Guest Post: Bruce Sheppard - Picking a Share

It seems that me old mate Bruce Sheppard is heading off into the sunset and his burying his blog, Stirring the Pot.

I frequently read what he has to say on a number of topics and he is always entertaining in the extreme.

He is at his most entertaining and informative to me though when he is writing about investing and specifically writing about shares.and the stockmarket.

With this in mind you must read what he wrote back in August of this year about Picking a Share.

It is an excellent place to start before putting your hard earned moola at risk and will put beginners in the right place when in comes to investing in the stockmarket.

Please pay particular attention to the long term nature of his investment style.

Read on:

Picking a Share

Any investment is worth to you what it will return to you over its expected life. As you outlay cash to purchase such an investment, "return" to you means cash returns.

As most investments can expect to keep returning cash to you until they fail, and good ones don't fail, the income from such investments can eventually be regarded as an annuity.

Humans on the other hand expire, and thus every investment has a time horizon on it, not dictated by the investment, but dictated by the investor's own circumstances.

Thus every assessment of an investment's future cash back to you should include a notional sale at a point in the future that is tailored to your own investment horizon. For most this should not be less than five years or more than 10. This does not necessarily mean you sell the investment at any time during that period.

So in order to value an investment and determine if it is cheap, you have to assess the likely future cash flows of the business. So how do you do this?

Brokers and forecasts

If you are penny wise and using an online broker, consider changing to a full service broker. If you are a full service broker's client, you should receive the bi-annual research data that they produce which will include one, three and five year comprehensive forecasts for cash earnings and dividends for most of the large companies and some of the small ones too. In addition, if you are thinking of buying a share, if they have any research on it they will send it to you.

Now while the cash flows they produce are interesting, and I have had these for over 20 years now, beyond one year they are totally conjecture. There is no statistically significant correlation between forecasts of earnings and actual outcomes beyond at most two years. So the most you should look at is the one year forecast.

This forecast is generally prepared by the broker following a detailed review of the financials, and a discussion with management, and the board. The forecasts are thus in essence the management and board's forecasts, and the most you can expect from continuous disclosure is a poor shadow of this data.

Historical Data

Well at least this is fact rather than conjecture, or is it?

Profit or EPS is simply an opinion. Earnings are now so spun with Financial Reporting standards that it is difficult to rely on Earnings or Earnings per share either. This said the past is a better source of data than the conjecture about the future.

Even the cash flow statement can be gamed, interest received from borrowers for example, was it really received by the lending finance companies.

What you can believe however is two things only. The price you have to pay for the share - as that is the money you outlay, and the cash that has been paid back to shareholders as dividends over time. Dividends are real cash. Or are they? Sure some companies hoodwinked shareholders with dividends that they pay with borrowings, in which case such dividends are not sustainable into the future, but testing the sustainability of past returns is phase two after you have completed the first shift of opportunities to reduce the list.

The first pre-screen

With listed equities (private company investing requires a different approach) to determine what I want to look at in more detail, I have a simple ratio called the PEGY ratio. This is an extension of the James Slater PEG ratio which I found in his book the Zulu Principle.

The plus of this ratio is that it does not require you to do much work or for that matter to make any assumptions. It is simply a hard number assessment of the value of a particular share.

The ratio, and even me a mathophobe can do it:

PE/( G+Y).

PE = the published price earnings ratio.

G = Normalised EPS growth over 5 years turned into a percentage multiplied by 100.

Y = the current pre tax dividend per share divided by the current price multiplied by 100.

PE and Y you can get from your morning paper, G, requires you to do a bit of work, ie you have to go back over five years of financial statements and pick out five years of Normalised EPS and calculate the growth over five years and turn that into an effective compounding growth rate from year one to year five. So I only tend to do this for companies that actually do have a dividend yield, as the lower the dividend yield the higher the growth has to be to justify the investment and with NZ equities growth is hard to find.

The lower the result of this formula on the face of it the cheaper the investment is, and thus on the face of it, it might be a buying opportunity; the higher the ratio is, the less attractive an investment is.


For example - you can buy a company on a PE of 20 with a Yield of 5 percent and a growth rate of 5 percent, this has a score of two. Or you can buy a company on a PE of 12 with a yield of 10 percent and a growth rate of 5 percent, this is a score of .8. Which company would you prefer to buy?

