The Global Search For Yield & Other Major Changes
Words We No Longer Use
Since becoming an independent economist at the end of September I’ve been supplying a bespoke handout for each of the audiences I speak with at presentations around the country. Recently that meant one focussed on the housing market for property investors in Rotorua, and another focussed on how businesses can handle their changing operating environments for accountants in Wellington and Auckland.
This handout is something quite different. I mention but don’t concentrate on the overall state of the economy, weak business sentiment, the housing market, and global developments. Instead the material here focusses on ways in which the world we have all come to know over perhaps the last 30- 60 years has shifted in ways a lot of people may not yet have caught up on. In some regards the missing of these changes can be considered “blindspots” in a business management sense.
One example of this would be assuming that the best route to making a higher business profit is to acquire more customers and boost output. But this is not necessarily the case in a new world of ongoing labour shortages and labour force management difficulties. In this new environment for many companies greater profitability can be achieved by heavily rationalising customer types and numbers and cutting output.
Over the past two years I’ve been building up a list of things which have structurally changed, and defaulted to calling it a list of words we don’t use. My talks around the country for Erskine and Owen are built around this list because it leads very handily to answering the question of why so many more people are now interested in investments such as syndicated commercial properties. So, in no particular order of importance….
Up until about three years ago people worldwide spoke about the quantity of oil available on the planet running out and that we were very close to hitting something called Peak Oil – meaning the pace at which reserves of oil were being run down would exceed new discoveries. But the technological revolution which we are living through has radically changed that, not from the development of just one technology, but the development and cross-blending of three. First, threePage dimensional ground radar technologies have allowed explorers to better identify locations where oil would likely reside. Second, fracking technology has allowed the pushing out of low pressure oil by pushing in mixes of sand and water. Third, horizontal drilling has allowed the setting up of drilled pipe networks underground able to extract oil from pockets sandwiched between layers of shale which previously were not reachable.
The rapid development of the shale oil industry over the past decade in the United States has now made that country the world’s biggest oil producer. This is not something any sane person contemplated at any point in the 1970s, 1980s, 1990s, or 2000s. This surge in oil supply has led to a structural decline in average oil prices which has struck the economies of oil-producing nations which have thrived since the 1970s in particular. It has reduced (though not removed) the importance of the Middle East to global growth, and reinforced the effectiveness of economic sanctions imposed by America on the likes of Iran for instance. Lower oil prices have provided breathing space in countries like New Zealand for governments to raise fuel taxes without pushing petrol prices to truly crippling levels. Governments have effectively captured for themselves the price benefits we consumers might otherwise have enjoyed from low international oil prices. The upshot is that while we may not enjoy low oil prices by any standards we each might have developed over our lives, worries about oil running out have disappeared. Worries now centre around the effects of continuing, gushing, carbon fuel production – global warming. And no-one uses the term Peak Oil any longer.
New Zealand has always been a nation of immigrants. But for a while after the combined effects in the 1970s of oil crises, rigid government policies, loss of export markets, and a construction sector collapse, and the impact in the 1980s to 1990s of economic reform hitting farming and manufacturing, we became something different. We became a country which anyone with a bit of get up and go got out of. We developed expectations that our children would leave our shores, at the very least doing an extended OE. We talked repeatedly in terms of the need for job creation schemes, the need to attract industries to New Zealand, the collapse of the regions, Brain Drain, and the last one out needing to turn off the lights. But now things have radically altered and the best way to see this is by looking at annual net migration flows for each of the past four decades. In the ten years to the end of 1988 on average each year we lost a net 16,000 people from migration flows. In the ten years to 1998 we gained 9,000 on average per annum. In the ten years to 2008 on average we gained 19,000 per annum. And in the ten years to the end of 2018 we gained on average 29,000 people per annum. In the year to August the gain was 54,000. There has been a severe structural shift in net migration flows into New Zealand driven by a range of factors. One is that the 1970s-80s were extraordinarily turbulent economic times in New Zealand which directly discouraged people from coming here, encouraged those of us here to leave, and affected our feelings about long-term prospects in New Zealand for a long time. But in the late-1980s, perhaps responding partly to these outflows, the government changed migration criteria from a focus on source countries such as the United Kingdom, to skills etc. This led to higher immigrant numbers from Asia. More recently the development of the New Zealand economy away from manufacturing and farming toward a diverse range of globally-linked technology sectors has encouraged young Kiwis to stay here – at least for longer than they would have done in the past. There is no sign that we are headed back to the bad old days and no-one uses the words Brain Drain in New Zealand any longer.
