Taking Stock 5 December 2024

AS THE calendar year stumbles to its end, one cannot review 2024 and seek an understanding of financial market direction without a concession to utter confusion.

No investor will misunderstand the main events that dominated the globe in 2024:

- Wars destroying lives and trillions of dollars of infrastructural assets.

- Immense increase in sovereign debt, China and the USA the biggest borrowers, debt servicing being met by more debt! US debt is now US$38 trillion.  It was US$1 trillion 24 years ago.

- Fiscal deficits everywhere, at levels that defy all historically valid guidelines.

- Uncontrolled immigration with desperate people seeking new lives in countries with cultures so varied as to be almost reconcilable with immigrants.

- Weather events creating havoc, making many coastal areas uninsurable, perhaps uninhabitable in the future.

- Demographics, highlighting the potentially calamitous drop-off of birth rates in developed countries, raising the issue of how pensions will be sustainable.

So how did financial markets respond to these unsolved messes?

Interest rates fell, making yet more borrowing apparently affordable.

Debt-fuelled US saw its dollar strengthen against most currencies.

Housing prices rose, though not in China. Inequality becomes entrenched.

Sharemarkets soared, as listed below, the biggest gainers, quite extraordinarily, being the world's weakest and most volatile economies (Argentina, Venezuela, Pakistan, Turkey).

Globally, interest rates vary from improbably low (most of Europe, China) to hideously expensive.

(These rates are drawn from available data at time of writing – pricing in local currencies).

Developed Markets:

US 10-year bonds: 4.21%Germany: 2.09%UK: 4.24%Japan: 1.08%Australia: 4.34%New Zealand: 4.34%India: 6.71%Israel: 4.90%China: 2.08%

Emerging Markets:

Turkey: 28.67%Russia: 15.13%Bangladesh: 12.89%Brazil: 12.01%Mexico: 10.47%Indonesia: 7.27%Venezuela: 10.43%Greece: 2.93%

Argentina’s overnight central bank rate is around 35%!

Yet consider these sharemarket returns year to date, with the figures alongside the bond or cash rates.

Share Index (YTD):

Argentina: +142%Venezuela: +85%Turkey: +29%Nigeria: +30%Israel: +23%Pakistan: +62%

Cash or Bond Rate:

Argentina: 35% (cash)Venezuela: 10% (10-year bonds)Turkey: 28% (10-year bonds)Nigeria: 21% (10-year bonds)Israel: 5% (10-year bonds)Pakistan: 11% (10-year bonds)

Does this imply that investors (fund managers) seek out high returns in those markets with the highest cost of money? Is this “long-term” investing, to find sustainable value?

Such logic would be lost on me.

Is Israel's market reflecting its various wars? How does war correlate with economic success?

As noted at the start of this article, confusion reigns (in our office anyway).

Why would fund managers invest in low-yielding bonds in the likes of Greece, Spain, France, Italy, (all less than 3% 10-year bond rates)? The European Central Bank might be the effective guarantor only for as long as Germany tolerates this. Does the collapse of the German coalition government reflect disagreement with the concept of Germany underwriting the likes of Italy and Greece? How close to collapse is the French government?

If Germany is having to fund the Ukraine war while Germany’s critically important auto industry is in disarray. For how long will Germany’s people tolerate the outcome – effectively, austerity; no room for wage increases, tax cuts, or welfare increases? Wages there are lower than in Greece.

Such conundrums abound.

An equally fair question centres on the large fiscal deficits everywhere, with the political determination not to broaden the tax base for fear of losing what are now high-paying, political jobs, largely paid to those whose careers have been limited to the public sector. (What happened to the Holyoake days of community service?) Have high salaries attracted into politics people with the wrong motivation?

To review 2024, and to anticipate 2025, without any reflections on those underlying oddities would be to avert one's eyes from the obvious.

In NZ, interest rates have fallen, job vacancies have fallen, despite some public sector cuts the public sector still is at or around historically high levels, and the new government will operate with huge deficits, yet without a plan to maintain, let alone improve, infrastructure.

Yet no tax reform seems likely, democracy delivers often the least experienced and most inappropriate people (Tory Whanau, anyone?), while governments and councils rack up ever greater debts.

Meanwhile the sharemarket rises inexorably, here and in most countries. Our sharemarket has risen by a double-digit figure amount (around 11%). 

Perhaps there is an explanation for share price rises.

One could argue that if the world keeps printing money (tens of trillions in the last five years) and the money trickles to the wealthy, then that money is going to be invested in assets or in sharemarkets.

The growth investment products today are exchange-traded funds, which by their own covenants must invest without regard to price or value. They invest in existing assets, mostly in shares, without regard to value.

In the USA decades ago, there were around 8,500 public companies listed on stock exchanges.

Today, there are around 4,300 companies that are listed.

If you print money, and it ends up in the hands of investors, who use ETFs, which invest indiscriminately in a diminishing pool of listed shares, then share prices will respond to the laws of diminishing supply and increasing demand. Prices rise inexorably. This may seem stupid, but it is logical.

Just in NZ, there were 400 (plus) listed NZX companies in 1987. Today there are around 140, similar to the ratios in the US, over the 40-year period.

Traditionally, US companies were priced at about 9 to 12 times their forecasted earnings, sometimes as low as 5 times earnings.

Today, the US markets are priced at 22 times the forecasted earnings, though if you extract the top seven technology stocks (Nvidia, Amazon, Meta, Microsoft, Alphabet etc) then the US market is priced at a lower, but still lofty, 16 times forward earnings. Investors might thank (or blame) ETFs.

The effect on investors is similar to the effect of thin air at great heights on mountaineers.

