Chris Lee & Partners Ltd

Taking Stock 14 December 2023

Fraser Hunter writes:

THE year has been a turbulent one, starting with central banks globally implementing record interest rate hikes in a bold move to curb rampant inflation.

This aggressive strategy steered the global economy towards recession and triggered financial instability. In March this saw the collapse of Silicon Valley Bank, Signature Bank and most prominently Credit Suisse, which succumbed to the pressures of a looming global banking crisis.

Amidst this drama, we also had continued and new geopolitical tensions, political regime changes, heightened energy supply concerns, and China's economic slowdown. This brew of uncertainty led investors to seek refuge in cash and bonds, capitalising on interest rates unseen for over a decade, while cautiously avoiding potential market sell-offs.

However, despite these headwinds, the economy and companies have shown remarkable resilience and adaptability.

The technology sector has been a driving force behind market growth, particularly in the last quarter. This surge has been lifted by the anticipation of an Artificial Intelligence-led boom, benefiting some of the world's largest tech giants.

Despite challenges such as increased borrowing costs, persistent global uncertainty, elevated inflation, and reduced consumer demand, global share markets have nearly reached their previous highs, leading to a notably successful year in terms of returns.

Investors, inherently more conservative and loss-averse, are reminded of the importance of maintaining a balanced investment approach. While it's easy to be swayed by dominant market narratives, often skewed towards pessimism, it's vital to consider both bullish and bearish perspectives.

There is never a shortage of negative risks and uncertainties, but even if they eventuate they don’t always have the impact on markets that commentators expect.

Below, I outline the optimistic, bullish view of the market heading into 2024 and beyond. It may not pan out that way, but markets have historically favoured the optimists, so this should be a key consideration in any investment strategy.

Attempting to time the market by exiting and then re-entering is extremely difficult, as it demands successful decision-making for both actions. It also involves a significant bet against markets that have generally trended upward over time.

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IN the face of rising interest rates that challenged both growth stocks and defensive sectors, which make up the biggest companies of our index, New Zealand companies have performed well. The NZX 50 saw a 5.3% surge in November, and at time of writing is flat for the year after being down as much as 7% earlier in the year.

Internationally, the United States has led the charge. Both the S&P 500 and the tech-centric NASDAQ 100 experienced significant rallies in November, climbing 9.1% and 10.8% respectively. Year to date the S&P 500 is up +21% while the NASDAQ 100 is up a whopping +37.0%. Both are approaching their previous all-time highs.

The Australian market is also making strides, with the S&P/ASX 200 Index up +5.0% in November, contributing to its year-to-date growth. Similarly, the MSCI All Country World Index, reflecting broader global performance, enjoyed a 7.7% increase in NZD-hedged terms for the month, signalling its year-to-date progress.

These gains can be largely attributed to a swift shift in interest rate expectations, particularly in the US, where a cooling inflation scenario has bolstered the prospect of a 'soft landing'. This change in sentiment has reignited investor confidence, offering an optimistic projection as we head into 2024.

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THIS time of year we see the year-end predictions for markets next year. In New Zealand, this often comes in the form of top picks for the year.

Over in the all-important US, strategists pick where the S&P 500 level and underlying earnings will be in a year. While predicting exact market positions 12 months ahead is fraught with uncertainty, the value of these forecasts lies in their underlying assumptions and reasoning.

The Wall Street outlook for 2024 contains cautious optimism, with forecasts for the S&P 500 ranging from a decrease of -8.5% to an increase of +19.7% from current levels. This positive is more impressive given it comes after the huge rally we’ve already seen and is a big shift from the previous year's prevailing pessimism. This broad spectrum and the higher end of the range signify a market that’s regaining confidence.

Key factors shaping these forecasts include differing views on a potential US recession, with some economists predicting a downturn that would be brief and shallow.

Despite this, consensus forecasts currently expect that S&P 500 revenue and earnings will grow to new record highs. This is fuelled by the return of consumer spending on goods and services, as well as operation improvement within individual companies lifting margins that had come under pressure over the past 12-18 months.

