand for timber.

China has reduced its domestic harvesting, reduced tariffs and increased importation of logs.

NZ, as we all know, is falling over itself to build more homes and wood has certain desirable seismic attractions!

The log pricing (S1 log was part of the report) is $128 per tonne today, which is 21% higher than the five-year average and 5% above the long-term average.

Within a $5 billion export industry, price movements of 5-10% are widely meaningful to our economy.

ETO III – Rocket Lab appears to be getting ready to carry its first payload (satellites) into orbit on only its second launch.

They, and the customers must be supremely confident about the likelihood of success for this next launch.

Subject to being correct, this is very exciting news for the young, ambitious, NZ company.

Investment Opportunities

Auckland Int. Airport – has announced its intention to offer a new six year senior bond.

Details will follow, but we expect a ‘fast moving, clients pays the brokerage’ type of bond offer and an interest rate a little below 4.00%.

We have started a mail list for this offer. Now is the time to consider whether or not you wish to invest, as this offer will come and go quickly.

Please only join this list if you are certain that you wish to invest.

There will not be sufficient time to contemplate the offer slowly. Potential investors can already access live information about the risk of lending to AIAL due to its ongoing disclosure obligations to the NZX.

AIAL has a strong ‘A-’ credit rating.

The latest investor information, including the annual report to June 2017, is available on their website: https://corporate.aucklandairport.co.nz/investors

Christchurch City Holdings – we observe that we have also been invited to a results presentation for CCHL and this may result in an approach to capital markets for debt funding support.

This would be consistent with the regions funding needs, payment of robust dividends to the Christchurch City Council and the latter’s reluctance to offer shares in its various entities.

CCHL has a strong ‘A+’ credit rating.

I think we’ll start a CCH bond list which anyone can join as we await more information.

Property For Industry – announced an intention to ‘consider an offer’ of bonds to the public.

Details are yet to be announced but many of you will guess accurately that it is likely to be a longer term (5-8 years) and this will result in a yield well above 4.00%.

We have started a list and all investors are welcome to join it if they wish to hear more from us once the offer is made.

Vodafone – has also announced its intention to list Vodafone NZ on the NZX.

We have a mail list for investors wishing to hear more about this proposed offer.

The fastest way to hear about new investment offers is to join our ‘All New Issues’ email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

David will be in Palmerston North and Wanganui on 10 October and New Plymouth on 11 October.

Chris will be in Auckland on October 16 and 17, then back in Christchurch on October 24 and 25.

Kevin will be in Invercargill on 19 October and Christchurch on 26 October.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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