Chris Lee & Partners Ltd

Taking stock 26th March 2020

New Zealand is about to discover the amount of money we habitually waste.

The closing of shops, cafes, restaurants, bars, the TAB, Lotto shops, beauty salons, movie theatres and sports arenas will have one certain outcome.

Confined now to our homes we will spend far, far less money in the coming weeks and possibly months.

We will be confronted with money left in our pockets, learning how much of our toil generates money that we spend out of habit, sometimes aimlessly. We have a very first world lesson that our catastrophic health crisis will uncover.

The economy and most businesses have been geared to high levels of personal consumption.

Today, the velocity of money, enabling all those ticket clips from GST and business margins, is already shrinking even as the lockdown inhales its first breath.

It will be fascinating to discover in the months to come just how much of the over consumption will die forever after the brutal first four weeks pass, the nation finding that there is little available on which to spend discretionary money.

Equally fascinating will be the evidence of the effect on skies, waterways, and oceans. When all the transport carbon is suddenly reduced will we see an immediate response?

The sun will appear in California in blue skies and the likes of Hong Kong and Beijing may discover instant changes in their skies.

As these outcomes become evident will the people, particularly in first world countries, be moved to change their habits, wasting less, spending less and polluting less?

My expectation is that retailing will change its shape permanently in grossly over shopped countries like New Zealand, Australia and Britain. We may find that random shopping becomes a weird and obsolete practice, ending the era when ''shopping'' is recorded by many as their favourite pastime.

From the shop owner's point of view the need to manage a business model that relies on yesterday's turnover to pay today's wages might be forced to accept there are more useful things to do than slave away in perpetual anxiety for very little long term gain. Most retailers work long hours for modest gain not because consumers underspend but because there are far too many departmental stores and too many mega shops to meet sustainable, sane demand.

If consumers discover that no-one really needs the sort of stuff that first world people hoard then the surfeit of shops might, thankfully, be culled. Surely picking our own fruit makes better use of our energy.

So from all this chaos, that will quickly move to tragedy when the frail and ill begin to battle the virus, some of the consequences will give us all a chance to recalibrate.

The planet might weep with joy (to the delight of North Auckland farmers).

We must first pray that we stop the progress of the virus before it kills.

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When fear grips investors and cash becomes the only asset that the frightened will trust then the price of paper securities responds to the new shortage - a shortage of buyers, a shortage of liquidity, or succinctly, cash.

Those holding cash, or raking it in each week as Kiwisaver managers do, have control of a scarce resource and are under no obligation to buy at the prices sellers would prefer.

Frightened investors, or people who were unable to prepare for unexpected events, suddenly have an urgent need for cash. Demand for cash quickly exceeds supply. Prices collapse until equilibrium is restored, effectively the time when the auction has as many buyers as sellers. (Perhaps for March 31 reporting times, buyers might temporarily appear, with other people's money!)

If those holding precious cash succeed with an offer of a florin for a ten bob note then the buyer's next bid might be a florin for a pound note.

If the troubled owner of the pound note needs a florin, he might sell. Urgent need for cash demands a fair deal.

I am reminded of a golf story in which Jack Nicklaus featured. He was on the 18th tee of the Masters, final round, about to tee off when a spectator emerged from the bush beside the tee and plaintively asked him if he had toilet paper in his bag. Jack smiled, replied that he had none, and was about to tee off when the spectator intervened again and asked him if perhaps he had some old scorecards in his bag. Patiently Jack shook his head.  ''Well,'' said the troubled spectator,''might you swap me two fives for a twenty?''.

In a buyer's market, bargains arrive.

Fleeing investors might have greater motivation than just a need for cash, or fear. 

They may have reached the view that our future financial markets might look nothing like the market that existed just four weeks ago.

For example they may see the imminent demise of the likes of David Jones stores and may be perfectly logical in seeking out someone with the opposite view, willing to quit at any price.

Furthermore, they may be shown in the future to have had foresight.

There may well be permanent changes in the way we spend our surplus money. There may be changes in where we work. Might we find that our staff are happier and more productive working from home, leaving all those highly leveraged owners of downtown office buildings to listen to their piped music, and gaze at their often ghastly art pieces, with far fewer tenants.

 Price falls in a panic environment are often not discerning, because the sellers are competing with different groups, including those who simply need cash, perhaps to bail out a family member. But there is at least some chance that some sellers are displaying more insight than fear.

Any recovery in market prices must surely begin with a credible solution to the virus with its threat to life.

We are told the virus can be thwarted by our isolation, starving it of victims, and then attacked by new antidotes, yet to be developed, unless Trump has them hidden in the Lincoln's glovebox.

But a real recovery must also deal with structural changes to our society, such as changes to consumer and work behaviour, and the aftermath of massively increased sovereign, bank and personal debt in a world already suffocating with excessive debt.

Such a recovery will take years of adjustments. A soothsayer may be able to be more specific. Few of us claim such prescience or omniscience, though a handful pretend to have these supernatural skills.

Order will certainly not be restored in the near future.

In the very immediate future falls seem inevitable, whenever frightening news emerges.

This makes a mockery of those self-interested pundits who capture the media attention by preaching that we should just sit and watch as the two trains approach each other at speed. Holding on to all shares, or an index fund, may well allow for a recovery in price over a very long period but as the sharemarket of the future must be irrevocably changed, investors would need to be certain of their analysis to take the risk of keeping certain shares. 

Most certainly the makeup of the index in the future will change dramatically, making a share index fund a highly improbable ''safe haven''. 

An obvious dislocation will occur next week when the index funds will be compelled to reweight each stock. ATM and FPH will need to be bought, reflecting their higher share of their index, while the property trusts, the retirement villages and the banks will have to be sold, their weightings having fallen. Do you think those who will have a choice to buy and sell might be aware of these forced behaviours next week?

All of us who began our careers many decades ago would be dim if we have not learned that when major events occur, the early ''sales'' are attended only by the impatient or the unwise.

The founder of the share index- tracking  fund , Simplicity, is Sam Stubbs, a socially pleasant salesman who would have had insight into the crash of the non-bank sector in 2007/08, Sam having led Hanover Finance Group, until its dying days. 

By using the media to advise people to hold on to their investments, he takes a great risk, and in my view shows no wisdom, perhaps revealing that his role in life is not to encourage personal research, but to herd people to accept whatever happens, that being the underlying basis of index funds. 

A more sanguine commentator might stress that the news will get worse before it gets better, the rare good news days being far outweighed by days when the progress of the virus strikes further fear into everyone.

One would expect that any frenzy would end only after all the bad news had been digested, fact sifted from fiction, a credible way forward accepted, the new shape of our country more obvious.

After the 1987 crash it was 1991 before the index stopped falling. Yet the cause of that crash was easily addressed.  Incompetent or dishonest governance of banks and public companies here , in particular, but also worldwide,  had created utterly stupid expectations, including the thought that New Zealand, with all its debt and annual deficits, and its shortage of savings, could be ''the Swiss'' of the Pacific. That repair of that relatively simple problem took four years.