The fall in inflation has also created a growing expectation that the Federal Reserve will have the flexibility to be more market-friendly with interest rates, providing a vital safety net for the economy and share market.

Valuations remain a point of debate, with some seeing them as elevated but not extreme or prohibitive for future returns, especially should rates come down further.

The market predictions, while varied, should be viewed with a healthy dose of skepticism, but lean towards a positive outcome for the S&P 500 in 2024.

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AS previously mentioned, the recent movements in the market were driven by the view that major central banks had come to the end of their tightening cycle. This shift from an aggressive monetary tightening approach in 2022 to a more cautious stance by major central banks, particularly the US Federal Reserve and the European Central Bank, is a significant change.

The Fed has raised policy rates to a 22-year high of 5.25%-5.50% to combat inflation. However, while continuing the hold, the most recent Committee and supporting forecasts indicated that the hike cycle may have come to an end, with 75bps of cuts forecast for 2024.

The market's response to this change in stance has been highly positive. Investor expectations of US inflation for the next five years have remained steady at 2.5%, which supports the view that the Fed is successfully controlling inflation without harming economic growth. Other key indicators, such as the slowdown in new job creation and the increase in long-term government loan rates, also support this positive view.

The end of the tightening cycle is having a positive impact on equity markets, contributing to the recent uptick in resilient earnings results. Historically, the end of a tightening cycle has boosted equity and bond markets, a trend that has been persistent in most economies, including New Zealand and the US.

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IN 2023, the New Zealand economy showed unexpected resilience, withstanding an unprecedented 75 basis point rate hike in November last year and high inflation rates, to avoid a recession so far. The initial fall off in GDP was followed by a revised growth of +0.9% in the June quarter, indicating a stronger economy than anticipated, boosted by record migration.

The RBNZ is now expecting a 'soft landing', with modest, stable growth without significant inflation spikes. Recent data presents a mixed picture - stable retail trade figures versus a decline in the building sector, particularly in non-residential construction. The RBNZ forecast is for 0.3% GDP growth for the September quarter, which will be released later today.

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THE global economy, while still recovering from the pandemic, Russia's invasion of Ukraine, and the cost-of-living crisis, has demonstrated notable resilience. Despite disruptions in energy and food markets and significant monetary tightening to address high inflation, the world economy has managed to maintain a steady, albeit slow, pace.

The International Monetary Fund (IMF) forecasts that global economic growth will decelerate from 3.5% in 2022 to 3% for 2023 and 2024, a rate lower than the historical average.

Inflation is also on a downward trend, expected to drop from 9.2% in 2022 to 5.9% in 2023, and further to 4.8% in the following year. Core inflation, excluding food and energy prices, is projected to decline to 4.5% in the next year. However, most countries are not expected to bring inflation back to within their targets until 2025.

Current projections lean towards a 'soft-landing' scenario, particularly in the United States, where only a modest increase in unemployment, from 3.6% to 3.9%, is expected by 2025. This scenario entails reducing inflation without triggering a significant downturn in economic activity.

However, the economic landscape is not uniform across regions. While advanced economies are experiencing a more pronounced slowdown, emerging markets and developing economies have shown unexpected resilience, barring a few exceptions like China which is grappling with a real estate crisis and declining confidence.

The US growth outlook is relatively positive, buoyed by robust consumption and investment, in contrast to the euro area, which faces a downward revision in its economic activity.

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THE other key point is that, even if we see the arrival of a well-flagged recession, this does by no means guarantee a bear market in stocks. Markets are forward-looking, while confirmation of a recession typically occurs when you are some months into one. It is not uncommon for investments to be sold off in the expectation of a recession and rally out of the recovery.

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AT the heart of a positive market outlook lies the belief that share markets will continue their historical trend of growth over time. Companies, compelled to evolve with changing demands, tastes, and technologies, will either thrive in this dynamic environment or cede their place to emerging market leaders.