Cautionary note

Now before you get carried away, the PE ratio and the Yield quoted in the paper is not always right. Sometimes you will see really low PE ratios and this is sometimes because they have used the reported profits, and not the normalised profits. So check it. Likewise sometimes they get confused about Imputation credits as well, and these are valuable.

Any score more than 1 is unlikely to be cheap and anything less than .5 may be a bargain.

This first skim is about the return side that you can expect from an investment, now the harder work begins, understand the risk.

In no particular order:

• The risk of total failure.

• The risk of adverse surprises to earnings or dividends.

• The sustainability of dividends going forward.

• The risk of fraud idleness or stupidity, i.e. the people.

So now to the second skim:

The first thing to look for is debt. In big companies debt is not like it is for us mortals, ie about security, it is about cash flow. So the key ratios for you to check around this are as follows:

• Net interest bearing debt ( net of cash holdings)/ Earnings before interest tax and depreciation. ( EBITDA)

It will be a rare company that can sustain a score above 5 and a ratio of around 2.5 is, depending on income volatility likely to be safe enough. As soon as it goes over 3 you are taking a risk of total default at worst and income or return default at best.

• Earnings before interest and tax/ Interest paid. ( interest cover)

$4 should be the minimum you would consider safe.

• Debt/total tangible assets.

This is sometimes important, but if any of the other ratios look too risky is a good one to do as well. If the lending is less than 50 percent of tangible assets even if the income is currently crappy or if the margin is a bit thin to cope with an adverse event the tangible asset backing might hold off a total default.

The list should be smaller now.

The third skim is around the risk of dividend default.

Three key things.

• The first is the dividend cover ratio which is the net profit after tax/ dividend ( net of ICA or other tax credits , but excluding Resident withholding tax).

A ratio of 2:1 is normally pretty safe, a ratio of $1.20 to $1 will normally indicate a high risk of dividend volatility especially if debt is also high.

• The next is earnings volatility. This is the maximum adverse movement EPS in the last five years.

It is earnings that fund dividends, high volatility of earnings and low dividend cover would indicate that there is a high risk that dividends will be volatile and might drop before they revert to trend.

• And the final one which should always be checked is the operating cash flow to dividend cover ratio. This is operating cash flow / Dividends net of ICA taxes etc.

It is cash that pays dividends , and if it looks a bit tight but everything else looks ok, you should be alright for at least one year.

Now in terms of your filtering you need to set your own filters, but mine go like this:

• A PEGY ratio of more than .9 strike it off the list.

• Debt, more than three times EBITDA, or exceeding 80 percent of NTA cross it out.

• Earnings per share volatility greater than 30 percent, this is the biggest one year adverse fall in earnings in the last five years strike it off the list.

• The sum of five years' operating cash flows should be greater than 70 percent of reported profits, and should be at least $1.50 for each dollar of dividends paid over the last five years, if not strike it off the list.

With these filters the list will be a short list, and now the real work begins.

Assuming you have nothing on your list and you are still keen to invest move the parameters by 10 percent. If more than one on your list, then rank them from the lowest PEGY ratio, as that is the most cheap stock relative to risk levels you are prepared to bear.

Now you are going to do some work on the company.

What do they do, how do they do it, why would a customer buy their product or service, how do they sell it what is the selling process, how do they reward the team to make money, who are the leading managers , who are the directors who are the major shareholders what are their track records?

To start with get the last three years annual reports, start with the oldest, read the Chairman's and CEO's reports. Write down the key predictions and outlooks, map it to outcomes. Check what they have said they will be doing , strategically, see if they did it. You are looking for people who take risks, who have at least some reliability of forecasting and say what they will do and do what they say. The most recent report has to have some element of optimism about it, and there should be no adverse continuous disclosure announcements.

Now before you buy you need to assess the likely return you will make on this investment, ignoring gearing. The factors are these dividend, earnings and growth of each over a timeline.

How much is enough of a return to justify the risks you have accepted is mute point and one that investors in finance junk ignored.

