Chris Lee & Partners Ltd

Taking Stock 24 November 2022

IF you figured that New Zealand's own billion-dollar bonfire was the perfect example of financial stupidity, you might need to put it into a new perspective.

Elon Musk's destruction of billions is now in full flight with his recently acquired company, Twitter.

Our most nauseating experience in New Zealand was the destruction of public and private money overseen, indeed mostly caused by, our then Prime Minister (Key) and government agencies, combining to make dreadful errors that they preferred to hide rather than fix.

The late Allan Hubbard's fortune was brainlessly handed over to a range of ticket-clippers, wide boys and entrepreneurs, after Key authorised the South Canterbury Finance receiver to flog off Hubbard's assets rather than allow time to restore them to full value, as Treasury recommended.

The receiver McGrathNicol will never be forgotten for its errors by those who fell victim to them. Neither will those affected ever forget the High Court's acceptance that it was a Crown error that precipitated the bonfire, and in my view, led to the boneheaded behaviour. Key and his Cabinet chose to ignore the error, thus magnify its cost, rather than accept it and make wise responses to it.

Key, I fear, has left a legacy that somewhat challenges the idea that his foreign exchange management was evidence of commercial nous. Perhaps most of us now accept the gulf between trading skills and real commercial wisdom, enabled by strategic analysis. Political skill rarely aligns with commercial wisdom, in this era of clickbait decision-making.

As some might say, this should still provide chow for thought.

Whatever Key fouled up, Musk seems to be performing in spades, doubled, redoubled, and vulnerable.

Musk is credited as the driver of what is presented as the planet's MOST carbon friendly vehicle, Tesla. He is a space explorer. He is cheerfully unconventional and has often been adjudged to be a thinker, different from others.

He is also an emotional, erratic investor, whose extreme wealth appears to have led to arrogance.

Musk's shares in his car manufacturer, Tesla, had a paper wealth of hundreds of billions. Those who enjoy keeping count and publishing their ''rich list'' estimates, reckoned he was at one stage the world's most over-moneyed man, in the company of those like Amazon's founder, Microsoft's founder, or the Berkshire Hathaway founders.

Musk then set out to prove the theory that genius comes with warts on the nose, and periodic bursts of brain fade.

He announced he was using Tesla's money to buy billions of dollars-worth of Bitcoin, when the token had attracted a Bigger Fools market willing to pay US $40,000 for each token. (Today they pay about US $16,000.) He later sold some (at cost) and kept some.

He spent billions wanting to fly into space, claiming commercial rewards would follow. (The carbon emission issue seemed anomalous.)

And then he loudly offered to buy out the messaging platform Twitter, which at the time was used by many, and had aspirations of being highly profitable, but was facing a loss of market share.

It was at this point that we learned how genius has warts on its nose and causes brain fade.

He has exhibited quite dreadful management behaviour.

Musk moved into Twitter, fired half the staff to cut costs, banned the subsidised lunches, demanded staff sign up to long hours of intensive work, and made several comments that so irritated its advertisers that large numbers chose to advertise elsewhere.

He discovered he had fired essential people and, after swallowing hard, sought to re-employ them.

His staff, anonymously but on public platforms, confirmed Musk had no idea about the inner workings of the company, and identified him as an idiot, a pachyderm in a crystal shop.

He retaliated by overseeing his staff's private communication and firing those who did not like him.

He came close to rivalling another business idiot I recall from the past who once threw out the window the cellphone of his boardroom guest, who banned people whose attire he disliked, and who humiliated an outside consultant by arranging for a clothesless sex worker to stand behind the hapless fellow while a photographer was framing the consultant with the clothesless person standing behind him. Ho ho ho.

Musk, like Donald Trump, appears to have no managerial skills but, unlike Trump, appears to have an ample IQ, though an equally large deficit in EQ.

Twitter's value has been decimated. Musk warns it may file for bankruptcy.

Musk did not have a credible plan, and clearly had inadequate skills in preparing to execute any sensible ideas.

He joins a long list of people who seem happy to destroy achievements through demonstrating a shortfall in the emotional quotient of their intellect.

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LAST week Taking Stock discussed the possible explanations for the missing billions in the cryptocurrency platform operator, FTX, valued a month ago in the United States at US$32 billion, now valued at nothing.

I wondered whether investors' money had been misappropriated, or whether it had been used as leverage for secured bank loans, or whether it had simply been destroyed, just as so many of Allan Hubbard's assets were mindlessly destroyed by ticket-clippers, receivers, and lawyers in New Zealand.

The high-powered receiver who has been appointed to oversee the FTX empire has discovered that the goofy founder Sam Bankman-Fried had never had any governance supervision, had appointed equally goofy friends to ''manage'' FTX, had no clues about financial reporting systems, left no audit trail of what happened to the money of individual investors, and was using other people's money to subsidise his cryptocurrency punting.

The US media allege that he borrowed billions of investor money without adult documentation and lent to his friends, in lumps of hundreds of millions. Nice chap.