Key to this optimism is the ongoing expansion of thematic-based investments, particularly in fields like automation, robotics, and artificial intelligence (AI). Coupled with the global push towards addressing climate change, these areas are not only creating new investment avenues but are also pivotal in steering the world towards sustainability.

The anticipated easing of inflation and potential rate stabilisation is set to invigorate business and consumer confidence, thereby fostering economic growth.

Global trade is rebounding, benefiting a wide range of sectors and enhancing economic connectivity. Global businesses saw a rapid advance in technology and pushed to adapt to lockdowns and workforce mobility restrictions, which have driven a shift towards digitalisation and online services. This trend is poised to continue driving growth, especially in the tech and e-commerce sectors.

Demographic shifts, such as the expanding middle class in emerging markets, are expected to boost global consumption significantly. The UBS 2023 report projects a 38% increase in global wealth over the next five years, signalling a robust recovery and future wealth generation. This growth will likely enlarge the pool of high-net-worth individuals, enhancing investment returns across diverse asset classes.

As we look towards 2024, there are compelling reasons to maintain an optimistic market outlook. Significant technological strides and a global commitment to sustainability are at the forefront of this positivity. The anticipated stabilisation in inflation and interest rates further strengthens this perspective, promising to drive economic momentum.

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AS investors will be aware, the above paints a highly positive outlook for markets and there are risks, known and unknown, which could drive market activity in the new year, making predictions quickly outdated. Investors should ensure portfolio strategies are fit for purpose, diverse and benefit from the upside markets often bring, while not causing distress or rash changes to strategy when things don’t go to plan. 

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THIS is our final Newsletter for 2023, with Market News and Taking Stock to resume the week beginning Monday 15 January.

Our offices will close at midday on Wednesday 20 December and re-open on Monday 8 January. We will occasionally check emails over the Christmas period.

Best wishes for a merry Christmas and happy New Year.

Taking Stock 7 December 2023

INVESTORS who have survived the market swings of 2023 will be facing quite significant new challenges in 2024.

The mood swings of the markets in 2023 were influenced by wars, by inflation, by lower household disposable income, by the pressure to reduce the demand for fossil fuels, and in some countries, by panic-ridden political behaviour.

Many markets had wild swings, enough to deter even the most resilient of investors.

Traditional planning methods did not always work.

For example, just weeks ago, Kiwibank was forecasting the NZ dollar would retreat to US 55c. Instead, it has risen to 61.5c, an 11% difference. This may be meaningless for many of us but is certainly not for those importers (like fuel companies) and exporters who buy insurance (hedge) to lock in exchange rates.

Equally the markets here and everywhere were wildly astray in forecasting a very brief period would squash inflation and restore “free” money.

By contrast, in December 2023 it is fairly obvious that “free” money was an unnecessary and misguided policy of goofy governments and finance ministers. Their error is costing the taxpayers unimaginably high sums, trillions in the US, hundreds of billions in the UK, and tens of billions here.

These losses will be kept from voters’ viewing by switching the losses under the headings of even more ongoing government borrowing and even longer and more expensive interest rates.

Key signals have been the 10-year government bond rates – roughly ten times its level of 2021-22 in NZ - and the oil price, likely to be ever higher, supply constraints and growing demand bringing anxiety to consumers.

Yet in all this mayhem, sharemarkets have behaved erratically.

Arguably the world’s worst economy (of sizeable countries) would be Argentina, where inflation has been touching 150%, where the currency has fallen to “penny dreadful” status, and where social dysfunction is extreme.

It has just appointed a fickle, right-wing fellow whose economic plans are as bizarre as those of Mao Zedong at his craziest.

His social plans are just as unconventional.

Yet when one reviews the different global sharemarket performances of 2023, Argentina is the sweetest, the Base Merval up for this year by a mouthwatering 302.50%.