It makes people giddy and increases poor decision-making.

The NZ sharemarket highlights of 2024 included the continued, inexorable progress of Infratil towards its eventual, inevitable status of New Zealand’s biggest company. Just two years ago it had a rights issue at around $4.50.

Today its share price is near to $13. Its valuers have extreme expectations on the worth of Infratil’s data centres.

Infratil’s progress has been admirable; astonishing even.

The recovery of Fonterra is another great story. Its shareholders owe a deafening round of applause to its chairman and its smartest directors, one of whom, Leonie Guiney, has spent years urging the changes that have restored Fonterra. She retired recently, a true Hall of Fame candidate.

Ebos and Fisher & Paykel Healthcare have grown in value relentlessly, and, like Mainfreight, have been governed well.

Air New Zealand and Fletcher Building have been major companies that could do with smarter governance, Air New Zealand perhaps a victim of government involvement in conflating social and financial objectives in what must be extremely awkward times for the hardworking CEO, Greg Foran. Perhaps Air NZ should be wholly-owned by the Crown.

Among the most exciting prospects must be Santana, with its gold mining project apparently understood by the politicians. They would be eyeing the potential royalties and taxes that would accompany the $300-$400 million forecasted nett profits, that assume gold prices do not retreat dramatically.

Such profits would see Santana reach the NZX Top 20. Its entry to the NZX 50 seems imminent, as shareholders shunt their shares to the NZ registry.

Older investors, and those who are cautious, will be watching the low-risk property trusts, which are enjoying bank debt servicing reductions and better valuations (for whatever they are worth).

Properties are “valued” at a multiple of nett returns. Lower interest costs help the nett returns.

Of course there is inherent in most properties the issue of tenant robustness. Tenants fail. Property trusts bear the cost. Unlisted syndicates seem especially vulnerable.

The most resilient stocks have been the power companies, the banks, and the small number of excellent companies which maintain competitive advantage and proper margins.

Hallensteins is a long-term surprise example.

There are a small number of good companies needing time to prove or disprove their strategy.

Heartland buying a bank in Australia was a strategy that should unlock better margins by 2027/28. At its current price it must be at risk of a private takeover.

Eroad has tested the patience of investors and made some awful communication errors but hopes to gain business as countries move towards road tax, away from fuel tax. It does have repeat revenues of nearly $200 million.

The retirement villages grew too fast, using models that had been too optimistic. The value of their real estate is real. Time should bring shares prices and underlying value together. Demand is inevitable given that there is no other access to geriatric health support. Their survival is critical (Recall the childish analysis that figured the villages were “profiteering”?)

Some must also be at risk of private equity takeover bids.

All the confusing market behaviour, decoupling prices from the fragile global environment, makes forecasting 2025 a dangerous game.

But as this is my last Taking Stock for 2024 – Fraser and James will write the next two – I offer the following (as I head off to Lake Taupo and then Waiheke for some beachcombing and golf):-

1. Trump will be denied by checks and balances from executing most of his promises. But he will run ever bigger deficits. Expect the Federal Reserve to be stoic. US interest rates might keep the US Dollar strong. Tariffs, if threats are realised, would fuel up inflation and interest rates.

2. If US interest rates remain near current levels, given the immense size of their borrowing needs, global rates might not fall to the expected levels. The US Treasury rates are critically important. In NZ, real inflation is not, and probably rarely has been, less than 2%, except for the mythical person who has a large mortgage and spends his disposable income on technology-driven appliances and devices. I do not plan on the Reserve Bank cash rate falling much below 3.75%. The 10-year bond rate may stay in the 4% - 4.5% range. Corporate bond rates will need to be at a premium to government bond rates. In 2025 I expect corporate senior bonds to be around 5%, and bank subordinated bonds to be offered around 6% - 7%. Mortgage rates may bottom out in 2025.

3. The NZX listings are boosted by pension savings. The smart managers, of which there are two big ones (Milford and Harbour) will enjoy the expected fall in the NZ Dollar, harvesting gains from careful selections of the world’s smartest companies. Those who slavishly follow an index might produce glum results. Hedging the currency might be wasteful. Stock selection will be critical. Excellence is a worthy objective. Note that even Warren Buffett has a staggering US$350 billion uninvested because he invests only when there is value in the price.

4. Many private equity funds would be forced to discount their valuations were they required to provide redemptions. Withdrawals often come in surges, when confidence is tested. Private credit funds will need to be imaginative to hide provisioning for looming bad debts. Such funds take on risk to achieve high returns. Buyer beware.

5. Bitcoin is clearly now an asset class supported by those managing other people’s money. I have no idea if or when the music will stop. Tulip bulbs did have a purpose in the 17th century.

6. Liquidators will make handsome profits. Our retail sector still survives on lean pickings, for now. Liquidations in 2024 rose by 27%. Tourism, hospitality, and even horticulture and non-dairy agriculture all face threats of higher costs and lower revenue. Unlisted property syndicates look vulnerable.

Repeat: asset selection will be important. So will asset allocation. Many investors do not have to chase high returns. For those in retirement, spending capital by choice is far better than chasing high returns and losing capital.

For fifty years I have worked in capital markets. Next year will be the 40th year of governing and managing our business. I am heading to twilight.

Watch for the new blood. Edward and his team are refreshing our offerings.

I will remain a director and hope to be well enough to work for some time yet, and to pretend that I still matter. Our new chairman James Lee will have value to add to our progress.

The challenges of the new environment are compelling, if daunting.

Season’s greetings. May 2025 bring good health, good fun, and may the gold price be strong!

Chris Lee