The only conclusion I can reach is that he was a fraudster whose ramblings in obfuscatory language somehow fooled allegedly clever US fund managers, regulators, and thousands of investment advisors.

This does generate queries over the analytical and due diligence skills of those who endorsed his business model and allowed other people's money to be channelled into the fraudster's bank account.

Those who remember Enron, or Bernie Madoff, will wonder why such humiliating examples of incompetent audit, due diligence, and regulation so regularly recur in the recalcitrant USA.

Is there any accountability applied to the intermediaries who recommended FTX? Expect to read of class actions against those who promoted FTX.

Was there any due diligence? Was there any audit? Did no outsider demand independent directors be appointed?

I am reminded of the errors made in NZ when a small group of genuinely experienced people flew down to Timaru in 2010 to investigate Hubbard's Aorangi Securities, having received an anonymous complaint that this contributory mortgage company was behaving like a finance company. (Contributory mortgage companies did not require the same sort of disclosure demanded of finance companies and were restricted in the areas in which they could lend.)

The small team of people spent a day or so in Timaru, crassly misunderstood some transactions relating to assets gifted by Hubbard to the fund, and it seems did not even check bank statements or the cheque book to validate their theory that Hubbard was defrauding Aorangi. Worse, they alleged, quite wrongly, that he had ''confessed'' to fraud.

A simple inspection of the cheque book or bank statements would have PROVED that Hubbard had taken no money from the company.

A simple check of the journal entries would have PROVED that Hubbard, far from stealing, was inserting his personal and his own trust's assets into Aorangi to protect Aorangi investors from any losses from bad loans.

The simple checks cannot have been made. The outcome was disastrous.

The small team returned to Wellington, reported to the Crown agency that Hubbard was defrauding Aorangi, and within two days Key's gormless people were announcing that Hubbard was allegedly a fraud, and that investors could lose tens of millions unless Aorangi, Hubbard, and Mrs Hubbard was padlocked in the Statutory Manager's cell.

As a result, Key and Treasury felt compelled to block a deal that aimed to use time and skill to restore the full value of Hubbard's SCF empire. That deal would have worked wonderfully. The Statutory Management decision, based on nonsense, effectively killed the deal that would have restored the empire.

Key, instead of accepting this deal, later instructed that McGrathNicol should flog off SCF's assets and over-ruled the PricewaterhouseCooper (PWC) advice that the sale of assets should be done over many years.

McGrathNicol discounted virtually everything, often at less than 50 cents in the dollar. A billion was incinerated. Aorangi was similarly destroyed by brainless sales at discounts.

Five years later the empire's assets would have been worth more than a hundred cents in the dollar. The various receivers and Aorangi liquidators, and their ''advisers'' charged a combined amount of around $75 million to oversee this wealth destruction.

The public (taxpayers) and investors in the SCF preference shares and in Hubbard's other funds were shafted, that outcome driven as far as I can tell by a preference for cleaning up behind closed doors, rather than admitting error and compensating at modest cost.

As an aside, no politician emerged with any credit. Ardern and Robertson preferred not to put things right when I approached them.

Indeed Robertson somehow reached the conclusion that the reason for my agitation was, in his words, to make money for myself, a petty, spiteful and stupid response, given that I had no SCF preference shares, having sold out when I lost hope, and given that the fight for justice was not exactly without considerable personal cost.

I recall all of this because it highlights the similarity in failures over the FTX case.

Unlike Bankman-Fried, Hubbard was not lining his pockets, indeed was not motivated at all by Rich List mentality, but the similarity is in the failure of third parties to behave like professionals and earn their multi-million-dollar fees.

Have we learned nothing much about the need to investigate star dust, and to take seriously the responsibility of protecting starry-eyed investors? Do we really want ''headline'' behaviour rather than ''detailed'' homework? Are we in an era when television images are more important than wisdom or substance?

Will the mix of directors, trustees, auditors, politicians, investment bankers, and regulators ever be effective guard dogs?

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A NOTICE of warning to those who expect financial markets to be predictive of change.

Central banks believe there is a 12-18 month time lag between the time a problem becomes apparent, and when consumer behaviour changes. Any degree of reality in the behaviour of markets requires markets to think about the longer term. Pardon me, but this seems like asking a drunk not to finish his last glass.

Over the next 12 months some 300,000 mortgages in NZ will have their rates reset, with a likely 2.5% to 3.5% increase for most of them.

If the average mortgage is around $540,000 (median mortgage $400,000), the extra cost for the mortgaged would be at least $10,000 of after-tax expense. Mortgaged households will not like this.

Consumer behaviour would change. Demand would fall. Most households run on very lean budgets, even without an increase in debt-servicing costs, and without the fear of job loss.

Many corporates will have reduced revenue. Margins should fall. Dividends might fall. Night follows day.

Tax breaks and wage increases would not bridge the gap in nett household income. Inflation is insidious. Overcoming inflation will create changes that hurt. We will pay for the profligacy of politicians whose main focus is on retaining their overpaid jobs.

Social dysfunction, you might surmise, might increase, as the discomfort levels rise.

Please may we be advantaged one day by having some competent leadership, in politics, and in the public and private sectors.