This time the cause is a vicious, lethal pandemic AND a world submerged in debt, far more complex problems to solve, especially given the need to simultaneously address world pollution, and carbonisation. 

I excuse the various newspaper reporters who uninsightfully engage with junior market salespeople and then dispense ''don’t panic'' advice. None of these people have any useful knowledge. I understand why fund managers want to slow down the selling queue, as they seek to minimise their losses. In my view the salesmen should be silent, not pretending foresight that far distances itself from their training or experience.

It might make sense to hold shares in some sectors that seem certain to retain their shape. Those of our clients who have authorised us to give them financial advice will get access to detailed analysis, displayed in the Advice Section of our website. No one, certainly not Stubbs or newspaper reporters or even experienced financial advisors should be offering specific advice to people they cannot possibly know. How can they know the risk appetite or the circumstances of all those who read their musings?

To emphasise the point, index funds have holdings in tourism companies, travel companies, hospitality companies, casinos and retail shops. Would anyone want to ''hold'' these expecting an imminent recovery?

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One share tracking index fund manager contacted me to discuss his view.

He noted that next month, during the lockdown, all fund managers, active and index, will report their quarterly results.

We know what the share index fund managers will report. Their results will track the fall in the index, perhaps 30 per cent in the last quarter.

The caller rang to say active managers will report similarly bad news. ''On average, they must be the same,''  he figured.''For everyone who beats the index there will be an equivalent loser''.

I think he misses the point.

An active fund manager should hold cash, for redemptions, and should hold cash as a strategy. He should hold bonds. He might hold alternatives asset classes like gold. He should have culled at least some of his riskiest share investments at the first hint of the virus.

If all his other assets totalled a third of his portfolio, and he had two thirds left that tracked the index, then obviously his loss of customer money will be one third less than an index fund.

I accept that it is not fair to compare an index fund with an active managed fund, with the discretion to reduce percentages in the riskiest asset classes, but I would have figured that is why we pay fund managers so extravagantly - because they should be adding value by reducing risk as well as by chasing the best performers.

Perhaps I am comparing apples with apples, but displaying a preference for Granny Smith over Golden Delicious.

Certainly I would have expected an alert active manager to have been selling Air New Zealand shares long before the government bailout was announced. An index fund had no such flexibility.

The next years will be extremely tough for pension funds and annuities, as well as index funds.

After the 2008 crash, many American workers, in companies like General Motors, found their pensions were slaughtered. GM simply reneged on its promises of a specific pension for life, slashing the amount by two thirds. The GM pensioners found that the pool that paid their pension had been decimated by sharemarket losses.

In 1988 the former staff of Farmers, here in NZ, had been well served by a carefully run pension fund. When the ugly risk takers at Chase bought Farmers a high level of the pension fund was hijacked to bolster Chase's aspirations. 

The Auckland-based property company Chase collapsed into shameful disarray, bringing disgrace to its governors and executives but, worse, destroying the pensions of all those retired Farmers staff.

By contrast, the late Sir John Anderson had personally analysed Chase at least three years before the collapse, wisely urging the National Bank, as it was then, to hold their noses and run from the smell that Anderson detected. No-one ever explained how that smell could not be detected from those in the Chase boardroom.

The sad truth is that at that time the law allowed the bone-headed manipulation of private pension funds.

It is very difficult to see how leanly- capitalised annuity funds, with no institutional shareholders, can continue to pay out their customers, the payments calculated on the basis that the funds would average four, sometimes, five per cent per annum AFTER the 2% fees have been deducted. Bond yields might be three per cent, cash yields might be one, but share investment returns might be minus thirty. 

Without a government bailout the prospects look bleak to me.

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A current victim of market disarray is the global and local bond market.

Globally, liquidity has dried up.

Here, even local government bonds were attracting few buyers until our Reserve Bank made the unprecedented decision to buy $30 billion of bonds. I suspect some of that money may eventually be used to keep the corporate bond market from falling fallow.

In Europe the European Central Bank, facing the same problem, injected 750 billion Euros, a stunning task for its cash printing machines.

And in the USA, the Fed will buy bonds until there are no sellers. This will pump even more money made from fresh air into the world's most indebted nation.

Maybe a needed outcome of the lack of liquidity in our bond market will be the restoration of credible credit margins when bonds are issued. As Michael Warrington discussed in Market News the power is now back in the hands of those holding cash and no longer starved for choice by zero interest global strategies.

In scary times the credit margin for BBB- rated bonds ought to be several hundred basis points higher than an AA bond or even an A rated bond.

Unrated bonds ought to be significantly more generous again.

My guess is that many potential bond issuers will prefer to restrict issuance to the wholesale market rather than be seen in public, confessing their need for more debt.

After 2008 for a short time it was possible to buy the bonds of the large Australian and British banks at yields of more than twenty per cent.

This time the banks are less exposed, and virtually guaranteed for a while by government, so it will not be them paying fancy rates.

But you could bet your big toes that US oil producers would happily pay twenty per cent to raise long term money with gentle covenants, and US retailers might be in the same category.

Our clients should talk to us regularly to keep up with the opportunities in the bond market.

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Insurers correctly announced that the premiums they accepted did not include any liability for travel cancellations caused by a pandemic.

Quite right. None of the premium was spent on offsetting that liability.

The premium was charged to cover liability for medical misadventures, lost or stolen personal gear or credit cards, or maybe damage to rental vehicles or funeral costs for those who die while overseas.

So people paid the premium, say $800, for cover against these possibilities from the moment when they embarked on their travel.

Now they are not travelling. There is no liability for the insurer for any of the mishaps that might have occurred.

So why is the premium not immediately returned, perhaps minus a tiny fee?

I accept this is another ''first world'' problem but for the life of me I cannot understand why the insurer, now covering no liabilities, thinks he is entitled to keep the premium; to cover what liability?

At very least the premium should be transferred to the next overseas travel.

If I buy and insure a car, and then sell it the next day, the insurer has no further liability so he rebates me with the unused premium, minus a tiny clip.

And the difference with travel insurance is ...?

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When prices of the property trusts plummeted I contacted Ian Cassels, the owner of The Wellington Company, to discuss his three Quantum property syndicates.

He responded that occupancy was virtually 100 per cent, rents were being paid, often by student- sponsoring governments and that the quarterly dividends seemed secure. Thank heavens for that.

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Brokers and even financial advisers are currently deemed to be essential services so are not required to close their offices.

We remain open for business but our office front door is locked. All contact must be by email or, if necessary, by telephone. We commit to efficient response. 

We will make specific times to ring clients who wish to discuss their investments with us. Edward, Kevin, Mike, Johnny, David and I will respond, will offer financial advice and will transact as requested. Our communications, such as Taking Stock, Market News and our imminent quarterly newsletter to advised clients, will continue. They may be longer. We asked clients if they would allow longer newsletters. No respondent demurred. We can be as wordy as we like!

We absolutely respect the need for client and staff safety which is why we reacted well before the health authorities issued their dictum. 

Please be safe, keep well and email us as often as you wish.

Chris Lee

Principal.