My base line is 8 percent for any equity, being double the tax paid risk free rate of return from cash, very roughly. I then increase this by the amount of volatility, so 25 percent volatility increases the hurdle rate to 10 percent. I then increase it if debt is high, again I calculate a base line figure. Let's assume the target has debt 15 percent higher than base case, or earnings are not correlated with cash, again if out of line, by how much as a percentage, or if the cash or profit cover of dividends is skinny again by how much. Then I add these percentages together, say the sum of these is 80 percent, then increase the base line yield by 80 percent. The required yield on this investment is 18 percent. If on a far wind the prospective yield is more than this, then the share is worth buying, if with the rubbish factor taken in for the first year, it is still above the base line equity yield it is still worth buying. Other wise pass for the moment and set yourself a target price. If you have to wait six months, learn patience, but before you put in the buy order make sure nothing has changed.

In the words of Buffett, the market rewards the patient at the expense of the impatient.

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c Share Investor 2010

The Lolly Scramble of Life

A brilliant post from Bruce Sheppard from the Stirring the Pot Blog just has to be commented on and included on my blog today:

If you want to understand human nature before the OSH, PC police, education and society in general have done with corrupting it, examine kids and a lolly scramble. Perhaps the real reason the OSH police don't like lolly scrambles is not because kids get hurt, but because it reminds kids what human nature is really about. Maybe they are the thought police from Orwell. And guess what? Real life resembles a lolly scramble. John, go to a kids lolly scramble and then look at the world as it is and you might find the flaw in your dream of a world of equals.

And parents, ignore the PC crap. Make sure every kid experiences a free for all lolly scramble at every opportunity. Tell the OSH people to go swim in an unfenced pool.

So imagine this: You are in a field with a whole lot of kids, keen and full of anticipation. On the four sides of the field there are the angels of opportunity the lolly throwers. And on the four corners of the field there are the watchers of activity, the policemen, the government, the regulators, call them what you will. Full article here.

Bruce's analogy of life being a lolly scramble is the perfect expression of how life actually is rather than how some would like it. It is hard, competitive "unfair" but it is life and it is the best way forward.

Any other constructed way of life - especially the current one pushed by the lefty interferers - is an inferior facsimile of life and eventually doomed to failure, with the consequent victims scattered like the dead ghosts of Stalin's wet dreams.

True Capitalism, the best way forward in business and something that I shout from the rooftops often is also the antidote to the lefts stealing from those that are hard working and resourceful.

Imagine the wealth we would all have if in the lolly scramble we didn't have half of the participants as government bureaucrats stealing 50% of all the lollies for themselves!

It aint sweet for some but a pure unadulterated calorie laded lolly scramble is what we need again to move us forward and take the bitterness of State sanctioned interference away.

That and a good rough game of bullrush.

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c Share Investor 2010

Bruce Sheppard's debt debate points the finger at you

Bruce Sheppard's crusade on NZX listed companies and their debt levels has apparently come to an end but what has it achieved?

Well, it is always good to get frank and open debate about our listed companies, because if you have been reading my comments over the years the NZX and their mates are almost a closed shop as far as communication and disclosure are concerned.

Bruce also highlighted several companies that have either collapsed or a sailing very close to the wind in terms of their debt levels; Cadmus-Provenco, Nuplex Ltd [NPX.NX], Fisher & Paykel Appliances [FPA.NZ] and more.

The non-reply's to Bruce's letters from Sky Network Television [SKT.NZ] and Team Talk reveal more about respective company management and poor attitude to shareholders apart from a possible debt problem.

Nothing substantive in terms of conclusions were made by Bruce but he quite rightly puts the responsibility back on individual investors to do their own homework:

Just as I and the SA are prepared to be judged by what we do, right or wrong, well or badly, so too should companies be judged. So rather than me analysing the responses in detail or providing you with any guidance on the strength or weakness of the companies written to, you must do this for yourself by reading our letters and their replies.

The companies were on my list because I thought, and still think, they have too much debt and are at risk in an economy such as this. That is my prerogative, you will each have your own risk profiles and you will each analyse the prospects and debt profile of these companies for yourself. It is my view that debt is the number one risk faced by equity investors today and that is why I did this work. 

Read the full conclusion @ Stirring the Pot

Why am I interested in Bruce's opinion so much on such matters?

Well, I mostly like what he says, he stimulates debate and he is an influential person.

The main point of Bruce's debt exercise? Looking at issues like debt, company management and company performance are essential when investing and should be done by you dear reader.

Oh, and he also finally disclosed ownership of shares in a couple of companies.

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c Share Investor 2009

Sky City debts levels now more manageable

Sky City Entertainment Group [SKC.NZ] has been named by Bruce Sheppard as one of his list of NZX companies with debt worries.