We are going to need it.

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Travel

I will be in Christchurch on Tuesday November 29 (pm) and 30 (am) with available times at 9am, 11.15, 11.45 and 12.45 on Wednesday.

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

David Colman will be in Whangarei on Monday 28 November and has a few available times.

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

I will be in Taupo Dec 4-16 and could meet by arrangement. (Be aware, shorts and jandals, my attire!)

Anyone wanting an appointment is welcome to contact us.

Chris Lee

Chris Lee & Partners Limited

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Taking Stock 17 November 2022

ANY investor wondering how financial market reef fish behave under stress had no need to look further last week than to observe the behaviour of Elon Musk's Wall Street bankers, and the events of the crypto currency markets.

Musk, of course, had a toe in both these cesspools, the ingenious founder of the Tesla electric cars also being a multibillion-dollar investor in cryptocurrencies, to his, and Tesla's, very great expense, so far.

Just months ago, Musk stunned financial markets by announcing that with his spare change – US$44 billion – he wanted to buy the social chat platform, Twitter.

I should confess to being gobsmacked by this plan, perhaps because I have never used any of the modern abominations, Twitter, Instagram, Snapchat, TikTok, Facebook etc.

As a result I have never been ''bullied'' and I receive no advertising spin on my phone or computer. None.

Despite this, I knew that Twitter had lost its unique advantage and was not the platform du jour for those who find it helpful to follow the opinions and doings of random people, and nutters, like Trump.

Twitter, it seemed obvious, was no longer unique, no longer top of the pops and, anyway, was losing some of the advertising revenue that would drive its successes.

Yet Musk offered to buy it, quickly suffered buyer remorse, tried to wriggle out of his offer, realised he would face years of expensive litigation and distractions, so sold off some of his Tesla shares and went to the banks to fund his purchase error.

Unbelievably, banks all around the world, including Saudi Arabia, committed to lend to him, and even more unbelievably, Wall Street banks pledged US$13 billion to help him complete a transaction which he clearly did not want to complete.

Last week those US banks, just a few weeks into the term of the loan, were dashing around the world trying to syndicate their silly loans, by discounting them.

To attract even sillier buyers, they were offering to sell the Twitter loan at a massive discount – 70 cents in the dollar, implying a bank write-off of US $3.9 billion.

To me, this sounded exactly like the desperation of Lombard Finance in the days leading up to the finance company collapse of 2008.

Lombard's appalling chief executive, Michael Reeves, aware that his company had breached the covenants of its trust deed, crept around Wellington trying to sell down doubtful Lombard loans to any finance company that had ample cash.

With one loan, based on a Brooklyn property development (Brooklyn Rise), he offered to forfeit the prime ranking security, offered to subsidise the interest rates, pay a fee, and offered Lombard's guarantee to repurchase the loan after 12 months.

I am not sure if he also offered free use of one of his Porsches, perhaps the one with diplomatic lookalike number plates that fooled many parking wardens.

I do not remember if these incentives were sufficient. Given the times, it is possible he found buyers.

Flogging off bad loans is like the twitch of a dying body.

Wall Street banks perhaps could not escape the commitment to lend to Musk before he signalled distress and sought to withdraw.

Another possibility is that Wall Street banks did not want to lose mana with one of the world's most visible entrepreneurs and took the risk as ''one for the team''.

Former PM David Lange coined the expression ''reef fish'' for goofy financial market participants. At other times he called them sharks.

I would guess that in this very stressed world, facing outcomes on many fronts that are unpredictable, those ''reef fish'' might have been described as ''jellyfish'' by Lange; brainless, without a spine, and good for nothing other than stinging others, in this case the shareholders of the banks.

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THE other event of last week that highlights poor behaviour under stress centred on FTX, a large platform that sells tokens, using the proceeds to invest in various cryptocurrencies.

In theory FTX could have been a simple platform, like Sharesies, offering to facilitate trading of assets, in this case the ''virtual'' asset of cryptocurrency.

If it were a trading platform it could not have transitioned from a company valued at tens of billions on Guy Fawkes night, to a company now filing for bankruptcy, apparently worth nothing.

Perhaps it could have made this race to ruination were there theft involved, or fraud. For example, if money had been illicitly smuggled over to a jurisdiction that shelters crooks, or if investor assets had been pledged as security for huge loans, dedicated to margin lenders, then a platform might go broke, at the expense of its clients.

Perhaps FTX misused investor money, lending it to others, or using the money to pay bills.

NZ investors with long memories will recall how Natpac Corporation in the 1980s, once named Renouf Partners, was so dreadfully administered that in a collapsing 1987 market it went broke, costing investors millions and drawing rather interesting portraits of those in charge. I still have a copy of the liquidator's report. It is remarkable that this has never been published.

But even in this mayhem, Natpac creditors received a little of their money back, so if FTX was simply a broking platform it should not have hit the rocks. If its navigators were that incompetent, there should be relief for its clients, via the courts.

Time will need to pass to explain how FTX collapsed. Rumours abound. The whole crypto market is fearful of the collateral damage in a very fragile world.