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Taking Stock 19th March

Chris Lee writes:

THE Ardern Government has announced a number of initiatives to calm the people of New Zealand. Many are so targeted and so subjective that they will need transparent discussion, generous interpretation and effective execution to be of much help.

The Government should have three golden objectives:

1) Maintain employment at or near current levels;

2) Pay the people whose jobs disappear as a result of the virus;

3) Upgrade our health services, filling them up with money and resources so that the afflicted can be isolated and treated with dignity. Even without the virus we are long overdue for a refreshed health service, most hospitals in need of cash injections.

Locally, Kenepuru Hospital in Porirua has ample grounds for a large number of containers that could quickly be gibbed out and converted to an isolated sanctuary for the seriously ill.

Germany did this in weeks for the refugees. China did it in one week.

Are we flexible enough to respond effectively to our new need for isolation?

My biggest fear after the health threat is unemployment. If there are 165,000 jobs relying on cruise ships and international air travellers, then there will be great discomfort in that sector alone. Retailers should be wary of falling social confidence. I foresee permanent changes in our social behaviour and our discretionary spending.

IF the velocity of money slows because of fear, leading to cash storage, then all sorts of businesses will have too many staff.

The Government package envisages this.

The lowering of the overnight cash rate might, or might not, reduce mortgage lending rates. Lower rates potentially could help the newly unemployed. But banks will need to agree to capitalize missed payments, with the approval of the Reserve Bank, and they will need to pass on any savings. Yet the banks will inevitably face the cost of business client failure.

Perhaps it is a pity that Kiwibank is not wholly owned by the Government. It might have taken instructions to help had it been owned just by the Crown. The Australian banks will display a hitherto unseen face if they exhibit kindness and social empathy. A new type of person will need to govern the banks. Leopards rarely lose their spots.

People will need money. The Government can run a huge deficit for a year or two. The people matter. I have hope that Ardern's kindness will help people get through a bleak period of time, which I perceive will be a catalyst for lasting changes, perhaps some for the good. It would be great if New Zealand emerged, eventually, with upgraded facilities and more sustainable lifestyle behaviour.

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When investors are confident, and markets are percolating in aromatic fashion, thoughts focus on what is a fair return for capital. In contrast, when fear rules, the focus reverts to capital retention.

When a bank deposit was returning 3% after tax, a reliable company with forecastable revenues (as the power generators/retailers would be regarded) would have discovered that a 5% imputed dividend was seen as attractive. Its share price would have reflected this.

A power generator would have found its bankers were relaxed, its access to more capital from any required rights issues being assured, everything looking easy in a bull market. Full marks to those who raised and hoarded money. No marks to those who inanely used company money for share buy-backs.

The keen investor would have bought the shares and self-managed, or worked with a share broker or adviser, or he/she might have bought in to a managed fund which bought the sort of assets that the investor found appealing.

The cost of advice and/or management would have varied but might have reached an extravagant 1.5% per annum, even more if there was a life coach or financial planner clipping the ticket.

In this benign environment, investors looked at the advice cost, the effect on the net return and were tempted by media articles, often written by teachers, seminar salespeople or company representatives. Those articles were rarely insightful and often naively focused on the trite headline that nil or low fees produce better value for investors. In bull markets, that might sometimes be true. In bear markets, it is rarely true.

In a bull market, when many companies are succeeding despite a poor business model, poor governance or short-termism, the salespeople who focus on fees may generate a following, especially amongst those without personal knowledge of capital markets.

As the bull market roars, virtually every company enjoys a share price rise so the lack of substance in the sales advice is not apparent and, for some, not even relevant.

In the past decade, trillions of dollars have poured in to index funds (ETFs) where costs are minimal, following that advice that reduced costs always produce better net returns. (Excellence produces better returns.)

A simple software programme had been written to mirror an index, aping the weightings of each stock. The cost of this was minimal. Fees reflected the absence of skilled analysis.

In an index fund, no research is performed. No experienced, wise person is employed. All that is needed is a sophisticated salesman, engaging with the media in a benign way, hoping the media will generously print the full sales pitch and do the marketing for the fund without much cost. 

Index funds have minimal cost so the fees, even at low levels, are lucrative for the owner of a fund, whose salary will be high but irrelevant, and rarely disclosed. The owners of such funds naturally exploited the bull market and the willingness of the media to promote them.

A $2 billion ETF fund would earn millions in fees even at 0.2% per annum fees. Costs would be next to nothing. Salaries will be affordable, even at revolting levels.

In this bull market, all is well. It is easy to imagine why index funds would not want there to be any structural changes in markets or in the behaviour of their followers.

If a stock like Synlait Milk rises significantly after the researched funds buy more, seeing growing value, the index fund at some rebalancing date would need to buy more to keep the promised weightings of the index. If the fund already had a million SML shares and pushed the price up by buying another 500,000 shares, the fund would then have 1.5m shares, all valued at the new, higher price.

Who cares if the price is higher than the fair value calculated by research? A gain has been established. Investors are relaxed. The ETF results on paper look good. The ETF fund grows. The analysts who could calculate that Synlait shares had a maximum value of $7 would have watched in wonderment as the share price rose to $14 on the buying, predominantly by index funds.

Regularly the market moves as researchers and analysts do their jobs and react to changing business conditions.

The ETF simply buys at whatever the price. It is a price-taker, not a value-seeker.

Then we get COVID-19 and investors everywhere are frozen, unable to see how society might change. The researchers see that trade uncertainties are likely to slow down the growth of Synlait Milk. Maybe they research the possible problems at Pokeno where Synlait has a dairy factory that its neighbour wants to close.

The active, researched managers immediately reduce their holdings. Synlait's share price falls disproportionately. Its share of the index falls, unless every share in the index is falling at the same time by the same percentage.

The ETFs must sell. Who is the buyer? The most likely buyer, AT A LOWER PRICE, is the active manager who sold at $9.00 and has cash. Perhaps that manager is a Kiwisaver manager, collecting new cash every week.

Will the active manager providing the liquidity for the ETF offer the ETF a good price? Certainly not! Liquidity in a bear market has huge value.

The potential buyer KNOWS that the ETF MUST sell, in line with its commitments to mirror the index.

The computer-driven fund has promised it will keep its weightings up to date. The promise is in the rule book and is audited. So the ETF says to Forsyth Barr, or whoever is its broker, settle the sale order by 5pm tonight.

Nobody forces the buyer to settle. The only incentive for the buyer is a cheap price.

No doubt Jonty Edgar, the executive director of Forsyth Barr, will decline to comment but he knows that if an order must be settled to enable the fund to meet its promise, then the sale price will keep falling until sufficient liquidity matches the order.

If Synlait's price was $5.00 at 4pm, it might well have to fall further to find a buyer to complete the order by 5pm.

At that new low price Synlait Milk may have an even lower weighting in the index. So more will need to be sold, unless the weighting changes. The share price enters a vortex.

That explains why the flood of money into Index Funds carries the real risk of being gamed and it is why one needs to understand this risk before buying into an Index Fund. It is a bull market strategy.