Sort The Wheat From The Chaff
This is the terminology we used to use with regard to growing a business by hiring new people. There used to be plenty of skilled, motivated people sloshing around the economy from the 1970s (not Barry Crump’s 1960s) and employers could place one job ad in the newspaper and pick and choose from a large number of good applicants. Very few employers can do that now. Despite the structural shift in our country’s net migration flows, labour of all types is in short supply and businesses can spend considerable resources trying to source people from offshore and lobbying the government for looser immigration visa criteria – with highly variable success rates.
In the NZIER’s long-running Quarterly Survey of Business Opinion a net 42% of business respondents in the September quarter said that they are having difficulties sourcing skilled labour. The ten year average is 30%. A net 28% said they are having difficulties sourcing unskilled people. The average is just 8%. Not only is labour in short supply, unskilled labour is now very difficult to find. And this is not because people do not want to work. A near record 68% of the working age population is now in work versus 64% ten years ago, 61% 20 years ago, and 59% three decades back. A high 23% of people aged 65 years of age and over are now in work versus only 7% 20 years ago. Businesses are having to spend time and money finding staff, training them up, redoing shoddy work they have done, counselling disaffected people, paying out personal grievances etc. And now businesses are losing long-serving people unhappy with low wages growth since 2009 and tired of training up a steady string of new people. Businesses often advertise for staff and get no applications. They end up having to take whoever they can. There is no longer any exercise of sorting the wheat from the chaff – and this situation is also apparent in many other countries as well. This makes running a business much more difficult from a labour force management point of view in New Zealand than at any point since the high employment 1960s. In fact it will be harder even than back then given the speed with which people tend to change jobs these days compared with back then. We Have to Get There Before The Shops Close No we don’t. Just about anything we want to buy these days, even fresh food, we can purchase online and have delivered. Retail “therapy” has partly become an online experience whereby we can get high enjoyment from looking for hopefully useful retail goods on our devices connected to the worldwide web.
Clean Green New Zealand
No we aren’t. The vast expansion of the irrigated, intensive dairying sector over the past two decades has produced widespread pollution of New Zealand rivers and lakes, plus hefty methane contributions to global warming. Dairying is our second biggest export sector. The biggest is tourism. But long-haul travel by air to New Zealand injects substantial quantities of greenhouse gases into the high atmosphere. We are no longer a clean green destination on the ground or in the act of getting here and this is now a vulnerability for our two biggest export sectors.
Desirable Seaside Property
Not necessarily. Now, living close to the sea or beside a river can be very risky. Global warming is producing warmer oceans and the extra heat makes for more intense storms and wave inundation and erosion. Longer periods of heavy rain on ground surfaces, caused partly by warmer air holding more water, is pushing greater volumes of water down rivers. Those rivers are increasingly breaking their banks, washing away farmland and houses, and eroding old dump sites. Eventually insurance premiums will rise to reflect increased inundation risks, and insurance might be pulled. That would mean mortgages might no longer be available for such properties, and the prices for such assets will reflect these changes. We are not there yet. But these are the risks which are building, and anyone contemplating purchasing a low-lying property near a river or the ocean might want to think in terms of erosion of the value of their asset over a multi-decade period. That means for many such a purchase is still a worthwhile thing to do, like constructing a building on land leased only for 99 years. We Need to Diversify Away From the UK and European Union That is what we all said over the 1970s-2000s as we saw the loss of markets when the UK entered the Common Market in 1973 and we faced barriers to entry into many markets for our largely primary sector exports. For the decades since we have sent our people offshore to find and develop new markets – and we found a rapidly expanding China.
But now the world is finding that there are challenges in trading with China revolving around the China Communist Party’s desire to control commentary about their country outside China’s borders. Business infringing on CCP propaganda goals can find their goods sitting on the wharves, tourists discouraged from travel, and consumers discouraged from purchasing goods. More recently, opprobrium in the West is starting to be loaded on companies which are seen to forsake key Western values of free speech and respect for individual rights in order to retain market access in China.
Trading with China remains highly attractive. But it has become more challenging and this is leading many businesses and countries to explicitly try and develop markets away from China. Hence, in New Zealand the desire to soon conclude a new trade deal with the European Union, and to be one of the first cabs off the ranks to secure a free trade deal with the UK once the Brexit mess settles down.
Now to The Nitty Gritty
Printing Money Causes Hyperinflation
This is what we all learnt based on Germany’s experience and the experience of other countries – such as Venezuela and Zimbabwe in recent years. But following the global financial crisis we have seen trillions of dollars “printed” and distributed in the likes of the United States, European Union, United Kingdom, and Japan over a longer period. No soaring inflation has appeared. What we have learnt is that just because high liquidity is available does not mean that banks want to lend it or people want to borrow and spend it. Money printing has stabilised banking systems, but demonstrably not caused sustained accelerations in the rates of spending growth and propelled inflation higher in any modern economy since the global financial crisis.