If an investor had instructed FTX to hold various cryptocurrencies on his behalf, then those tokens ought to be identifiable and returned to the investor. The tokens may be of lesser value, but might still be exchangeable for real money.

The founder of this ''platform'' to enable punters to invest in tokens was Sam Bankman-Fried, a surname one imagines was contrived, and might prove to be prophetic.

He was said to be worth US$16 billion a month ago; now nothing.

Virtual assets when markets are stressed can quickly be revalued, their pricing based on punters' confidence, some arguing that there must be confidence that the ''Bigger Fool'' theory never will be interrupted. (I accept that crypto zealots might regard my view as disdainful.)

Hysterical behaviour accompanies highly stressed markets, especially when the fervour has been created by leverage, and involves tokens that lack universal credibility.

The FTX collapse is the media focus of the day in the USA. There will be many more subjects to overshadow it if financial markets continue to assume that the next era of ''free'' money is simply part of a normal cycle, and that the bigger fool syndrome will always appeal to reef fish.

 _ _ _ _ _ _ _ _ _ _ _ _

ONE crucial issue to be highlighted by the FTX collapse is the danger of allowing superannuation savers to make unilateral decisions with their subsidised savings.

These savings are named ''KiwiSaver'' contributions in NZ and are placed into the hands of some fairly average but nevertheless licensed fund managers, the investors' assets held in trust, meaning the investor endures no pain if the fund manager itself should collapse.

The fund managers do endure some inspection of their fees, but very little inspection of the charges against investor income that can be claimed, and very little transparency over matters like bonus pool calculation and distribution, and of executive salaries.

Despite these design failures, and fund manager behavioural foibles, the investor is protected from foreseeable disaster in NZ.

This is not the case in Australia, as the FTX failure highlights.

In Australia, where salary contributions are 10%, not 3%, investors have the right to self-manage their superannuation funds. Often these savings are worth hundreds of thousands of dollars.

It seems there are no rules to protect those who have no training, no experience, and no skills in investing, but want to self-manage their savings.

Their law allows a self-managing investor to place the whole of his superannuation savings in FTX, or one crypto token. I am not sure if one could use the whole fund to buy lotto tickets, but if crypto is fair game, so might be lotto tickets.

Last week various Australians learned their decision to self-manage, and use FTX as their sole investment, might undo all of their subsidised savings. I spoke with one such remorseful investor.

I had imagined that self-managed decisions would have been signed off by a competent intermediary, who would be accountable for ensuring the investment strategy was credible.

This is not the case in Australia.

One hopes that when NZ inevitably moves to give savers more transparency of their KiwiSaver funds, then after the next step (self-managed), the changes would require expert oversight by accountable intermediaries.

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LAST week I discussed the lunacy of a government energy strategy that constrains the future of gas exploration but encourages the use of imported coal.

I referred to NZ as being an outlier, having the benefit of a high level of renewable energy.

I wrote that 80% (plus) of our energy was sourced from renewables. I should have written that 80% (plus) of our ELECTRICITY was sourced from renewables.

Of course, energy includes transport fuels.

In fact, only 40% (plus) of our total energy consumption comes from renewables, as half of our total energy requirement is not met by electricity.

Back in the days of the 1970s oil price hikes, our PM Muldoon sought to incentivise our transport industry to switch to compressed natural gas, or liquified petroleum gas, and had some success, hoping to reduce our need to import oil.

The conversion cost attracted subsidies, and there was a brief period when it looked as though NZ would transition away from oil, at least partly.

There were also government efforts to convert gas to other useful fuel but these measures faded away, oil went through price slumps, and the world move to fracking, reserves also boosted by discovery and modern technology, which extracted more oil from old wells.

In Trump's infamous presidency, oil prices fell to around a third of today's price per barrel, Trump claiming he purchased future supply contracts of oil at negative cost, at one stage.

Then came revisions of the world's ''peak oil'' calculations. The analysts now calculate that the world has enough oil to last us for many decades, even without more discovery.

Our dependence on oil for our transport sector looks to have a future of some decades and, of course, we now all know that Britain, China, India, Germany, the USA, and Australia continue to burn coal, many times dirtier than gas.

I imagine that the next change in government might lead to a return in NZ for exploration of hydrocarbons, but it would be an ugly call if we were to revert to coal, of which we have ample supplies.

Meanwhile wind farms and solar farms continue to be developed as NZ pushes on towards 90% of renewables for our electricity requirements.

Nearly 50,000 of our cars, which number in excess of 3 million, are fuelled by electricity, at least in part. That leaves at least 2,950,000 that are not fuelled by electricity.

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New Issue

 

BNZ Bank (BNZ) has announced that it plans to issue a new senior note maturing in 5.5 years’ time.

The interest rate has not been announced, but based on comparable market rates, we are expecting an interest rate in the range of 5.50%p.a. to 5.70%p.a..

 

The notes have a strong credit rating of AA- and will be listed on the NZX.

BNZ will not be paying the transactions costs for this offer. Accordingly, clients will be charged brokerage.