Yet such funds are promoted by people in the media who might hold seminars but are not connected to the capital markets. Often, I regret to say, these promoters are causing harm. Should they be giving advice to all and sundry? The law exempts the media from any competence assessment. I ponder the justification for this. Uninformed advice is likely to be poor advice, and is not accountable under current media laws.

In the world of financial advice, the golden rule is that each buyer must have considered risk as well as potential return, before buying. Risk must match personal circumstance. Investment horizons must be calculated and are of critical importance. No one wants to be forced to sell in a bear market.

The return of capital, rather than the forecasted return on capital, will be the primary concern for some, most, or even all investors, in a bear market.

If we are to witness a free-falling market for some time yet, investors would need to have a real knowledge and experience to avoid the horror of unimagined paper losses, realised because of a need for cash.

The advice of ''Buy now, timing is irrelevant'' remains the most obvious signal of an ignorant person or a highly-stressed salesman, trying to achieve his budgeted sales targets, or trying to slow down withdrawal rates.

The cost of real advice might be irrelevant, in a bear market.

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The media in 2008 accepted all sorts of advertisements from the likes of Bridgecorp, Hanover, Money Managers etc., and often quoted the opinions of their people, in return for advertising support.

My opinion is that in this stressed time the media must be wise, and ensure it does not leave open a path for salespeople, of any financial product, let alone a product that in tough times is extremely vulnerable.

Seminar presenters, teachers and those without genuine and personal wealth management experience, and without any accountability for their ''advice'', should be regarded as entertainers, rather than advisers.

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Given the urgency for a review of strategy, and a repositioning to avoid being left behind by the speed of social and business changes, resulting from this health crisis, we believe all of our clients wanting advice should regard NOW as the time to review strategies and identify any need for change.

Advised clients do not pay for this monitoring service. The cost is included in our annual set fee.

We are able to respond now, as Phase One of the virus allows us to work normally. Please contact us, preferably by e-mail. We commit to be efficient in our response.

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Johnny Lee writes:

Markets continue to tumble worldwide, as the Coronavirus crisis evolves, and anxiety continues to spread, rightly so given the certainty of changes in all aspects of society.

The speed of change is making analysis difficult, as facts from Day One are superseded by those facts presented on Day Two. One natural consequence of this has been the withdrawal of formal guidance, as the likes of Air New Zealand and Auckland Airport simply note that they have no ability to accurately forecast the impact of these events. At time of writing, Air New Zealand has suspended all trading in its shares, pending a material announcement.

Quarantines are now being put in place throughout Europe, as people are urged to avoid public gatherings and postpone non-essential travel. Sports events are being cancelled or played in isolation away from the public. World leaders are themselves being placed in quarantine. From Wall Street to North Korea, people are temporarily withdrawing from society, causing major headaches for businesses that rely on the willingness of people to engage in society. Borders are closed. Will we soon see all front doors closed?

Globally, the sectors most eyes are on include the airline stocks, hoteliers and companies that rely on the willingness of people to congregate en masse in specific locations – think casino operators, cruise ship operators and theme park owners. These sectors have seen very large falls – the shares in Norwegian Cruise Line, the world's third largest cruise operator, have fallen over 80% over the last month. These sectors will be stretched. The key test will be access to funding – either through lending or from reserves – to see them through what will undoubtedly be a challenging environment for months to come.

On the positive side, some sectors are being viewed as potential beneficiaries from the global pandemic. Zoom, a US-listed company, has seen a substantial jump in share price as the crisis has unfolded. Zoom provide remote conferencing services, allowing businesses to communicate with staff, and attend conferences while confined to their homes. Certain biomedical companies have seen a flurry of interest, while certain sectors, dubbed 'Stay at Home' shares, have shown some resilience to the worst impacts of this downturn. These include those companies that provide home entertainment, such as Netflix or Activision, or those that provide delivery of food and groceries.

The New Zealand market has its fair share of large falls, with the brunt being borne by our ports, airline and banks. However, even the likes of Genesis Energy, Ryman, Summerset, Synlait and Fletcher Building have seen drops. The selloff is indiscriminate.

Some of our companies will be genuinely tested. The likes of Moa Group, a brewing and hospitality company, will be nervously awaiting a return to normality and the re-opening of wallets. Those companies with weak shareholders, or shallow cash reserves, will be holding on grimly. 

Some will not. Those providing essential services, like Telecommunications or Energy, will not yet be experiencing any material hardship, yet we have seen dramatic falls in these share prices, prompting those with a long-term view (and cash on hand) to continue accumulating while prices seem low. Perhaps surprisingly, Heartland Bank has reaffirmed its guidance, stating that it sees the previously forecasted profit guidance of $78 million is ''likely'', a result that would not justify a share price in the doldrums. Chief Executive Jeff Greenslade has spoken with his wallet, acquiring 50,000 shares in recent days.

For some recent investors, this environment will be an unwelcome introduction to the extreme volatility that trading in the share market can bring. Those who have experienced market crises over the decades might not yet be panicking. However, the last twelve months have seen many investors enter the sharemarket for the first time, a good outcome for proponents of liquidity, risk management and engagement to our capital markets.

Many of these first-time investors have used discount brokers to enter the market, void of any advice, trading based on personal research, media coverage or Google searches. Most will hopefully be sitting on a profit, as share prices have climbed over the last year. How will they respond, if markets continue to fall?

Numerous reports of Kiwisaver investors 'rushing' to transfer money from Growth funds to Conservative funds will exacerbate the situation and create opportunities to those outside Kiwisaver sitting on cash. Fund managers may have no choice but to sell out of shares and purchase bonds. One would hope that those in Kiwisaver, a long-term savings scheme, are not treating it as a day-trading tool. It was not conceived for such a strategy.

Media outlets will be seeing a large increase in viewership, as people endeavour to stay informed of official advice and global developments. These organisations will be well aware of their role in ensuring critical information is available for the public, and not hidden behind paywalls, and not allowing uninformed opinion to pose as information.

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Another sector experiencing pain has been the oil and gas industry, which is suffering from the fallout of a huge decline in the price of crude as Russia and Saudi Arabia continue their disagreement over production cuts. At the same time, global quarantines are depressing demand for oil, as people postpone travel.

The New Zealand share market does not have any major oil producers, with the likes of Air New Zealand, New Zealand Refining and Z Energy being among those impacted by price movements. 

In Australia, Woodside Petroleum has halved in value in the last month. Oil Search and Santos have suffered similar declines. The larger companies will have substantial cash reserves, allowing them to fight for survival during temporary downturns. 

The bigger risk may be in the US, where debt-fuelled shale oil producers have operated on low (or negative) margins, even when oil prices were at much higher levels. The banks that lent money to this sector, and the bond-holders, will be on red alert.

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The long-term consequences of the outbreak remain to be seen.

One expected outcome will be a re-evaluation of the effectiveness of Business Continuity Plans and 'Telecommuting', or 'Working from home'.

New Zealand, being an earthquake-prone nation that has experienced devastating natural disasters in recent years, will already be ahead of the world in these respects. Most of our larger businesses have already developed plans to ensure business can continue under quarantine or disaster conditions. 