This is what we all worried about in the 1970s-90s in particular. Our workforce was more unionised than now, and unions were often successful in gaining wage rises which would compensate their members for rising cost of living – inflation. Finding their wage bills going up businesses would raise their selling prices. Unions would then demand higher wages – and so on. Breaking the cycle of wage and price rises proved extremely difficult for many economies in the 1980s and required very high interest rates and more often than not recessions. But nowadays no-one speaks in terms of wage-price cycles. The key reason for this is that even with half century-low unemployment rates in the United States and United Kingdom, and low unemployment rates in Australia and New Zealand, the pace of wages growth has not lifted by all that much. This runs directly counter to how our economies have functioned in the past and how our economic models are constructed. The absence of expected wages growth has meant inflation has stayed far lower than expected, and that is why virtually every forecast of sustained interest rate rises made for any country since 2009 has been wrong.
Do we know why exactly wages growth does not rise as before? Not entirely. We can attribute some of the restraint to reduced unionisation, some to the internationalisation of the labour market (competition for our jobs from people offshore), some to young people apparently seeking more than just good wages when considering where to work. Maybe some young people also do not seek wage rises because they expect outright promotion at a quick pace instead! We don’t fully know. And that is a key reason why there is no basis for forecasting a sustained rise in interest rates in the near future. If we cannot explain why wages growth is so low there is no basis for us to say when the relevant factor(s) change and the old dynamic reasserts itself. There may however be another extremely important factor underlying low wages growth. To whit…
We all used to do it, and some sectors still can – electricity, insurance, local governments. But in virtually all industries around the world the ability to respond to higher costs by easily raising prices has permanently disappeared. And that perhaps is why there has been greater resistance from businesses to demands for wage rises. What has changed? In the 1970s, if I wanted to buy a new table and perhaps recalled that the style I liked was being sold for $200 by Smiths City Market along Columbo Street in Christchurch I would take the single family car into late-night shopping on Friday to buy it. But say I got there and the table was priced at $225. In order to find some other shop selling the same or a similar shop to compare prices I would have to get all the kids back in the car again and perhaps drive to Northlands or Hornby. Maybe we would go to New Brighton on Saturday.
Searching for information would cost me a lot in terms of petrol, car wear and tear, time, stress, and missed television viewing. The search cost was high. So I’d pay the $225 and plan to go on strike in a few months for higher wages as compensation. These days, should I deign a shop with my physical presence, and should I find that the thing I want is higher in price than expected, I leave. I will go online and seek alternatives, with 99% expectation that I will be able to find something cheaper. And my confidence and determination will be so strong that I become prepared to wait six weeks for the item to be delivered from Uzbekistan rather than pick it up the same day from Harvey Normans. Searching for information is virtually costless. In fact the cost could be negative because we enjoy searching for things online, anticipating a dopamine hit at some stage which we can multiply by clicking
And, perhaps if someone is peeved off enough by the high price at the local shop they will write something negative about them on social media. The ability of businesses to raise their prices to customers has gone out the window and I believe this is a key reason why inflation is remaining so low around the world. And there is no reason for believing that this situation is going to change. For the business sector, managing profits through simple costplus pricing behaviour is no longer possible. Which brings us to the crux of the matter and the absence from our conversations now of something we spoke about very often back in the days of higher interest rates to fight inflation threats.
The Power of Compound Interest
When contemplating our wealth management we would be able to project good growth in our capital by seeking out a good interest rate and watching compounding automatically raise our wealth over a period of years. Now, interest rates are low, going lower, and expected to remain low for potentially decades, and we can’t bring ourselves to look at our old spreadsheets showing how our money could easily grow in a simple low risk investment such as a bank term deposit, corporate bond, finance company debenture, or even a government bond. As realisation of the sustainability of low interest rates has sunk in around the world investors have been chasing yield in assets other than term deposits. They have pushed up share prices, house prices, commercial property prices and so on. And the process is not yet “complete”. We can see evidence from real estate sector data that the recent global and local fall in interest rates and shift in rate expectations is pushing house prices up anew whilst sending sharemarkets even higher.