We have uploaded the investment statement to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/BNZ170.pdf

If you would like a FIRM allocation, please contact us promptly, with an amount and the CSN you wish to use no later than 9am, Friday 18 November.

 

Travel

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

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

David Colman will be in Whangarei on Monday 28 November.

Anyone wanting an appointment is welcome to contact us.

Chris Lee

Chris Lee & Partners Limited

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Taking Stock 10 November 2022

THE notion of negative interest rates – now banished as one of the globe's more stupid ideas – is now revealing its consequences.

Trillions of dollars of bonds were issued worldwide at negative interest rates and trillions more were issued at rates that assumed that money would be ''free'' forever.

The word ''inflation'' had been removed from the market's dictionary, it seems. Those ghastly, artfully-marketed bond funds and pension funds filled up on long-term, no-interest bonds, our KiwiSaver funds, most notably Simplicity, even resorting to term lending at 1.5% p.a. as an alternative to buying low-interest bonds.

The result today is that managed bond funds, year-to-date, are producing reliable returns of negative 20%, as the long bonds have their value cut to reflect today's rates.

Bond funds, marketed as a ''cash'' equivalent, now return to those needing the money a bleak 80 cents in the dollar, on average. As the PIE Fund baker, Mike Taylor, noted recently, bond funds have been eaten up by value losses, the trading value of bonds devastated.

Meanwhile, genuine ''cash'' funds, NOT ''bond'' funds marketed as ''cash funds'', have returned a tiny positive result and those wishing to cash up receive all of their money back. How clever were those who switched their KiwiSaver funds into boring cash funds, in so doing ignoring the self-focused sales pleas to ''ride out the downturns''.

One hopes the marketing ''errors'' will bring new focus on selling techniques, and a little more commonsense in the behaviour of the media, which published their vacuous advice.

Of course, bonds are not the only asset class to have been marketed as though we could have ''free'' money forever.

Bloomberg has published this week a list of sharemarket returns from around the globe.

The results are interesting. Below is a sample of annual performances over the past 12 months, published this week.

Dow Jones (US)              minus 10.83%

S&P 500 (US)                 minus 20.89%

Nasdaq (US)                   minus 33.04%

FTSE 100 (UK)               minus 0.67%

TSX60 (Can)                   minus 8.45%

Euro Stoxx (Europe)       minus 14.19%

CAC (France)                  minus 11.33%

HDAX (Germ)                  minus 15.27%

Athens (Greece)              minus 1.69%

Irish overall                      minus 17.3%

FISE MIB (Italy)               minus 14.86%

AEX (Netherlands)          minus 15.80%

OMX (Sweden)               minus 17.38%

Swiss                              minus 16.22%

ATX (Austria)                  minus 19.78%

IBEX (Spain)                   minus 8.18%

WIG (Poland)                  minus 29.36%

MOEX (Russia)               minus 43.07%

Africa Top 40                   minus 6.39%

ASX 300 (Australia)         minus 7.56%

NZX 50                            minus 13.48%

Shanghai (China)            minus 15.63%

Hong Seng (Hong Kong) minus 30.93%

Malaysia                          minus 9.65%

Kospi (South Korea)        minus 32.50%

Taiwan                             minus 28.50%

Pakistan                          minus 6.14%

As many readers will have observed, 2022 has been a terrible year to be invested in offshore markets, though in the case of the United States the rise of its currency has largely offset index falls.

It will have been a sad year for those invested in Facebook (Meta) minus 75%, Netflix, Microsoft, Alphabet, Tesla etc, and a rotten year for those invested in the equivalent big names in China, where prices had reached heights beyond the stratosphere.

The fallout has spread across the globe, with one Australian fund, once managed by a media-acclaimed Master of the Universe, Hamish Douglass, watching its share price fall by 80% as the fund's heroic focus on Chinese stocks proved to be unwise.

Douglass' Magellan fund in December last year managed around $100 billion. Around half of its funds under management have been lost or withdrawn as the world has re-learned the absurdity of the concept of Master of the Universe status. The Magellan share price has fallen from A$72 to A$9.60.

Magellan is not the only fund to have been lost support. Indeed in the USA last month some $60 billion was withdrawn from index funds and shifted into cash.

In such a bleak landscape there have been few winners. Those who switched in 2022 from falling share markets into rising bond rates have enjoyed the 5%-7% returns, the ASB Bank the latest bond issuer, offering a four-year bond with a return of 5.928%. (The bond closed today, very fully subscribed.)

Those who bought individual bonds for income purposes, planning to be repaid on maturity, have been the big winners over the past year, with nett returns of 4 to 5%, and no sign of lost future value.

It is, of course, the new higher-rated bonds that have led to the loss of the bonds issued two years ago at pitifully low rates. Paper loss is important for traders and bond fund investors.

As an example, 10-year NZ Government Stock rate in 2020 hit a low of 0.42%. Today it is nearer 4.6%.

If you multiply the difference in coupon (4.6 minus 0.42 = 4.18%) by eight years, the paper loss for bond funds and bond traders today would be in rough terms 4.18 multiplied by 8. That is 33.44%. Paper losses become real losses if the bonds are traded today.