Some businesses simply cannot function without a physical presence. The likes of hospitality workers, fruit pickers and hairdressers cannot work remotely. 

Teladoc, a US-listed company that offers patients the ability to remotely connect with their doctor over the internet, are among those increasingly offering services to promote remote access for the service industry. Presumably, this has flow-on effects to traffic management, fuel consumption, carbon emissions and retail spending.

Twitter Inc has also been insisting that all global staff work remotely and stay out of office.

Longer-term, this will pose challenges to the service sector, as most will not be equipped to deal with a long-term downturn in consumption. Our cities are largely designed to promote foot-traffic around our cafes and restaurants, a model that may need to adapt to the environment it finds itself in. People will still need to eat, but will be less enthusiastic about sitting in a crowded room with a group of strangers.

Our service sector is essential for our standard of living, and one we should take care to protect.

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One specific risk caused by the state of the market is access to capital.

During times of high volatility, especially when such volatility is accompanied by an overarching negative outlook, shareholders will be reluctant to commit capital to struggling companies, unless provided with a hefty discount.

Most shareholders will look for downside protection, such as that offered by Westpac in their recent capital raising. In Westpac's case, the rights issue was priced at the lower of a fixed price, and a small discount to the average price in the week leading up to the offer closing. This meant that, as the share price began to fall, shareholders were protected from paying what might have been a reasonable price at the time the offer was initially made, but was no longer a fair price upon the issue closing. 

In these conditions, underwriting becomes riskier. Already this year, we have seen one capital raising abandoned, only eight days after a public announcement. Markets are moving quickly.

Companies, especially those which are due to repay debt later in the year, may look to ''beat the herd'' by entering the market soon. Investors can afford to be selective with these opportunities, as market volatility is not showing any signs of subsiding.

Companies choosing to invest their cash in their own shares, called a Share Buyback, would be carefully scrutinising whether this is still fit for purpose. Over the last decade, American companies have largely been the biggest buyers of their own stock. Reducing capital in times of exuberance will be seen as a mistake, maybe a fatal mistake, in prolonged downturns.

Their national airlines, which have reportedly spent the last five years purchasing about $40 billion of cash on buying back their own shares, are among this group. These same companies are now seeking US Government aid, to the tune of about $50 billion. 

Strong shareholders, access to capital and cash reserves are all integral parts of managing a business during difficult times. 

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

One term being introduced to the general populace of late has been the concept of share market Circuit Breakers. Some readers may be unfamiliar with this concept.

A Circuit Breaker is the term used to describe the automatic shutdown of trading once certain thresholds are met. In the US, if the S&P 500 drops 7% below its previous close, it triggers a 15 minute closure on all exchanges, unless the drop occurs too late in the day. A fall of 20% halts trading for the day.

Circuit Breakers are predominantly designed to prevent 'Flash Crashes', as occurred in May 2010. On that day, computer-based trading software behaved unexpectedly, and began selling enormous quantities of shares to send the Dow Jones down 9% before traders were able to react. The crash exposed some traders behaving illegally, and prompted an update to the rules governing Circuit Breakers.

This month has already seen these Circuit Breakers triggered thrice, a reflection of the sense of panic day traders are experiencing at the moment.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Metlifecare's share price may have piqued the interest of observers, as it tumbles well below recent levels.

Metlifecare is currently subject to a takeover offer at $7 from a group controlled by Swedish giant EQT. The offer is subject to various approvals, and was made prior to the specific conditions we are experiencing now.

The shares are trading below $6. If one believed the takeover was to proceed, purchasing them now would be a no-brainer. 

The only real explanation for the current trading behaviour is that the market does not believe the takeover will proceed. Metlifecare's announcement, dated only on Tuesday, seems to suggest the company is confident that the market is incorrect.

Time will tell which party is correct.

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Travel

All of our planned city visits have been deferred, in line with Government and health department recommendations.

We will now meet requests for telephone appointments at times arranged with clients.

Emails remain our main point of contact, where responses are easier to sequence than phone calls.

We recognise this is an unduly lengthy Taking Stock. We invite user feedback, as to its relevance and usefulness!

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Taking Stock 12 March 2020

THERE are two undeniably logical reasons for current sharemarket nerves, tipping the world into a highly stressed state, at least for the immediate future.

Obviously, a measurable fall in business activity is occurring, lower tourist numbers and restricted trade having a direct effect on revenue, margins, profits and, consequently, repercussions for the workforce, here and everywhere.

Any restaurant with reduced custom needs fewer staff and collects less GST for the Crown.

Much of the outcome of reduced consumption is able to be forecast, leading to reviews of revenue and profit, and thus recalculations of share price value.

Underpinning these behavioural changes by customers are changes to what economists describe as the ''velocity'' of money.

Velocity of money refers to the speed at which money is spent, and thus circulated. Each time money is spent, a ticket gets clipped, GST is payable, and wages are affordable. Discretionary spending keeps the tills tinkling. The higher the velocity, the better it is for an economy.

Some years ago, Kevin, Michael and I toured the country addressing investors, discussing the financial markets and in particular the issuance by banks of Tier One and Tier Two instruments in New Zealand.

We also talked about the economy.

I began each talk discussing the importance of the velocity of money, illustrating that somewhat dry economic jargon by recounting a colourful story often used in universities.

Kevin and Michael must have been unhealthily bored by the constant use of the illustrative story, but it makes its point clearly and unfolds like this.

A tall, wealthy Texan enters a struggling Galway hotel in Eire and tells the troubled owner that he wants a good bed and the best fillet steak meal each night for two weeks, whatever the cost. He must have a good bed and wants to check the bed before he confirms his booking.

The publican tells him he must pay a 100 Euro deposit before he checks the beds in each room. The Texan heads upstairs having handed over a refundable 100 Euro note to settle his dues.

The publican has no steak. He rings the butcher. The butcher wants his unpaid bills from previous months paid. The publican sends over the 100 Euro note.

The butcher needs his delivery man to deliver the steak. The courier demands the butcher pays his outstanding bill, so the 100 Euro note goes to the courier, who in turn pays off the petrol station, whose owner owes money to a sex worker who owes the hotelier for room hire.

Clutching the 100 Euro note, the woman returns it to the hotelier just as the Texan comes down the stairs unimpressed by the beds, demanding his 100 Euros be returned. The hotelier hands over the same 100 Euro note.

Meanwhile the unpaid bills have all been paid, local business credit reputations are restored, and normal business conditions resume.

The velocity with which that 100 Euro note restored business relationships had been high. It was ''spent'' six times in 15 minutes.

It is the lack of consumer confidence, badly dented by the Covid-19 virus, that is currently hurting businesses globally, logically leading to price falls in sharemarkets, and a fall in the velocity of money.

Consumers lack confidence because of the unknown time that the virus will continue to constrain global trade, and the unknown time involved in proving that the virus is just another flu bug, solved by most people having a resilient immune system. In the meantime, the vulnerable are rightly terrified of being struck by the virus.