A precis of market performances, globally, looks like this: -

Argentina

+302.50%

Venezuela

+176.10%

Pakistan

+49.7%

Russia

+46.9%

Turkey

+44.2%

Nigeria

+39.2%

Greece

+37.1%

Italy

+25.4%

Now remind yourselves which countries in our world have the worst economies and are least likely to resolve their issues in the coming decade.

Go figure!

Of the countries on which our fund managers and wealthy investors focus, here is a list that is less unbelievable, as at the time of writing. Note there have been wild day-to-day swings in recent days.

US (Dow Jones)

+7.7%

US (S&P 500)

+18.4%

US (Nasdaq)

+35.1%

UK

+0.03%

Canada

+4.22%

France

+12.9%

Germany

+16.4%

Ireland

+17.5%

Netherlands

-7.75%

Switzerland

+1.16%

Austria

+5.41%

Spain

+22.2%

Saudi Arabia

+6.67%

South Africa

+3.4%

Israel

-1.27%

Australia

+0.69%

NZ

-1.25%

China

-1.92%

Hong Kong

-12.64%

India

+11.20%

Japan

+28.3%

Singapore

-5.48%

South Korea

+13.36%

Taiwan

+23.31%

Thailand

-17.29%

Good luck in figuring out the logic of these figures.

Good luck to those who buy into managed funds that ride this sort of rollercoaster.

The signal that stress is ruling investor mindsets is the incidence of illogical, emotional, and even ideological investing, fund managers willing to bet with other people’s money on what will be inside those boxes that the Cockney wide boys used to sell from the back of a truck at a quiet end of Oxford Street, back in the day.

The crowd would see one box reveal a gold watch for which a stooge in the crowd paid sixpence.

The next box, for which a spectator paid 100 quid, would be opened to reveal a rubber band.

The appetite for risk that is revealed by those who chase shares in Argentina, Venezuela, or for that matter Nigeria, is similar to the Oxford Street punter.

In 2024 we might see the opening of the boxes sold from the back of unregistered trucks.

The only advice of any general nature is to ensure your potential losses are affordable!

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AMONGST the many disappointments for equity investors in 2023 was the dismantling of My Food Bag, a NZ company created by media darling, Theresa Gattung, now a philanthropist.

Gattung, of course, was for a short period CEO of what has often been New Zealand’s biggest company, Spark, then called Telecom. Her leadership coincided with Labour Party intervention resulting in Telecom being dismantled, failing to accommodate the social aspirations of the reigning government.

Retired from listed company executive positions, Gattung became a founding owner of My Food Bag, a company later sold to investors at a price that today looks ridiculous, having fallen from its listed price, $1.80, to around 14 cents. Investors have been more scorched than singed.

This is despite the enthusiasm of our two best fund managers for the stock, Milford, and Harbour Asset, both being sizeable supporters.

My Food Bag’s very short-term successes before its price collapse included the period when New Zealand was locked up because of Covid. My assessment is that the trendy aspect of having food and recipes home delivered had a fair amount of short-term fashion involved, from many fickle young consumers. Its user numbers have fallen a little. Its signalled dividends have vanished.

Those with surplus income and a risk appetite, when mortgage interest rates were falling, often were younger people whose respect for what seems like good value, and convenience, quickly altered when Finance Minister Robertson’s prediction of negative interest rates was seen to be goofy.

In the more austere environment that followed higher mortgage rates, mis-shapen but edible fruit and vegetables regain popularity and cost savings become more important than the convenience of having your diet delivered to you.

My Food Bag and its competitors may have been victims of the rather more grown-up version of pragmatism that accompanies troubled times.

The food deliverers still have some sort of a role but the extreme valuation of companies like My Food Bag now look as silly as those valuations once ascribed to the likes of Sharesies and Supie.

Rather than focusing on boring matters like revenue, margins, costs, profits, and dividends, today it is possible that valuations based on some dreamy version of the future fit badly with austerity.

Gattung and her fellow founders extracted vast sums of money by building My Food Bag, Gattung pocketing tens of millions, which she now shares generously with various charities, seeking particularly to help women.