A $10,000 0.42% coupon bond bought in 2020, maturing in 2030, is now worth to a trader $6656. Ouch.

As Johnny explained in Market News, transaction costs and trading losses are not endured by those who invest for long-term income. Their ''loss'' would be the lower rate they endure until the bond is fully repaid on maturity, rather than a realised loss of capital, caused by trading the security.

The bone-rattling issue facing investors as we head to 2023 is which bogeyman is scariest?

Is it the fear of recession? The UK's Bank of England forecasts a two-year recession there. The USA forecasts a recession there in 2023. Will NZ escape a recession? Not likely.

Is the bigger fear that of unemployment? Central banks seek to squash inflation by imposing austerity, linked to income loss (unemployment), causing lower consumption. Unemployment equates with loan defaults and forced housing sales.

Is the bigger fear that of inflation? The UK forecasts another year at least of double-digit inflation. The NZ forecasters have generally been inept for decades but may be right in forecasting a rate of 6% to 7%. Inflation is cruel for all on fixed incomes, i.e welfare beneficiaries. Wage increases and inflation often chase each other, with inevitable distress for those no longer working.

Is the bigger fear that of loan defaults, caused by higher debt costs? Loan default correlates with unemployment. Loan defaults exacerbate inequality and social dysfunction and, inevitably, lead to banking responses that damage even the better borrowers.

The self-protective nature of bank behaviour generally helps deepen the loan default problem. Let no one forget the forced farm sales of the1980s which led to suicide rates that devastated our communities.

Is the bigger fear that of political and public leadership blunders?

It is doubtful that many would ever respect Key, or more recently Ardern, for their strategic analysis, problem solving, wisdom, or execution skills. Being clever at winning votes is a quite different ability to the skill of executing well considered solutions (following a transparent, consultative period of consideration), that solve problems and address the long-term needs of society.

Or is the bigger fear of geopolitical events, perhaps focused on the NATO/Russia de facto war, or China's reset, or North Korea's buffoonery, the latter the equivalent of belching in church to gain attention, as Trump does so loudly.

Investors will have their own batting order of these fears. Note that I have made no mention of weather patterns or inequality.

Berkshire Hathaway, Warren Buffett's flagship, ponders whether the global outlook is simply bad, or badder.

Optimists, of whom I am one, believe that NZ and the world will somehow adapt. We will still produce high-value food. The world will need it.

And we did beat the Aussies at cricket!

 _ _ _ _ _ _ _ _ _ _ _ _

BERKSHIRE Hathaway made headlines last year when its 90-year-old sage, Warren Buffett, joined in the refrain started by another global sage, Jeremy Grantham.

Grantham stated that the world must adapt to the ''end of cheap''.

There would be no more cheap labour, commodities, money, oil, water, food, or energy. He made this prediction before Russia invaded Ukraine. The days of ''cheap'' had ended, he opined.

Buffett showed his hand by spending US$40 billion on oil exploration and production companies, and US$6 billion on a gold producer in Canada.

A recent piece of US research published by the economic commentator John Mauldin, seemed to imply that Buffett was ahead of his competitors in recognising the world's determination to mobilise with internal combustion engines for many more decades.

Perhaps Buffett read this data on global energy usage.

Primary energy is calculated in the ''substitution method'', which takes account of the inefficiencies in fossil fuel production by converting non-fossil energy into the energy input required if they had the same conversion losses as fossil fuels.

The data Mauldin displayed showed that over a 150-year period between 1800 and 1950 global consumption of energy grew from virtually zero terawatts per hour (TWH) to 20,000.

In the next 61 years, the world's population grew from 2 billion to 8 billion (400%), but energy consumption per head grew by twice as much per head, to a 2021 figure of 160TWH (800%).

I would guess that travel, transport, electrical devices, air conditioning, and industrialisation all had a role in this dramatic increase.

Of special interest was how the globe supplied this energy:

              1965            2021

Oil           42%             36%

Coal        38%             26%

Gas         12%             20%

Nuclear     0%               4%

Hydro        8%             10%

Wind         0%               2%

Solar         0%               1%

Other        0%               1%

In this context one has to ponder any decision to ban gas exploration while the world explores for, mines, and consumes coal, many times more toxic than gas.

Clearly Buffett has analysed the future of oil as being long-term and accepted that the environmental-focussed funds that exclude oil from their investment considerations will not be relevant to exploration programmes. Investors will fund what exploration they regard as essential to their lifestyle of the day. The current climate conference is unlikely to end the ''live for today'' focus on today's population.

Note: NZ's source of electricity is close to 90% from renewables, though our nation's energy usage is only 40% produced by renewables.

We still burn coal. We import it.

We do not allow gas exploration. This is another example of how, as the television people tell us, we lead the world. Some wonder whether the world notices this leadership.

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Travel

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

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

David Colman will be in Whangarei on Monday 28 November.

Anyone wanting an appointment is welcome to contact us.

