Welcome to the September edition of the Generate KiwiSaver Scheme Newsletter. History was made on August 22 when the bull market for US shares became the longest ever; in simple terms we are witnessing the longest period of good performance from this market in history. Closer to home the RBNZ was surprisingly dovish in their Monetary Policy Statement, signalling that they expect rates to stay at the current low level until 2020! This news put downward pressure on the NZ dollar, which enhanced the returns of offshore investments and propelled the NZ share market higher.

Returns to 31 August, 2018 (after fees* and before tax).

*except the $3 per member per month fee.
**the funds opened on 16 April 2013
Note: Past performance is not necessarily an indicator of future performance.

The Funds enjoyed another month of strong returns in August with the Focused Growth, Growth and Conservative Funds returning 2.07%, 1.71% and 0.91% respectively. As we have mentioned before we expect markets to remain volatile in the short term at least and consequently continue to hold elevated levels of cash and fixed income securities. This will allow the Funds to take advantage of any market weakness.

Polar Capital Technology Trust was the strongest performing international equity holding in August appreciating an impressive 10.4%. One of the Trust’s top holdings, Apple, announced strong financial results and provided a positive outlook commentary. Two of the key highlights of the result were stronger than expected sales of the iPhone X and good growth in services/other revenues. This news catalysed a strong rally in Apple’s shares, pushing the aggregate value of its shares through the US$1 trillion mark, which was a first for a US company.

Siemens was the weakest performing international equity holding in August declining 5.4%. The company’s share price ticked higher in late July as the market became increasingly optimistic that the company would announce a significant restructure at the time of their second quarter result announcement. The changes announced lacked financial detail, which disappointed the market and as a result the company’s share price came under pressure. In our view, the digitisation of manufacturing will underpin earnings growth for a number of years, which will translate into attractive returns in the medium to long term.

Ryman Healthcare was the strongest property and infrastructure holding generating a 15.8% return over the month. This stock has enjoyed a significant rerating over the last year, producing a total return of 58%, which is a little over three times that of the broader market. While other stocks in the sector have also enjoyed a period of strong performance (as the market paid up for aged care companies with good development track records) they failed to keep pace with Ryman. Ryman has built an exceptional earnings growth track record since listing a couple of decades ago and offshore investors seem to be rewarding the company for that strength.

Interestingly the weakest performing property and infrastructure holding was only down 2.2%, which reflects the strength of these companies over the month. The weakest performer, Mercury Energy, had a result that was modestly ahead of the market’s expectations, but disappointed some investors with news that it would not be paying out a special dividend. Instead, the company announced that going forward excess cash would be used to fund growth or buy back shares. The special dividends would have been tax inefficient and so we do not regard this news negatively and in fact took the opportunity to add to the portfolio’s holdings at what we believe to be attractive prices.

The definition of a bull market varies, but according to the most commonly used definition a bull market is where a market goes up by more than 20% and lasts until it suffers a 20% decline from its highs.

According to this definition the current bull market started on March 9th, 2009. At that time the US share market was at peak negativity, some commentators were predicting that the global financial crisis was going to descend into the next great depression. Needless to say, the S&P 500 had declined significantly.

These dire projections turned out to be ill-founded. The Federal Reserve, European Central Bank and other centrals banks “pulled out all stops” to cushion the economic impact and the market recovered.

On August 22, exactly 3,453 days after the start of the bull market, history was made. This bull market exceeded the previous record set in the 1990's (between October 1990 and March 2000). The length of the bull market can in part be explained by the severe sell-off prior to its start and also the pace at which the market has appreciated (solid but not spectacular).

It is important to note that there have been a number of occasions when the market has suffered a significant pull back since the start of the bull market. While none of these quite made the 20% mark, some came close and the sell-offs felt pretty severe at the time. For instance, do you recall all of the headlines earlier this year when the S&P 500 was off 10%? It is rarely a smooth ride...

It is impossible to pick with any accuracy market bottoms and tops, but we are reasonably confident that the volatility seen earlier in the year will return, which is why we have elevated levels of cash.

Notwithstanding this volatility, in the medium to long term we expect the market will continue to rise. This belief is based on the foundation principle of finance: investors should receive a return to compensate for delaying consumption and taking on risk.

There was a wide dispersion of share market returns in August. The US share market enjoyed another positive month hitting all-time highs while a number of other markets suffered from continuing trade tensions and the risk of contagion of Argentina’s and Turkey’s economic crisis. In aggregate, the high weighting of the US share market ensured global share markets enjoyed a solid 1.4% return when measured using the MSCI World Index (in local currencies).

In the US, the S&P500 gained 3.3% in August and in the process achieved the longest bull market run. There was a strong end to the reporting season in the US, which pushed the percentage of companies beating expectations to a new record of 80%. We have already noted the strong performance of Apple during the month following the release of its second quarter financials. Not only did this drive up Polar Capital’s returns, but the size of Apple’s market capitalisation meant that it also accounted for almost one percentage point of the S&P 500 returns for the month. Apple’s market capitalisation increased by US$180 billion in August alone! To put this into perspective the entire market capitalisation of the NZ stock exchange is only US$65 billion.