The unknown is the cause of the fear, but the fear leads to known consequences – a fall-off in the velocity of money. We slow our spending when we are scared. We hoard it.

Border closures or blockages will slow the transporting of goods. We might panic-stock our larders but that rush of spending is offset by less spending later, so it solves nothing.

The share price falls are not a sign of hysteria. They are recognition that the slowdown in the velocity of money means far less ticket clipping by all those involved in commerce.

My expectation is that normality will begin when the health scare recedes and consumer confidence is restored. That will require the health outcomes to be credibly communicated and accepted.

Two Sundays ago the Wellington Regal Restaurant had just one client (me) between 6.20 and 7.20pm on its busiest night of the week. Last Sunday it had 15. Usually it has 100-150 in that time.

Most businesses have squirrelled insufficiently to bear a loss of customers for any length of time.

We need confidence to be restored, quickly.

 _ _ _ _ _ _ _ _ _ _ _ _

Coinciding with the anxiety of a health threat has been an oil market disruption, a dispute between Saudi Arabia and Russia. The Russians would not agree to production controls so the Saudis, whose production costs are lower, have blitzed the other producers, threatening to flood the market with oil at their low cost.

Oil and other trading disputes have many natural, almost inevitable, outcomes.

The higher-cost producers get isolated from bank credit and then default, leading to distressed sales.

Countries under extreme pressure, such as Russia, can escalate their woes with military responses. They probably will see Saudi Arabia as a proxy for the devil incarnate, the USA.

Trade wars can lead to military wars. Russia's bellicosity is well evidenced.

The sector disruption will cause the lenders to the sector to be on red alert. Those institutions and funds which bought junk bonds, issued by high-cost oil producers, will panic. Banks will panic. What may be a temporary slump in revenues may easily lead to disastrous outcomes, even if the Saudis back off from their own belligerence.

Currently, junk bonds issued by oil producers in the USA are selling at about half the price they attracted last month, some barely a third of their stated face value.

The fear of oil wars results in investor fear, leading to widespread hoarding of cash. The velocity of money slows even further.

Share prices react. Pension funds are victims of market downturns, as are annuity providers. The Exchange Traded Funds endure immediate falls, leading to robotic selling and general disarray.

Until the circuit is broken, asset prices fall for lack of liquidity and lack of confidence.

Around the world, central banks and governments will seek to intervene, injecting cash into the system, perhaps guaranteeing banks, buying bonds and even shares, promising tax cuts and pledging to borrow at sovereign level to spend on infrastructure projects.

That may help restore confidence but what simply must be prevented is a rapid rise in unemployment, which would lead to mortgage defaults and social (and banking) disaster. Unemployment for people who want to work is a scourge.

None of these outcomes are certain.

My expectation is that the virus fear will moderate and that borders will reopen, though the restoration of confidence will take time. I expect people will develop immunity to the virus, a vaccine will appear one day, and the vulnerable will quarantine themselves.

I expect oil wars to be rapidly resolved, Russia bullied into a sensible production agreement.

I am not a soothsayer. I am an optimist.

The solution for the worst of the annuity providers and pension funds is not obvious. After the 2008 global crisis many pension funds had to renege on their promised monthly payments and reduce amounts paid.

Annuities are proving to be even more of an anachronism in this era of zero interest rates. I am unsure why they are marketed as a solution for retiring people. They are a high-risk option, as signalled by their credit rating.

With so many ignoring the underlying risk and treating ETFs like bank deposits, these modern weapons will be much less attractive. Yet another ''modern day solution'' will likely revert to being used only by people who like the profile of the ETF and can afford the risk.

Chaos may prevail in the near future. Robotic selling fuels bonfires.

What we all must hope is that 2020 will be seen as the year in which investors are rewarded by successfully negotiating the violently swinging market, created by the confluence of unpredictable events.

All those who have ample cash and own shares in real and appropriate companies will have no reason to cash up, unless they wish to become traders, seeking to forecast the flows and ebbs of financial markets.

We, at Chris Lee & Partners, will be arranging our days to be available to provide knowledge and, if asked and authorised, advice. We will be busy.

My lawns may be uncut for a week or two! They will still be there when order is restored.

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IN New Zealand, annuities have a tiny share of investors' money, thank goodness.

The promise to investors in exchange for a one-off large lump sum payment is a regular payment until death, the size of the payment based on the likely longevity of the client, and an estimate of annual investment returns.

Someone who is 80 will be promised more per month than someone who is 70.

If an annuity manager persuades himself that returns will average 5%, the promised sum would be greater than that of an alternative annuity manager who figured only 2% was an achievable annual return.

No one assumes that future market troubles will produce negative returns.

When returns are negative, the annuity obviously can be paid only from capital. That is a dangerous outcome and would ultimately lead to default if the results did not improve.

Annuities chew up fees, often at around 2% per annum. They no longer enjoy tax advantages, nor should they.

The current market conditions will be testing the validity of their structure, which by definition assumes their ability to look at the past and project future returns from this inspection. I foresee difficulties for this sector.

_ _ _ _ _ _ _ _ _ _

WHEN historians seek to nail down the point in New Zealand's history that began the era of nonsensical executive salaries, many will point to the arrival in New Zealand of the Hay Consulting Group.

These remuneration consultants arrived, possibly in the 1970s, but gained corporate clients at a great rate in the 1980s when all sorts of public companies and institutions engaged with their systems.

What characterised their clients might have been the autonomy of directors and executives to commit the funds of external shareholders to a programme that I reckon ramped up executive salaries. The directors and executives were playing with other people's money.

Perhaps I should confess that I was one of the beneficiaries.

Effectively, Hay's process sought to evaluate jobs by looking at various headings, including how many staff each manager had, how much influence on financial performance each group had, and the potential cost of having buffoons perform the job badly.

If the mailman opened envelopes containing cheques totalling millions, he was more important, and critical to performance, than the mailman who collected much smaller cheques.

As the mailman was important, his manager was more important, and as the manager's manager was more senior, he became as important as the Prime Minister.

Perhaps I am slightly stretching matters here, but Hays, in my opinion, had a key role in the ratcheting of management remuneration.

Yet there was a more serious offender to take up pole position in the order of extreme-salaries facilitator. It was the Higher Salaries Commission, a group of political appointments, maybe still managed by a former journalist/politician, Frances Wilde.

The Higher Salaries Commission in the last decade has ramped up public sector rates and politicians' rewards and must accept the charge of being a pioneer of inequality in New Zealand, if one believes that inequality began with the 1980s and 90s practice of glorifying the status of executive positions.

Nowhere is the HSC's fingerprint more visible than in the table of highest paid Prime Ministers and Country Heads (Presidents, Chancellors, etc.).

Recently a website (Newshub) published a list of the world's seven highest paid leaders.

By any private sector measurement – population, gross domestic product, taxes collected, expense budget, etc. - New Zealand would rank far from the top of the league.

Yet our HSC, run by politicians, made decisions that had us in the top league, Clark, Key and Ardern all given a status that much bigger countries like Canada must regard as absurd.