Chris Lee

Chris Lee & Partners Limited

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Taking Stock 3 November 2022

THESE days advisers and managers of other people's money are more caring, holistic if you like, than they have ever been. Better sanctions against poor behaviour mostly apply, and nobody wants to be de-licensed.

The statistics tell us that the people licensed and qualified to manage money or advise on wealth number barely a tenth of the riff-raff crowd that created havoc in the days of Broadbase, Money Managers, Reeves Moses, Vestar and so on.

Just as it has intended to do with the licensing of trust companies, auditors, and receivers, the new licensing regime eliminated many of the rogue operators.

I pondered this when I read last week that an investment company had behaved unwisely towards a retiring office staff member.

Retirement beckoned for what seems to have been a 65-year-old single woman, whose KiwiSaver funds just covered her remaining mortgage, leaving her to live debt-free with what might have been little more income than her national pension. However, the un-named investment company advised her to increase her income by borrowing several hundred thousand dollars and investing it, the theory being that her investment gains would exceed her cost of debt.

As theories go, this one was pretty darned stupid.

Of course the investments have since come off their hydraulicked highs so the retired lady now owes about $400,000 and has an investment fund worth around $250,000.

Perhaps her investment manager suggested she should buy Meta, or Amazon, or Netflix, or a bunch of Chinese stocks.

The advice she was given was juvenile, absurd, and probably actionable.

I expect the investment company will be compensating the lady and leaving her free of fear of losing her home, to settle her unrelenting debt.

But what remains worth discussion are two questions:

1. Who lent her the money? Surely not a bank.

2. How many others of modest wealth are being advised to borrow to invest?

Hopefully only bucket shops would use such strategies.

The comforting news is that in these turns of the investment cycle, banks become vigorous in assessing loan applications, no longer performing stupid lending.

Just two years ago, when ''free'' money was being dumped on the banks and the market by a commercially-inept government, every personal wealth banker was aggressively searching for borrowers, with a focus on those who were earning huge bonuses.

A professional person just beginning their career would be assessed on their income potential and then offered extreme credit lines, secured against that potential stream and the stated value of the assets to be purchased.

A young newly-qualified, newly-promoted lawyer, accountant, or investment manager would be viewed as a target by lenders whose own bonuses, directly or indirectly, relied on their loan book.

I met young people who had been offered million-dollar lines of credit, which came with few conditions.

Jet skis, big launches, sports cars, mountain chalets, McMansions, and bizarre investments, often in areas where cash burn was high, were funded by banks, secured by a mortgage over a home that was deemed to be growing in worth, perpetually.

Government printed money was so cheap it was virtually ''free'' so debt servicing was not seen as a threat. Nobody seemed to remember that free money blows up demand and asset prices, leading to inflation, high interest rates, asset prices, and misery for indebted households.

Our communications preached debt reduction, preparing people for the inevitable turn of the cycle. We may have been an outlier. Not now.

Countless young people chose to embark on major, high-risk projects. Some bought land and prepared plans to develop sections and houses, hoping to overcome the resource consent process and make a quick fortune.

They cared not a fig for the inconvenience of having no cash flow for years. Debt was serviced with what they deemed to be parking meter coins.

Hmm. The outcome of this madness was initiated by stupid banking executives, governed as they are in New Zealand by traders rather than by strategists. The outcome is now beginning to surface.

The property plans took years to be consented. Meanwhile interest rates rose, the loans were recallable, the land became worth less, and now there are fewer people interested in signing up for the pre-sale programmes.

The result is that literally hundreds of bright, ambitious, but wet-behind-the-lugs, young masters of the universe are no longer being invited by bankers to join them for a day of harbour yachting festivals with Moet and lobster for lunch.

These ambitious but poorly-advised youngsters are instead being summoned to the distressed loans department of the bank and invited to consider selling their own McMansion to someone who can afford it, creating the money to repay debt.

Banks, which live with short-term horizons, are frantically stress testing all these ''yuppie'' loans at 8 or 9%, at the very time when bonuses are being reviewed downwards and may be nil in coming years.

The concept of borrowing to invest in speculative ventures is off the agenda, except for the best-heeled and most experienced developer.

The concept should never have been on the agenda, except in those rare cases where the borrower had such ample wealth that he/she could cope with market corrections, comfortably.

The self-protecting behaviour of banks now also extends to its corporate lenders.

Covenants that are attached to corporate bank loans are no longer accommodating, and will constrain many corporates, especially those seen as having uncertain revenues and margins.

It is precisely for this reason that investors with money are enjoying a flow of corporate bond offers, the wise corporates realising that the value of long-term, fixed-rate debt is much greater in an era of high inflation.

The bond issuers receive kinder and more tolerant covenants, the term of the loan is not reviewable at the whim of our dreadfully-governed banks and, if necessary, the big corporates can swap fixed-rate debt with floating rate, or short-term debt, achieving a package that fits their needs precisely.

We have long surpassed the era when banks would engineer such a convenient outcome for its corporate clients.