Eurozone equities had a negative month with the Bloomberg European 500 declining 2.2%. Three headwinds hit European share markets in August. First, trade tensions continued to weigh on the share price of manufacturers. Second, a number of European banks have direct exposure to Turkey and so Turkey’s developing economic crisis weighed on the banking sector. Third, growing concerns that the new Italian government would announce a budget that would see debt expand at unsustainable levels and as a result amplify tensions with the rest of Europe put pressure on Italian stocks.

The Chinese share market declined 5.1% in August, giving it the dubious honour of generating the weakest returns of all the markets we monitor. The impact of weaker than expected economic data was compounded by the announcement from President Trump that he was considering increasing the tariff on the $200 billion of Chinese imports from 10% to 25%.

The weak returns from the Chinese share market dragged emerging markets as a whole into negative territory in August with the local currency MSCI Emerging Markets Index declining 1.2%. Interestingly, the much-discussed contagion of Turkey and Argentina’s economic ills was not evident in their share market returns; their currencies and bond markets bared the brunt of investors’ nerves.

Over the ditch, the Australian Stock Exchange enjoyed another positive month; the ASX200 Accumulation Index was up 1.7%. The vast majority of companies in Australia have financial years that end in June and report their financial results in August making this a key month for the market. In aggregate 56% of companies reported results that exceeded expectations and earnings revisions were better than typical in August. The technology sector was a highlight; for instance, the stellar performing WiseTech was up another 40% in August. It now trades on an eye watering valuation of 95 times next year’s earnings.

After taking a breather last month the local share market had a strong month with the NZX50 Gross Index appreciating 4.4%. It is difficult to argue that the local reporting season was the driver of this strong performance. Reported earnings were broadly in line with the market’s expectations and guidance for next year was weaker than expected. The surprisingly dovish Monetary Policy Statement delivered by the RBNZ during August is in our view the more likely driver – low rates for longer makes shares more attractive.

After 50 years at the helm of Berkshire Hathaway (which is currently one of the largest investments for both of our growth funds), Warren Buffett has become widely regarded as one of the world’s greatest investors. In his annual letters to shareholders, and in various interviews he has given, he has shared many of the lessons he has learned during his career. This month:

"You do not want to give Jeff Bezos a 7 year head start.”

Here Buffett is referring to the head start Amazon founder, Jeff Bezos, had in cloud computing and data centre services. Amazon Web services dominates this space in the developed world and although companies such as Microsoft and Alphabet have invested enormously in this industry they still have a fraction of Amazon’s market share. Buffett believes Bezos to be the most impressive entrepreneur he has witnessed in his long career. Notwithstanding this Buffett has never owed Amazon shares – possibly because they have had a high price/earnings valuation since listing.

Never invest money you cannot afford to lose

One of the golden rules of investing – if not the golden rule – is “never invest money you cannot afford to lose.”

It is a natural human tendency to want to overreach, by putting more money in than one can afford to lose, and go for the big ‘pay day’. This trait tends to be magnified if one’s financial situation deteriorates because of the hope that hitting the jackpot will make all the problems go away.

The first goal in investing should always be to avoid major losses. Give potential investments the ‘sniff’ test – if it seems too good to be true then it probably is! Also be patient, and seek the advice of qualified, well regarded investment professionals. Finally, ensure the costs of making the investment are reasonable. This recipe may not sound overly exciting, but it is a tried and true formula.

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Mercury Energy

Mercury Energy is a NZ based electricity generator and retailer - or ‘gentailer’ for short. We have recently added to the portfolio’s Mercury holding, because it offers a combination of great assets at a reasonable price.

Mercury Energy generates electricity using hydro-electricity and geothermal power stations (deep wells are drilled down to superheated liquids which can be used to drive electricity generation turbines). As a result, all of its generation is fuelled from renewable sources.

Not only does the exclusive usage of renewable generation provide the company with a big tick for environmental impact, but it also positions the company well for increases in the cost of emitting carbon. NZ carbon units have increased by circa 20% in the last 3 months and forward prices suggest they are likely to continue to increase. A number of Mercury’s competitors will suffer increases in their cost bases as carbon emitting becomes more expensive.

The company’s generation assets are also well located. All of Mercury’s generation is located in the middle of the North Island. Not only is this close to a significant proportion of the company’s customers, but it also means that its hydro production is not correlated with the large hydro schemes in the South Island. This is important because it means that when Mercury experiences a dry or  low production year, South Island generators can be enjoying a normal or even wet year, which caps power prices.

Finally, in our view Mercury shares are trading at attractive levels when compared to the other gentailers. For instance, Mercury is trading at a 20% discount to the other large renewable gentailer, Meridian.

Next month:

Transurban

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