Perhaps it is fortuitous that the HSC did not combine with the Hay Group. The mind boggles. Would the spiral ever stop?

The highest paid politicians in the world, according to Newshub, are:

1) Singapore (PM) – NZ$2.4m per annum

2) Hong Kong (CEO) - $0.8m

3) Swiss Confederation (President) – 0.7m

4) USA (President) – 0.6m

5) Australia (PM) – 0.56m

6) Germany (Chancellor) – 0.55m

7) NZ (PM) – 0.47m

Clearly our HSC does not benchmark on the basis of global significance.

One wonders how many of our other grossly overpaid executive positions are benchmarked on Ardern's emolument. If she gets half as much as a CEO, and she gets a salary rise, he must get twice that rise to maintain relativity.

I despair.

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Travel

In the current environment of caution relating to the coronavirus, we have postponed air travel and will communicate with clients as information improves and our plans can be confirmed.

Johnny will be in touch with those who planned to meet with him closer to the date on 25 March. After those discussions his trip will either be confirmed or changed.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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Taking Stock 5 March 2020

Please note: Our March 2020 quarterly confidential newsletter for those clients we are authorised to advise is now displayed in the Private Client section of our website (Articles and Research). We are publishing it now as a response to rapid market changes. It will also be emailed to advised clients with their quarterly reports later this month.

 

 

Chris Lee writes:

THE nerves of investors are being tested as Coronavirus spreads around the world.

If everyone who contracts the virus passed it on to three other people each day, then in three weeks everyone on Earth would have the virus. The common flu is passed on to two people each day so clearly there will be resolute medical efforts to contain the virus.

Currently one has a better chance in NZ of winning Lotto than being infected by Covid-19, but that will change this month, and by month end the fear gene will have been activated in most New Zealanders.

The obvious corporate victims will begin with exporters, tourism operators, manufacturers, airport and port operators, and educators. Restaurants, bars and other places where bugs can quickly be transferred will also be affected.

Indeed, the Chinese restaurant in Wellington that feeds some of my family each Sunday, normally crowded to its 150-person capacity, had precisely one person in it at 7pm last Sunday. Me. The Chinese owner explained that its regular patrons, long-time Chinese immigrants, had been intimidated into staying at home.

Yet the nearby restaurants - Indian, Japanese, Korean and Thai - were all buzzing with cheerful patrons. There is no logic in behaviour that follows panic. In Auckland many Chinese restaurants are closing until order is restored.

The question asked of us by clients, the media and sometimes by the general public, is, What is a logical response? We are NOT seers, nor medical professionals, so we treat this like any other item of bad news, where there is no known date for the bad news to end.

1. Keep enough money in cash and in at-call bank deposits to meet all needs for a long period. For many people the required sum will be in tens of thousands, for some it may be a six-figure sum.

2. For those who have enjoyed rich sharemarket returns, trim some profits to build up cash if necessary.

3. For Kiwisavers, please ensure your fund matches your need for cash and your ability to sleep at night.  As we noted on National Radio, those planning to use their Kiwisaver to buy a house within the next five years should NOT be in Growth or Aggressive funds, and probably should be in the lowest risk cash fund.

4. Those of sufficient wealth who would have enough interest income even at today’s bank rates should never hesitate to reduce risk.

5. Spending capital is a legitimate option. The concept of saving capital for future generations has been challenged by the last decade of low interest rates but higher asset prices (family homes etc).

6. A home equity loan, priced at lower interest rates, is an ultimate back-up and should be a comfort for those who fear that their capital is insufficient to maintain a dignified living standard.

7. Those who have ample income, no special requirements for one-off spending, and an investment portfolio may choose to monitor but do nothing, accepting volatility, knowing they have made gains in recent years, expecting prices will follow the tracks of previous downturns, recovering when pessimism ends.

There is one special signal every investor should regard as a key indicator of short-term trends.

I refer to the flight from Exchange Traded Funds (ETFs).

Most of the almost-crazy rise in prices of stocks worldwide has resulted from the modern, oversold practice of buying into an ETF that invests in every stock in an index, regardless of its merit or prospects. Trillions have been invested in this way.

When people withdraw from ETFs, the robot that buys and sells for the ETF sells some of everything it holds, to meet its promise of mirroring the index and the various stock weightings.

So as a simple example, the ETF would sell some of the electricity generators, the retirement villages, the property trusts and the sellers of medical masks, as well as selling the shares of tourism operators, exporters and manufacturers.

There is no human intervention, no engaging of the brain.

It is for that reason that ETF operators have no credibility when commenting on individual companies. They do not have authority to impose their thoughts on any company. ETFs do not pay for experienced, deep-thinking, capital market specialists, to manage their funds.

Such funds, in a period of market disruption, are often gamed, their selling obligations easily forecast.

When, for example, the share price of Synlait Milk rose, so lifting its weighting in the NZX50, the ETFs were forced to buy. The same situation occurred with Napier Port.

The ETFs paid $13 for Synlait shares. They now sell them for $6, when clients withdraw money.

The first evidence of mass selling would be ETF driven. One hopes it does not happen.

Recall that foreign money – pension funds and ETFs – have been the power behind the rising value of NZ shares, and the liquidity of our bond market.

We will be watching for any change in their behaviour and will be watching for any desperate ‘’do not panic, please’’ news media releases from their salespeople.

 _ _ _ _ _ _ _ _ _ _ _ _

Congratulations to The Listener for its compassionate treatment of the Wellington property enthusiast, Jones, after he called off his defamation case against a critic who had called him out, alleging racism in one of his now-ended newspaper columns.

Jones was simply trying to be funny, not racist, he insisted.

The Listener produced a kind summary of the trial, clearly recognising that Jones is in his late 80s, no longer in the public eye, and should not be regarded as fodder for media scorn.

He has endured health issues since he was a lad, had a tough youth (strapped, literally every day at school, he told the Court), had suffered the indignity of watching his public-listed company crumble to penny dreadful status, and has had more civil court cases than any man I have ever met. Surely it is time to leave him to puff his pipe in peace.

Those who wanted a tougher summary would have found an article on The Spinoff, a news site based in Auckland.

I thought The Listener’s generous treatment of Jones exhibited kindness at a time when an old bloke living on the Hutt hillsides would benefit from our understanding.

 _ _ _ _ _ _ _ _ __ _ _

LAST week’s Taking Stock article, lauding some dairy farmers for their natural, environmentally friendly, profitable farming philosophies, brought as much response as any item in my memory.

Several people called me out, identifying other farmers that practise dirty dairying and destroy waterways, and calling my article unbalanced.  (It was not intended to be a review of all farming practices.)

Far more enjoyed the defence of clean farming and appreciated a ‘’townie’’ who tipped his hat to those hard-working farmers who create New Zealand’s wealth.

Two publications sought to reproduce the article, two more correspondents wanted to forward the article to mainstream media and volunteer me as a spokesperson for farmers. (Thank you, but not my job.)

New Zealand’s foremost agriculture commentator described the article as ‘’perfect’’, a word not usually prefacing any reference to me other than perhaps ‘’perfect nuisance’’.