Now that time has passed since Bruce debt analysis, on June 30 2008 figures, lets take a look and see whether his criticism about high debt levels is now warranted.

Lets look at company debt levels from the last 5 years:

FIVE YEAR SUMMARY
Consolidated Balance Sheets
As at 30 June				2008	2007	2006	2005	2004
				$000	$000	$000	$000	$000

LIABILITIES
Current liabilities
Payables				121,668	119,501	100,776	97,005	93,619
Interest-bearing liabilities				-	-	-	100,758	101,000
Derivative financial instruments				-	-	25	-	-
Total current liabilities				121,668	119,501	100,801	197,763	194,619
Non-current liabilities
Interest-bearing liabilities				677,884	753,002	950,904	956,795	579,967
Subordinated debt - capital notes				123,772	123,756	123,720	121,510	149,644
Subordinated debt - SKYCITY ACES				186,538	161,410	177,956	-	-
Deferred tax liabilities				77,891	52,992	60,596	45,438	-
Derivative financial instruments				23,561	50,774	3,072	-	-
Convertible notes				-	-	-	-	8,910
Other term liabilities				-	-	-	-	27,216
Total Non-current liabilities				1,089,646	1,141,934	1,316,248	1,123,743	765,737
Total liabilities				1,211,314	1,261,435	1,417,049	1,321,506	960,356

Interest cover (EBITDA/Net Interest)				3.8x	3.3x	3.3x	3.4x	5.1x

Full 5 Year Financial Summary

We can see then that debt incurring interest or charges (of all different types) nearly doubled from 2004-2006 to over NZ $1.3 billion at its highest (due mainly to buying and financing Adelaide and Darwin casinos and cinema assets.) but since then, at balance date 30 June 2008, (Bruce's debt level comparison date) debt had been paid down to just under $1.1 billion.

In addition to that, the company has paid back $84 million with the proceeds of a capital raising and other debt reductions to take total debt to below $ 800 million, still high but more manageable and it leaves net debt to ebitda ratios that Bruce worried about down from 3.8x in June 2008 to below 2.5x as at 9 July 2009, the lowest ratio in 5 years.

This has further been alleviated by a large increase in profit and revenue for the 2009 Full Year result to be announced 26 August.

As I said above, debt levels are still very high but steps have been taken to change that and with good management the company has put itself in a position so that the business is functioning well and is an even better position now to consolidate this debt.

As interesting as Bruce Sheppard's company debt analysis has been it would be even more interesting to see how June 2008 stacks up with June 2009.

In Sky City's case I think he might assess that they have addressed his worries.

They have mine.


Disclosure: I own SKC shares in the Share Investor Portfolio

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c Share Investor 2009

List of Bruce Sheppard's top NZX listed company debt worries (UPDATE 7)

This update adds GFF, SKT & SKC to the List

Further to rumblings made by Bruce Sheppard on behalf of the New Zealand Shareholder's Association in May that in his opinion, roughly 20 listed companies in New Zealand were breaching banking covenants and after writing to these companies 2 so far have replied to Bruce. He is naming names as each company replies to him.


1. Fisher & Paykel Appliances [FPA.NZ]

2. Nuplex [NPX.NZ]

3. Tourism Holdings [THL.NZ] - Read THL's letter to Bruce
4. Vector Ltd [VCT.NZ] - Read VCT's letter to Bruce

5. Freightways Ltd [FRE.NZ] - Read Bruce's letter to FRE & the reply
6. Skellerup Holdings [SKL.NZ] - Read Bruce's letter to SKL & the reply

7. Comvita Ltd [CVT.NZ] - Read Bruce's letter to CVT & the reply

8. Ebos Ltd [EBO.NZ] - Read Bruce's letter to EBO & the reply

9. Abano Healthcare Group [ABA.NZ] Read Bruce's letter to ABA & the reply

10. Metlifecare Ltd [MET.NZ] Read Bruce's letter to MET & the reply

11. Restaurant Brands Ltd [RBD.NZ] Read Bruce's letter to RBD & the reply

12. Kirkcaldie & Stains [KRK.NZ] Read Bruce's letter to KRK & the reply

13. Sky Network TV [SKT.NZ] Read Bruce's letter to SKT *

14. Sky City Entertainment Group [SKC.NZ] Read Bruce's letter to SKC & the reply

15. Goodman Fielder [GFF.NZ] Read Bruce's letter to GFF & the reply *


I will post the rest here as and when the other 5 odd companies reply to Brucie.

