Newsletter June 2010
June 1, 2010
The World Is Far From Fixed
Events in Europe over recent months highlight the depth of the financial crisis around the world. It was easy to be lulled into thinking we are getting back to normal, however the plight of Greece, Spain and others (United Kingdom?) clearly shows the problem has shifted rather than been removed. The debt hasn’t gone away – it has simply been transferred from individuals and corporations to governments. The massive sovereign bailouts in the U.S, the U.K and Europe provided financial markets with the confidence needed to keep the global monetary system operating; however there is now a realisation that the debt still has to be paid back.
The International Monetary Fund and EU rescue package amounted to US$1 trillion. What is a trillion? I had to Google it to find out, and it can be either one million million, or one million, million, million! Whatever it is, it’s an obscene amount of debt that the Greeks are going to be saddled with for generations. Some question whether a rescue package should have been put in place at all. Why not let a poorly managed company/country fail and suffer the consequences? I guess the politicians have to weigh up the social implications as well as the financial implications of letting a country go bankrupt. You only need to look at what is happening in Zimbabwe to get an idea of where Greece would head if it failed. Already the austerity package has resulted in deaths – a complete failure would result in many more.
One concern I have with the mind boggling debt figures of some countries is the dreaded “I” word – inflation. I know I rabbit on about inflation too much, but I wonder if debt-laden countries are going to be happy to let inflation take care of a good part of their problem. If I was saddled with debt I would be more than happy to see double-digit inflation reducing the real value of my debt. I don’t think it is as big a problem here in New Zealand; however it is still worth keeping in mind. Our public debt as a percentage of Gross Domestic Product is a relatively conservative 14% (but rising) compared to Greece at 120%, Japan at 190% and Zimbabwe at 300%. Public debt is different to “external” debt, which reflects the foreign currency liabilities of the public and private sector. Our external debt is very high, and is predominantly concentrated in the private sector (mainly housing).
Budget
Most of what came out of the Budget was well flagged beforehand and shouldn’t have come as too much of a surprise. The main effect on investors is in the property sector, with the Government removing the ability to claim depreciation on most permanent buildings from April 1st next year. The listed property trusts have been directly affected and their share prices have dropped accordingly. How much of the decline is a direct result of the Budget, and how much relates to the general malaise in the market is debatable, however there is no question the property trusts have had significant declines over the last two years. The general consensus is that it could have been worse for property investors, with capital gains tax being mooted as a possibility. Some of the negatives will be offset for investors by the reduction in personal income tax rates, and the reduction in the corporate and PIE tax rates. Property is a very cyclical asset, and you can be confident prices will improve as the economy improves.
As I suggested, although I was surprised it was done so soon, the Government has cracked down on the eligibility for benefits. Trusts have been targeted, and will now be included as part of a family’s total income when determining eligibility for benefits such as student allowances and community services cards. Even though it affects me personally (my children are eligible for student allowances) I think the move is fair. Why should I be eligible for a benefit (funded by taxpayers) that someone else is not eligible for simply because I have structured my financial affairs in a certain way? I have a friend who is an assessor for the Government-funded home insulation scheme. He tells me a good portion of those applying for the subsidy own large houses on equally large farms, and many of them have a community services card. In time, will the Government include trust assets when determining the eligibility for rest-home care subsidies?
Despite the Government’s changes, trusts will remain a valid vehicle for protecting your assets for the benefit of others. Not all trusts are set up to rort the welfare system – one of the main reasons is to ensure your assets pass to the people you want them to. Since the passing of the Property Relationship Act the rules relating to marital splits are also applicable to de facto relationships. If you leave your estate through your will, whatever your children receive will be at risk of property claims by their partner in the eventuality of a relationship breakdown. Your lawyer has much more experience than me in the merits of trusts, and I would encourage anyone who is thinking about their estate planning needs to contact their lawyer.
Ron Hay
A big thank you must go to Ron Hay for taking time out of a busy schedule to come and speak to our clients. The main point I think investors should take from his presentation is “volatility.” He has been proved right with sharemarkets around the world taking a hammering over the last month. We are fortunate to have access to a firm like Baillieu’s in Australia, as they are “on site” and have direct access to the executives of the companies they are recommending. They have provided sound research over the years, and have picked some very good stocks for our clients.
I try and encourage most investors to get some of their money out of New Zealand. Our market is tiny in comparison to the main global markets, our liquidity (the ability to buy and sell easily) is lower, and we don’t have access to as many sectors (minerals, emerging markets, healthcare, IT, and banking) as other markets. My main concern, however, would be if New Zealand suffered a major catastrophic event. Think what would happen to your investment portfolio if Wellington or Auckland was levelled by an earthquake, or, heaven forbid, if foot and mouth disease entered New Zealand. You could be assured your share values would halve overnight, regardless of what companies you held. I view my overseas investments as a simple insurance policy against “NZ Inc” performing poorly.
Some of Ron Hay’s recommendations included:
- Banking – Commonwealth Bank of Australia, ANZ, National Australia Bank, and Westpac
- Diversified Resources – BHP and Rio Tinto
- Retail – Woolworths and Wesfarmers
- Building Materials – CSR, ABC and Brickworks
- Energy – Woodside Petroleum, Origin, Molopo, Orica, and Worley Parsons
- Education and Information Technology – Seek
- Computershare – the world’s largest share register
- CSL – pharmaceutical company specialisig in plasma products and vaccines
Short-Selling
Ron Hay was asked a question about short-selling, and the effects it has had on share markets around the world. The practice is illegal in New Zealand, but is common in other markets. Short-selling is a practice whereby you can sell shares you don’t own when you expect prices to fall. A short-seller would typically borrow the shares through a broker, who would be holding the shares for another investor. The investor/broker receives a fee for lending the shares to someone else. The short-seller then sells the shares in the market, waits until their price drops, and then buys them back, returning them to the broker/investor. Their profit is the difference between what they sold them for and what they had to pay to buy them back, minus the fee paid to the broker. It can have a very distortionary effect on markets. Germany has recently banned “naked” short-selling (the seller doesn’t own the shares, and doesn’t borrow them to cover their position) of certain securities.
Shares – Risk – Time
I have fielded a number of calls recently about Telecom and GPG. Anyone who has owned these shares for any length of time will be as disappointed as I am with their seemingly interminable price decline. The question I’m asked the most, unfortunately, is a questions I don’t have the answer to – are they going to recover? Too often I see share investors who shouldn’t own shares in the first place. We all accept that share investments carry risk, however risk is not only a function of the fortunes of the company – it is also a function of the time-frame of the investor. One question share investors need to ask is;
- Have I got time to ride out the volatility in prices?
The next question you need to ask is:
- What is the best use of my investment capital from today onwards?
Far too many people refuse to sell a poor-performing investment because they have paid more for it than it is worth today. No matter how hard it is you must take your sunk costs out of the equation. Look at your poor-performing investment and ask if there is something else that will perform better for you.