The New Normal
For investors this is a new world which will take quite some time to be figured out. The most obvious implication of sustained low interest rates is much lower returns on all assets, but that part of the decline in return stems from increased capital values. We do not know for sure when the adjustment in asset prices will be over. History does however suggest to us that when asset market prices rise for some time they can easily overshoot. We have no guidance toward this current structural adjustment however and from experience of the past ten years have learnt that old asset valuation and economic forecasting models no longer work as they did. There is a message in that.This increased uncertainty of interrelationships between real world and financial variables means that the need for diversification and some insurance against reduced predictability is of higher importance than in the past. The case is made for a greater spread of assets in a standard portfolio and not the concentrated chasing of what one thinks might be the “solution” to one’s investment problem. And this brings us to one of the most important things which new investors in particular can take some time to figure out. It is not until one has a lump sum to invest (and it does not have to be $19mn from a Lotto win) that one realises making investment choices can be a problem and it can be stressful. We humans need stress but we don’t always like it, and often our subconscious minds will steer us toward “solutions” to removing this stress. History tells us that these solutions often involve a single asset (or a range of assets in one asset class, such as many finance companies pre-GFC rather than just one). Our natural tendency is to want to place all our eggs in a basket which we think will solve our stress by removing our investment worries.
Thus my desire is to end the targeted part of this handout with two recommendations.
1. Recognise that investors will not get the returns they could in the past from low risk assets.
2. Acknowledge that chasing old returns can lead to excessive concentration of one’s portfolio at a time when uncertainty about how the new world works requires that we increase our diversification.
Our Economy In Brief
This handout is already long enough, and including the contents of my standard handout examining why business sentiment is so low despite good economic conditions, and the outlook for our economy, would blow it out to 14 pages. For additional commentary on the state of and prospects for the NZ economy feel free to sign up to my free weekly “Tony’s View” publication where I discuss the economy in plain language and most weeks discuss developments specifically in the housing market. In summary, business sentiment is low despite our economy still growing at above a 2% rate with low unemployment, low inflation, and high export prices, for a number of reasons. One is that growth is in fact slower than the average of 3.5% per annum from 2014-18. Another is that businesses are struggling to manage their labour forces, struggling to raise prices to cover cost increases, uncertain about numerous developments offshore, and challenged by society to address an increasing range of issues. These range from global warming to gender diversity, use of plastics, water pollution and so on.
So, Are We Set For Recession?
No. As humans our natural tendency is to focus on the negatives. We are more attuned to threats than opportunities. Those who ignored threats in the past got eaten by the wild animals and weeded out of the gene pool. We are the descendants of the scared and cautious cowards who ran for their caves at the first hints of trouble. So, we are naturally drawn to negative headlines and peddlers of woe on the internet.
There are some strong forces suggesting that the slowing of NZ growth since the first half of 2018 will not continue in straight-line fashion to recession – unless the world economy falls over and that is not likely despite the gasps of astonishment about President Trump or the UK Prime Minister, or leaders Bolsanaro, Duterte, Putin, Erdogan, el-Sisi, Maduro, Xi, Trudeau, Kim, and so on.
1. Net migration inflows have eased from 64,000 in mid-2016. But at rates just over 50,000 there is still an extra 1% boost to our population occurring. That does not lift income per capita, but that is not relevant for businesses simply hoping for more customers.
2. Consumer confidence is below average but still in positive territory.
3. There remains underlying growth in sectors like aged care, healthcare, and the digital economy.
4. There is so much construction to be done yet a shortage of people to do the work, that activity levels in the widely defined construction sector are likely to remain firm for many years.
5. World growth is expected to recover slightly next year.
6. Monetary policies are being eased around the world, and while their effectiveness has reduced, the changes nonetheless will deliver some small stimulus.
7. The NZ dollar is below average and may decline further in the near future.
8. Our terms of trade are only just off record highs.
9. Fiscal policy is on a stimulatory setting and highly likely to be eased further before and after next year’s general election.
10. The tight labour market is keeping job security firm and buffering the economy. It seems reasonable to keep expecting that outside of unpredictable shocks, our economy will continue to record growth rates near 2% – 2.5% over the next 3-5 years, that inflation and interest rates will remain low, and that wages growth will be mild. However, in some sense it does not matter all that much for many businesses just how fast our economy grows in the near future. That is because their problems are not solely related to not being able to find customers to service, but to shortages of resources, rising compliance costs, rising rents, and shrinking margins. In some sectors such as construction, retailing, and farming, we are seeing businesses fail in spite of strong sectoral fundamentals. This tendency for the most indebted, disorganised, and optimistic to be weeded out is likely to spread to virtually every other sector in the economy over the next three years. A period of weeding out is upon us – and that weeding out may become quite severe if the world economy turns down sharply and/or our commodity export prices collapse.