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Bridge talks Business: 20 August 2024
Episode Transcript
Ryan Bridge
Kia ora and welcome to Episode 2 of Bridge Talks Business with Milford. I’m Ryan Bridge and if you’re serious about investing and keeping on top of market news, this is the place to be. Here are your top 5 business bits from the week.
Number 1: Finally we have a rate cut. Not only did the Reserve Bank cut rates but it’s now clear we’re on the path to a cutting cycle even if the central banks said it was data dependent.
Number 2: Tthere’s a party in the USA, well sort of. Strong economic data at least, inflations behaving, consumers spending better than expected. Say bye bye to that wobbly growth scare that we had.
Number 3: China continues to struggle. It’s disappointing. Retail sales did rebound after a weak period and fiscal support there should be enough to hold things together until Christmas.
Number 4: Earnings season has landed. This week we get stuck in and find out how our companies have been fearing here in New Zealand. Perhaps most importantly, what are they saying about outlook given those rate cuts?
Number 5: Look to the Rocky Mountains. This week we hear from the US Federal Reserve at Jackson Hole, it’s like Davos for central bankers. Will the Fed signal rate cuts as the markets are expecting?
You may have heard the collective sigh of relief as Adrian Orr cut the OCR for the first time in 4 years. Yes, that was pre-COVID the last cut. Relief for mortgage holders but what about investors and savers? What types of companies typically perform well in a cutting cycle? And what happens to the more than $200 billion that Kiwis have sitting in term deposits as rates ease?
I’m joined by Mark Riggall, portfolio manager at Milford. Mark, nice to be with you.
Mark Riggall
Nice to be here.
Ryan Bridge
Just a note. This interview is informational and not intended as financial advice.
Mark, did you sigh with relief when you heard that OCR cut?
Mark Riggall
I think it was a momentous occasion because it was not just one rate cut, we’re likely now in a rate cutting cycle. So, I think it was a big deal last week. Which is obviously going to be good news for businesses, for Kiwi companies. What are they saying? How are they reacting to this news? Well, I think we all expected this cycle to come at some point and now we’re officially in this rate cutting cycle. So now we can look forward to that optimism that maybe this economy can finally stop slowing and start maybe picking up some steam. And it’s going to be a while before we actually see that in the data. But we can be optimistic now at least, that that will start to come through. And companies are saying that. They’re saying they’re seeing optimism or they’re feeling optimism that they’ll see improvements going forward even if they’re not seeing it yet.
Ryan Bridge
We’re going to talk a little bit and a little bit about what companies are feeling, what sort of companies or what sort of industries you might be looking at in terms of share market investments. But just for now, let’s talk about savers and those who’ve got term deposits. We’ve got more than $200 billion in term deposits in New Zealand right now. What happens typically to those investors?
Mark Riggall
Well, of course, those investors have enjoyed some pretty healthy rates on those term deposits over the last three, four years as interest rates have been high. And of course, they’re going to go down, right? So, they’re going to be receiving less income from those term deposits. So, they’ve already started falling. Because investment markets look forward and price interest rate cuts before they actually start. So, term deposit rates on a one-year term deposit have fallen around 0.6% already. And they’re probably going to fall further over coming years as the OCR gets cut further. So, if you’re a saver and you’re in a term deposit, then you’re still going to be earning a reasonable amount. But it’s going to be diminishing over time. So you might want to be thinking about other things you could do with that money.
Ryan Bridge
How quickly do you need to think about that?
Mark Riggall
Well, the market’s pricing that the RBNZ will be cutting rates over the next 12 to 18 months back to around 3%. So that’s the kind of timeframe we’re talking about. The RBNZ, for their part, have a roughly similar timeframe. It’s not quite as quick as the market to get down to 3%, but they are expecting to cut the OCR towards 3% over the next couple of years.
Ryan Bridge
How much does that term deposit, you know, the $218 billion we’ve got, how much does that fluctuate depending on a rate cycle?
Mark Riggall
It doesn’t fluctuate a huge amount because there’s lots of other things going on in the economy and lots of other opportunities for investors at different points in the cycle. So, it doesn’t change a huge amount. But if you’re an investor, individual investors was different from the aggregate. If you’re an individual investor and you’ve got lots of money in term deposit because it’s been offering you fantastic returns, then maybe it could be a time to start reassessing and thinking about what else you could do with that money. Or you know, are there alternatives to cash, if you like, for investors now available to you because we’re in this cutting cycle?
Ryan Bridge
Which brings us to bonds. Tell us about bonds because they’ve been having a pretty good run just lately, right?
Mark Riggall
Well, they have. And let’s not forget they had a terrible run from 2020 through to 2023. But over the last 12 months or so, we’ve actually seen bonds coming back. So, there’s a government bond index, which has returned around 17.5% since October of last year. That’s a healthy return from a bond.
And so if you’ve been in bonds recently, then you’ve done really quite well. And the reason for that is that bond markets again, look forward. They look forward to what interest rates will be doing in the future. And what bond markets have done is effectively priced this cutting cycle already. So bond markets now expect in the price of bonds going forward, interest rates to be cut to 3%. Another way of saying that is that the bond prices have pulled forward the return. So unlike a term deposit where you wait for your return through the interest, bond prices fluctuate and those prices have delivered you that return now, rather than waiting for that return over the next two years via the interest you’re going to get paid.