The laggers need to get a wriggle on, otherwise it wont look good for them.

Bruce is going to list those that didn't reply to him next week.


Disc I own FRE, SKC & GFF shares in the Share Investor Portfolio


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c Share Investor 2009

Bruce Sheppard: Explanation Received

Capital raising, company creditworthiness and business viability during these highly unsure and volatile economic times is very important for investors with NZX listed companies in their portfolios and that is why I am following the stoush between Bruce Sheppard and Mark Weldon at the NZX with much interest.


In a post I made this morning I pointed out that I thought Bruce was being irresponsible in blanket accusations over NZX companies defaulting on bank credit terms and the NZX wanted him to explain himself and name names.

I thought he should too.

He has in a general way this morning with a letter addressed to Mark Weldon, NZX CEO:

Mark,

I have thought about this long and hard, read all my blogs. They explain the background to the issue, and they explain the simple matrixes that I have applied and they have explained how I have analyzed the financial statements with this in mind. Either analysts are blind stupid or inefficient, the simple numbers that you need to check reasonable compliance are these and they don't require a detailed breakout of financial statements:

They are these:

1) How much interest are they paying, a bit hard to find sometimes but not hours of work.

2) Continuing EBITDA (earnings before interest, tax, depreciation and amortisation), not hard to find either but you do have to make some assumptions about what is recurring and what is not, this is explained in my blog.

3) Interest bearing debt, and where it is parked, parent subsidiary, its composition between capital notes, and those notes' terms, bank debt and so on. Currency risk is an exposure, and hedging polices come into play. I have not analyzed hedging as disclosure on this is such a tangled web of crap that it is almost impossible to work out how they have hedged their interest and debt exposures and the issues that go with that. Many have foreign currency debts with no natural hedge.

4) Book Equity... that is easy.

5) Net tangible assets is a bit harder but not to hard.

Read the full article

Bruce gives his reasons and goes into some detail as to why he made his sweeping accusation without further elucidation and it seems generally correct, to the point, accurate and honest and we need to know that detail.

Having said that, I still maintain all the research and detail that he says is coming on particular companies should have been released coinciding with his general release.

Us investors need to know but need to know in full before he slanders the good NZX listed companies among the obvious bad.

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c Share Investor 2009

Bruce Sheppard: Please Explain

I am a big fan of Bruce Sheppard and agree with his usual well considered and fully explained point of view most of the time. He is more often than not right, expert at financial matters and blunt to the point appearing rude.

This blog yesterday received many hits with Bruce's name as a search and I didn't have the time to explore why.

The reason for the controversy is in Bruce's blog post published on May 8.

It is explained in this piece in Stuff.co.nz that basically he has put his line in the sand and alluded to various NZX listed companies having problems with debt levels:

According to Mr Sheppard, around half of 47 major listed companies he analysed during a three week investigation are at risk of defaulting on their bank terms. However, he said he will not reveal names until companies have had a chance to respond to letters he has written to them.

He selected companies based on published 2007/2008 debt levels and applied assumed bank terms to their financial metrics. Mr Sheppard added that his research raises questions about exchange operator NZX continuous disclosure regime and its role as regulator.

What Bruce has failed to do, and this is unusual for him, is provide corroborating evidence that backs his May 8 accusations.

Frankly if he does have evidence, he needed to come out with it at the same time he made his claim, and not scare the horses so to speak.

It is highly unprofessional to do otherwise because it taints every NZX listed stock with the same debt brush.

He has received a "please explain" from the NZX and unusually again I agree with the NZX and that doesn't happen often:

14 May 2009 - Shareholders' Association chair Bruce Sheppard has contributed meaningfully to capital markets debate over the years. The broader interests of the market, and market confidence, would be best served at this time if he released his analysis at a very detailed level. Investors can then draw their own conclusions as to the health of the companies in which they are investing.

NZX shares Mr Sheppard's goal of healthy, open and transparent capital markets in which investors can have confidence. Providing detailed and transparent information to support his conclusions will further that goal.

Time to put up or shut up Bruce.