The fund managers who backed her have not sought a legal review of the listing, where assumptions were not validated by outcomes.

At 14 cents, the share is now the type of share that could next year be a star performer, a rise to 21 cents being a 50% gain.

In many ways My Food Bag and Supie were the products of a generation that welcomes disruption to the “old” ways. That generation is still learning about risk, but it sure knows how to disrupt.

Supie was driven by the popular daughter of a well-heeled family and was funded largely by people like venture capitalists, who dispense other people’s money.

It never had anything like the capital needed to go to war against giants and never did attract anything like the number of committed clients needed to meet its weekly costs. It was a romantic story, like a novice golfer winning the British Open.

Its directors seemed to assume more capital raises would be a formality. There would be no obvious alternative explanation for their failure to recognise the microscopic levels of revenue it was achieving.

One feels relieved for the staff, bailed out by a well-wisher, but one feels surprised that the suppliers of the stock – growers etc – were blindsided by the ultimate failure. The unsecured creditors will get nothing for their produce. Their decision to supply now looks reckless.

It remains a mystery that no one has asked about the credibility of a concept that seemed to be endorsed unthinkingly by the directors.

Only a tiny percentage of “clients” actually bought groceries from the company.

My Food Bag and Supie might be examples of the sort of extravagant thinking that afflicted markets twenty-odd years ago, during the absurd dot.com boom.

These failures were stand-outs and reflect the hazards of investing in disrupters, and the frailty of the processes of angel investors, venture capitalists and crowd funding. Those whose money has been torched may once have acknowledged that failure was a possible outcome. Lost, the money may now be missed.

Facing a new era that surely will reflect lower disposable income in many households, markets might need to revert to a greater level of sobriety than has been evident under the contrived “zero interest rate policies” that have characterised the past decade and fuelled silly investment risk.

There seems little doubt that a responsible government that will actually execute its solutions will focus on infrastructure, health (Pharmac etc), education, and law enforcement, at the expense of things like the Auckland harbour tunnel or the pedestrianisation of primary thoroughfares.

Higher unemployment, difficult fiscal deficits, ongoing high interest rates falling only slightly, imported inflation, skills shortages, and unaffordable housing will not lead naturally to rising corporate profits and improved dividends.  Perhaps the measurement of the esoteric EBITDA will revert to measurement of NPAT and cash flows.

The expected slight fall in interest rates should help a little to restore property valuations and should reduce debt servicing, which might mean property trusts and retirement villages recover a little in market value.

However, it would be an optimist who assumed any government can atone for the dreadful errors of the past 15 years, when those things that were prioritised revealed often poor execution, wastefulness and, sadly, carelessness in handling other people’s money.

The short period of indulgence, when the likes of My Food Bag was flogged off at an extravagant price, and when venture funds were burning money at Supies, seems likely to be paid for by a period of caution.

So for 2024, my expectations are slightly lower interest rates, slightly lower wage increases, lower inflation, more unemployment, and house prices (and rents) moderating, affordability being the issue.

Those who bought six to seven per cent long bonds will have regular income. I expect dividend policies to have more downward reviews, than upward.

We just have to hope that imported inflation is low, that China generates enough domestic wealth to keep export prices stable, that nature is kind to New Zealand and that there is genuine recovery of sensible standards in health, education and law enforcement.

In this, my final Taking Stock for 2023 (Fraser will write the final Taking Stock next week), I caution that the worst possible outcomes would be resurgence of inflation, higher interest rates, rising unemployment, leading to a new level of mortgage defaults and bank lending restrictions.

Throw in a natural disaster and life would be tough.

Yet the last few days have seen markets signal new optimism that has drowned out the caution of many old-timers.

So a Christmas cheer for a benign New Year, with good health and good cheer!

May the young optimists have spotted the right portents.

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Our office will close at midday on Wednesday 20 December and re-open on Monday 8 January.  We can be contacted by email over the Christmas period.

Chris Lee