Ryan Bridge
Does that mean what their pricing now is increases? Are they that far ahead?
Mark Riggall
Not quite. What I would say is that the bond market is expecting cuts to 3%, right? That might happen, but there could be alternatives. What if interest rates have to go further than 3% as in lower to 2% or maybe even 1% – remember we got close to zero. So there are scenarios where that could happen and those scenarios bonds are going to do really well. But that’s going to be like a tip into recession, probably a global recession that’s going to cause the RBNZ to have to cut rates all the way below 3% even further.
Ryan Bridge
We’re hoping that doesn’t happen.
Mark Riggall
That’s right.
Ryan Bridge
All right. Now the juicy part, this is a quick fire question for you because I know people are very interested in what you guys at Milford are investing in at the moment. So, quick fire questions for you. When rates start cutting, when they start dropping in a rate cutting cycle – not just here but around the world – which is happening, do we favor Kiwi or overseas shares?
Mark Riggall
It depends.
Ryan Bridge
Okay. Whenever you say depends, we’re going to come back and dig deeper on that. What types of companies, cyclical companies, income shares companies?
Mark Riggall
Again, a mix of everything. I’m going to sit on the fence on some of these, I’m sure.
Ryan Bridge
Great quick fire!
Mark Riggall
Yeah, sorry. Sorry for the lack of snappy answers.
Ryan Bridge
All right. What about one you can do? Burger Rings or Salt and Vinegar Chips?
Mark Riggall
Salt and Vinegar Chips, without a shadow of a doubt.
Ryan Bridge
We’ve got an answer. All right. So, let’s talk about shares. Whereabouts you are investing and what the differences are between buying shares in New Zealand at the moment and buying shares in other jurisdictions?
Mark Riggall
Yeah. So, let’s talk about those different types of companies, right? Because not every company is the same – there are different structures. We talked about cyclicals. What are cyclicals? They’re companies that are highly tied to the economy and therefore if the economy improves, then they’ll do well. So, people are very excited about cyclicals here in New Zealand because with a rate cutting cycle, the economy should improve.
Also overseas, the Bank of England’s cutting rates. We’re seeing the Bank of Canada cut rates. The Federal Reserve even might be cutting rates in September. So, countries around the world cutting rates, global cyclicals should be in theory expected to do better. However, you have to examine what are the valuations of those cyclicals. Are they already expecting today, going forward, that economies will improve? And that’s where it depends, because cyclicals both locally and overseas, are expecting some improvements in economies. And so valuations are elevated. It’s not a kind of a slam dunk that those cyclicals are going to perform. What if rate cuts don’t deliver that cushion to economic performance? What if we get a shock? What if we get that recession that we hope we don’t get? Cyclicals will be risky.
Ryan Bridge
Because then you’re more exposed, right?
Mark Riggall
That’s right.
Ryan Bridge
Because they’re up and down with the condition.
Mark Riggall
Correct.
Ryan Bridge
So, what about income shares?
Mark Riggall
Right. So, income shares – I think it’s worth defining what an income share is.
Ryan Bridge
Please do.
Mark Riggall
We talked about bonds, right? Income shares are your kind of equity version of bonds. So they’re companies with a very well established asset base. Think about a utility company – they’ve spent lots of money to build that infrastructure. And then they are selling that utility to people who are then providing them with an income stream. So, there’s lots of cash flows coming to that company. And they need a bit of reinvestment to CapEx. But by and large, they behave like a bond.
Ryan Bridge
And unlike cyclicals, they’re not up and down with the market.
Mark Riggall
They don’t tend to be as volatile as cyclicals. They’re much, much lower volatility. But they benefit from a falling interest rate environment because the cash flows are much more valuable when interest rates are falling. So they can do very well over an extended period of time. They’re not going to be your growth companies that can blow the doors off. But they can provide you with a very solid return and very low volatility. And we see income shares as income shares in the local market, over in Australia or even further afield. We do see those types of companies all over the world, and that’s where we try and look for good investments.
Ryan Bridge
And with the cyclicals, is there a particular market where you would be looking at the moment?
Mark Riggall
Yes. So different cyclicals are priced differently in different markets. One geographical area that we’re looking at the moment and heavily investing in is the UK. UK companies are, by and large, cheap. They’re under loved. The Brexit issue caused people to forget about the UK and it’s now become a backwater. And basically, it’s as unloved as it could possibly get. So, there’s only upside, right? And so, if you look at a company in the UK and compare it to a similar company in Australia or elsewhere in the world, the UK company is much, much cheaper. So, we think there’s good upside to UK companies and we’ve been looking at investing there. What’s the catalyst? Bank of England’s cutting interest rates as well. And they’re cutting from a high level and people are not expecting them to cut interest rates as fast as many other markets around the world. So, there’s potential upside from a cutting cycle in the UK too. So we are heavily investing in the UK.
Ryan Bridge
That’s fascinating. So with the UK, a friend in need is a friend indeed! Much cheaper than those Americans. Thank you very much, Mark. Great to talk to you as always.
Mark Riggall
Great to be here.
Ryan Bridge
That’s Mark Riggall from Milford Asset Management. And that is it for episode two of Bridge Talks Business. See you next week.
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