Read the answer to the NZX request

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c Share Investor 2009

Sweetheart deal for Fletcher Building's friends makes small investors sick

Bruce Sheppard had a go at it yesterday and now it is my turn to have a go at Fletcher Building [FBU.NZ] management for the cavalier attitude they have for small Fletcher investors.

At the heart of that attitude is the recent capital restructuring to raise funds to retire debt and reinforce cashflow.

Institutional investors basically got a sweetheart deal from Fletcher management when they got cut price shares at NZ$5.35 per share on a pro-rata basis. That is, in proportion to the shares they already hold. A deal apparently will be offered to smaller shareholders, but capped at NZ$100 million and not pro-rata, so we got the arse end of the donkey here.

Compounding this favouritism, apparently non-institutional "large investors" (whatever that means) have also got some cream on top of the sweetheart deal for institutions that makes it so sweet smaller investors are bound to chuck up after reading it. This particular deal will give special rights to those large non-institutional investors to ratchet up their holdings to reduce the diluting effects of the placement to institutions.

Now I don't know about you but if you are a small Fletcher shareholder (I am, I have 1000) you might be suffering a diabetic reaction to all this sweet favouritism to the big boys by now and wonder out loud to yourself again why the NZX might be an unfavourable place for New Zealanders to invest considering they are not on a level footing with the big boys that Mark Weldon's NZX has granted a wavier to to snap up more of Fletchers.

According to the NZX website the folk who may have participated in the $405 million placement of shares concluded last week are connected to Fletchers by virtue of the fact that some are "Associated Persons of FBU Directors by virtue of having a common Directorship with FBU and several placees participating in the Placement".

Those people are:

(a) ANZ National Bank Limited, by virtue of Sir Dryden Spring’s and Mr John Judge’s common Directorship;
(b) Westpac New Zealand Limited, by virtue of Mr Ralph Waters’ common Directorship; and
(c) the Accident Compensation Corporation, by virtue of Mr John Judge’s common Directorship.

So it gets even worse when you dig down into the detail. Its like a bloody incestuous Utah Mormon clan!

I haven't got the time to read through the pages of verbose detail but I guess some will be revealed at a latter stage. Most will be lost on the average small mom and dad Fletcher share holder because media are too lazy to do the research - all except Bruce Sheppard, I am sure we will be hearing from him again on this matter.




There is however a solution to this.

Strong demand from those mentioned above for shares in the capital raising aside, Fletcher Building still operates in an environment of weak business prospects and an uncertain future as far as sales go.

Global stockmarkets have raced ahead over the last month or so and there is downside to come.

Shares in the company have ranged from $5.11- $6.50 over the last six months (see chart above) and it is not unlikely scenario that smaller shareholders like me could pick up extra shares cheaper than the proposed $5.35 to stop dilution of their holdings by buying them on the open market. You don't have to participate in this madness and still stay undiluted!

That is just what I am propose to do .

Bugger them.


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BRUCE SHEPPARD: Recession, how deep? How ugly?

A very interesting blog post from Bruce Sheppard's Stirring the Pot I missed it in all my travels recently but it discusses the subject of our failing economy and where Bruce sees things going.

He is very pessimistic but elements of his post ring with clarity for me.

If things do descend into chaos there is no doubt the economy will face very tough times.

This post is essential reading for those who like to get all sides of the economic story.

Bruce Sheppard in Stirring the Pot | 2:08 pm 8 May 2008

For two years now I have been predicting the collapse of the finance sector and the result will also be a collapse of the domestic economy. It will not be isolated as Reserve Bank governor Alan Bollard thinks.

Let us start by joining the factual dots to date.

• New Zealand households are seriously screwed. Over the last 5 years they have binged on debt and consistently spent $1.20 for every dollar they earned, on average. What this means is that the bottom end of the economy probably spent $1.50, the median household spent $1, and the top end spent maybe 75c.

For households to do this they had to have access to debt, either in the form of credit card, finance companies or mortgage top ups. For banks to do this they had to have access to cheap offshore funds, largely funded via the carry trade that has held up our currency, and screwed our exporters.

• Then 12 months ago the sub prime bubble started to burst and progressively the merchant banks in the middle of all this hype have hemorrhaged value, destroying the savings of middle and upper income households globally. NZ is not immune, a number of managed funds have now suspended redemption's.