One company, Infratil, foresaw this phenomenon nearly 30 years ago. Its founder, the late much-admired Lloyd Morrison, had seen how banks behave when we watched the banking madness after the 1987 sharemarket collapse, his company OmniCorp forced to sell assets at ruinous prices, the decisions made by bank-appointed receivers or bank distressed-loan collectors.

Infratil decided to borrow through corporate bonds, now has more than a billion of funding from the retail market, and has had calm banking relationships because of its retail bond successes, its reliance on banks now so low that the bankers are disposable.

Do we all learn from this example that the late Lloyd Morrison and his treasury team designed?

The retiring office lady who was persuaded to borrow $400,000 was naïve and most unwise, but probably felt that her interests would be nurtured by a long-term employer.

She may yet be right, as her long-term employer is likely to resolve the problem rather than face sanctions and public judgement for its behaviour.

One hopes that readers of Taking Stock will not be contemplating such problems.

Borrowing to invest, even in the easiest of times, has never been on the agenda except for those of extreme wealth.

I will not discuss why such people would want to extend extreme wealth by taking on more debt.

(I presume their motive is altruistic, to help the country grow.)

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GIVEN it has such a huge effect on the country, it is regrettable that the banking sector's image is as the great, goofy ape sitting on top of the roof of corporate towers.

It was not always so.

In the 1960s and 70s, banks were great contributors to our progress.

They spent generously on staff training, shifting their developing managers around different cities, aiming to produce bank managers who had useful knowledge of many sectors of the economy.

My uncle Phil, one of the land's most admired bankers, was an example of the banking excellence of that time.

Pressed suit, shoes cleaned each morning, familiar with all of his clients, admired and liked by the staff he developed, willing to take medium-term lending decisions, quick to spot a backstreet smart alec, Phil was the quintessential banker of his era. He oozed common sense, humour, and care for his clients and his employees.

At his Newton branch in Auckland, he was seen as the equivalent of a ''General Manager'' in his area, often used as a confidant by staff and clients.

He was primarily a business lender, focused on two things:

1. Whether the client could repay and, whatever the struggle, would WANT to repay;

2. Whether the use of the loan was wise and would produce the necessary cash flow.

I suppose he also cared about the realisable value of the security taken, but he also advocated that a loan that is repaid by the sale of the security was a failed loan, the signal of a bad decision by the bank.

In that era banks were cash-flow lenders.

In my book The Billion Dollar Bonfire, I explained the multitude of moronic decisions that led to tax-payers losing at least a billion dollars, shareholders being ripped off, and the South Island losing what was potentially a highly valuable lender, South Canterbury Finance.

I explained the difference between cash-flow lenders (banks) and asset lenders (finance companies).

Regrettably, banks have increasingly behaved like finance companies, no longer develop their key staff with long-term programmes, motivate lenders with ridiculous bonuses, and fill their boards with people who have no or little experience in banking, often with track records as good talkers, but with little evidence of strategic or economic wisdom.

Lending on housing is a low-risk game, requiring little skill until interest rates rise rapidly, as is happening now.

Business lending, especially to small business, requires skills and experience not often developed by banks.

Perhaps the whole economy is guilty of the sort of short-termism that characterises and debases banking.

Returns on capital are prioritised but other measures, like returns on staff numbers, are used to judge different banking activities.

Obviously, the high-risk game of derivative trading requires fewer staff so its returns per staff member are high, leading to bonuses that do not seem to reflect the risk involving using other people's money to make a fast quid.

Our central bank led by Adrian Orr, himself once an executive with the ugliest of our banks (Westpac), has moved to compel NZ's banks to have higher capital levels than apply in most countries.

But no one has yet used the fit and proper person judgement to squeeze out those slick boys and girls who look more like fast buck property developers than wise strategists and governors.

Anyone who reads this and wonders if I am being too tough should read the findings of the Australian Commission of Inquiry into the banks there.

They should then do the maths and acknowledge that the Australian banks hold more than 80% of our banking business.

My hope is that the new paradigm, brought about by the latest cycle of inflation and rising rates, will allow our Reserve Bank to be freed of goofy politicians, freed of inappropriate governors, and freed of squishy social objectives.

It might then focus on dragging our banks into an era much closer in appearance to the 1960s, than to the last decades.

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INVESTORS may next year find that the risk of banking malfunction is replaced by a Crown guarantee.

The current proposal is that depositors will be able to buy a guarantee from the Crown, exercisable should a bank fail.

My guess is that it will work something like this:

A depositor might be able to choose between an unguaranteed deposit, with a rate of, say, 4% for one year, or a Crown-guaranteed deposit, with a rate of, say, 3%. The savings in rate would be paid to the Crown for its guarantee.

There might be a $100,000 maximum per deposit, per person, per bank, meaning a married couple could invest $200,000 in each of five banks, thus having a no-risk strategy for a million dollars.

One wonders whether the guarantee would be changeable, if halfway through the investor wanted to switch the guarantee or be released from it.

There has been no indication that a different government would abolish the proposal.

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Travel

Johnny Lee will be in Christchurch on Wednesday 9 November.

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

Anyone wanting an appointment is welcome to contact us.

Chris Lee

Chris Lee & Partners Limited

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