Thank you for your various thoughts. My article might have been written with some whimsy, but it was sincere.

Having worked for five years as a lad on Sundays at a Hawke’s Bay orchard, taken on by a wonderful family, I have deep admiration for the good people of the land, and am in awe of their range of skills.

The concept of a real farmer or orchardist displaying indifference to the sustainability of his activity is oxymoronic, in my experience.  I cannot account for idiots.

There will be poor or lazy people but the real farmers and real orchardists are much closer to my definition of a hero than any sportsman.

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Johnny Lee writes:

THE past week has seen more than its fair share of panic, as traders and overseas investors sold New Zealand shares heavily, giving us our worst week in recent history. For context, our index is now at a point last seen in December 2019. The drop, which makes for good headlines, is unlikely to be sending long-term investors into negative territory. In global media, share price falls tend to be better at grabbing eyeballs than share price rises.

The panic remains centred around Coronavirus, but the impacts are indiscriminate. Companies which reported record profits, record growth and enormous sums of cash on hand only a week prior, saw significant falls.

Impacts on companies like Port of Tauranga, Napier Port, Auckland Airport, Sky City, Mainfreight and Air New Zealand are logical. The ports are reporting a drop in log exports as Chinese inventories surge while warehouse workers and factory workers remain in lockdown. Travel bans will mean fewer tourists and overseas students, which may mean empty rentals and empty planes, not to mention empty casinos.

The impact on companies like Heartland Bank and Genesis Energy is less direct, yet both have seen significant falls in share price. Dividend yields across our market are reaching levels long-term investors may find compelling.

Part of the rationale behind the share price falls will be explained by a withdrawal from overseas investors in certain asset classes, including shares and the New Zealand dollar.

The dollar has fallen over the year, meaning the value of New Zealand shares to overseas investors has fallen on this basis alone. Indiscriminate selling of all shares, regardless of their connection (or non-connection) to the virus, will provide opportunities to long-term investors, while inducing panic from traders who do not have the luxury of riding short-term downturns.

There is, of course, the risk that the issue becomes protracted and spreads further.  If this were to occur, one could expect interest rates to fall further, as they did during the SARS epidemic of 2003 in a bid to stimulate the economy. This has occurred already in Australia and the United States, and could happen in New Zealand as early as this month.

Early indications from recent business confidence surveys suggest that businesses were quick to ‘‘batten down the hatches’’. Business confidence is falling in the wake of the global epidemic.  Our agricultural sector in particular is pessimistic about its prospects, with both hiring and investment intentions significantly down.

Recent headlines regarding the struggles of our local tertiary education providers highlight how vulnerable we are as a small, island nation.  While some of this will no doubt be politicking, the impact of quarantining entire cities is felt around the world, especially from export-reliant nations.

Investors should continue to monitor these developments and position themselves accordingly.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

ONE bright spot amidst the gloom beginning to pervade financial markets was the annual result of A2 Milk (ATM).

ATM reported a 32% increase in revenue and a 21% increase in profit.  It is spending tens of millions on marketing and growth initiatives, while maintaining zero debt and enormous cash reserves.

It reported cash reserves, as at 31 December, of over $600 million, with global ambitions to match these figures.

Readers may have seen stories showing empty supermarket shelves in China as people rushed out to purchase food and supplies amidst a crackdown on freedom of movement.  This stockpiling extended to baby formula, with ATM seeing a large spike in demand from China as the quarantines were put into effect.  Nervous that its Government might extend containment restrictions, people stocked up on essentials.

ATM is realistic that this is a temporary effect, as such stockpiling is simply a shift in the demand profile from the future to now.  Nevertheless, it reinforces its status as the premier brand in many parts of China.

The company is also targeting growth in the US, and with an enormous war chest to fund the growth, shareholders can afford to be confident in the company’s prospects.

The sheer size of the ATM cash hoard puts the company in a very strong position to target growth, but shareholders will be keen to see it used effectively over the year ahead.

Whether ATM decides to distribute these funds to shareholders, or look to acquire a complementary asset, remains to be seen.  Shareholders will be too delighted with share price performance to accuse the company of a lazy balance sheet, but ATM, which is known to take strategic holdings in key parts of its supply chain, will want to ensure any capital spend continues to fuel its growth and resilience.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

THE Government’s decision to compel default Kiwisaver funds to exclude fossil fuel investments is poorly conceived and presents three major concerns in my view.

Firstly, the justification for the action, that it ‘’makes sense for the funds themselves given there is a risk of investing in stranded assets as the world moves to reduce emissions’’ is hogwash and inappropriate.

As any investor knows, markets are forward looking and priced by the individual decisions made by millions of people around the world.  The world’s push to decarbonise is hardly a global secret, and share prices for the likes of Shell and Exxon Mobil will accommodate this among the many other rationales for investing in a stock.

Any long-term executive at these firms will also be keenly aware of these facts.  The likes of ExxonMobil is investing hundreds of millions into alternative fuels and renewable energy as it looks to maximise shareholder value.

The justification also exceeds the Government’s mandate.

Members of Parliament should always be cautious about providing their opinions on share investments.  Fund managers around the country will already be focused on maximising investor returns and allocating investor funds accordingly.  Any suggestion that fund managers are unaware of the likely impact of society’s efforts to decarbonise is ludicrous.

Secondly, governments of both stripes should be far more delicate about implementing changes to New Zealanders’ primary source of savings.

Kiwisaver has had a remarkable take-up rate, with almost all of the country’s under-65 population now a member of the scheme.  However, the Government should take care not to politicise the allocation of the fund’s assets.

Investors, especially those entering Kiwisaver at a young age, have a typically long-term investment horizon and need certainty over the rules that govern the scheme before locking themselves in.  Already, we have seen changes made to the scheme from both sides of the political divide.

Lastly, the definition is needlessly vague and should be clarified.  I find it baffling that ministers were unable to even clarify what sectors would be excluded. It is hard to find any politician with experience in funds management or any role in investment research.

If the ‘exclusion list’ is to include all users of fossil fuels, this would surely include the likes of Genesis Energy and Air New Zealand, two companies that are, of course, majority owned by the Government.

Instead, if such a list only included actual miners and producers of carbon emissions, such as BHP Billiton and Rio Tinto, then the move may simply add administrative cost and reduce diversification. One assumes that, if the sector were to feature a period of outperformance, the Government would reconsider its approach and advise fund managers to allocate investor funds in the sector.

In my view, a better solution would be to understand why investors choose to stay in default schemes and choose not to make active decisions on their savings.  There are already some funds that claim to invest only in companies outside the fossil fuel producing sector, giving investors the choice to prioritise these values over others.

Educating these investors and engaging them in making better financial decisions seems a more worthwhile goal than insisting fund managers avoid certain sectors in the hopes of achieving a better return, or scratching some political itch.

_ _ _ _ _ _ _ _ _ _

TRAVEL 

Johnny will be in Christchurch on 25 March.

Edward Lee will be in Napier on 8 April.

Please contact us if you wish to arrange an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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