• Finance companies to the extent they have survived are struggling to maintain liquidity, so they are not lending. The banks are now also faced with increasing defaults on the back of a property melt down, so they have now got an increasing incidence of asset impairment, so they too will now struggle to maintain liquidity. This means they will be exceedingly unlikely to top up homeowners for consumption expenditure.

Now, the next predictable outcomes of all of this that are now being borne out by some statistics:
The net effect of all this is the bottom end is going to be forced to live within their means and reduce expenditure. The middle sector will find that they too need to borrow to maintain their lifestyle and may well be disinclined to do so.

The top end has already seen significant wealth elimination. Falling share markets, falling property prices, finance company defaults and investment scams like Blue Chip. Thus they feel poorer. When the relatively wealthy feel poorer they simply spend less and save more. Not a single sector of the economy is consuming at the levels they were 12 months ago.

In October last year I was quoted in the media as saying we would be in recession by Christmas. And that the Christmas of 2007 would be the worst for retailers for a decade, that NZ has to forget all the talk of a soft landing, and even for that matter hard landing. This recession is going to be a crash landing. Briscoe managing director Rod Duke at the time commented that he thought this was unlikely. Now his group turnover is down 10 per cent on a year ago and he is blaming the Government and rightly so.

He should have been yelling a year ago. My advise to Rod at the time, was forget his mantra of “stack em high and watch them fly” and instead adopt a mantra of “stack em low and don’t let them grow”.
Was this avoidable 2 or 3 years ago? The simple answer is yes. Did I nag Finance Minister Michael Cullen and Bollard? Yes. What needed to be done?

• The OCR had to fall, and more or less we had to adopt a monetary policy on interest rates that reflected that of our major trading partners. If we had done that we would have an OCR of around 4 per cent and a currency to the US dollar of around 60 cents, most likely. The export sector would then be viable, thus providing an employment balance for the inevitable correction in the domestic economy.

• To correct the property market bubble Cullen had to effectively ring fence rental losses, and he could have done that by treating all investment income (including rental) as a separate tax base and capping the tax on rental income at, say 30 per cent, the same rate as Portfolio Investment Entities (PIEs), but only allowing investment losses to be offset with investment gains. A sizable incentive to save, which could have been increased even further by lowing the tax rate on investment income to, say 20 per cent. And we needed to save.

• To correct the consumption bubble the regulation of credit creation by banks and finance companies could have been redressed by simply increasing the level of equity and near cash holdings as a percentage of lending. I.E. a reversion to, or a tightening of, the reserve asset ratio regime.

The lower OCR would have significantly reduced the carry trade and the domestic credit expansion that fuelled the property boom.

All of these points are covered in my submission to the Finance and Expenditure Select committee in September last year. Six months on still no action. Useless leadership again.

It is now too late for any of that. So what might the next twelve months look like?
Everything I say about what might come next is conjecture.

• Domestic expenditure will shrink as will the domestic economy over the next 12 months. It will take down retailers, importers, and manufactures that are dependant on the domestic economy with it.

• Unemployment will rise strongly, maybe to depression levels.

• As unemployment rises mortgage and credit card defaults will accelerate. More finance companies will fall over. It won’t be a matter of how few fall over it will be a matter of how few are left.

• As the default rate on mortgages climb, banks will scramble for liquidity. And will press good customers to repay. I am already seeing this happening.

• The property market tumble will accelerate, but most likely the banks won’t bother mortgagee selling much as there won’t be any buyers. Bankruptcy will rise.

• Bollard will lower interest rates, first cut will be a full 1 per cent and my guess is as early as July. It won’t make any difference; the banks will increase their spread to pay for the bad debts that will be mounting. Bollard will cut each month thereafter through to Xmas, until the OCR is around 3.5 per cent and still it will make no difference. He will then have to request the Government to regulate bank spreads so that mortgage rates fall.

• While all this is happening the carry trade will reverse with a vengeance. The balance of payments will go to hell in a handcart, all on invisibles and capital account. We will have a reasonable balance of trade surplus, but the currency will haemorrhage. We will fall against the USD to mid 40 to 50c, and against the Australian dollar to high 60’s.

• Petrol will hit $3 per litre by Xmas and inflation will be running in the high teens, a regular stagflation depression.

Now, how will our people react to this, will we just hunker down and accept a significantly diminished lifestyle, or……. might it be really ugly and if it is how will we as a nation deal with that?
By the election we may have a rising level of civil unrest. The public marches against the Electoral Finance Bill will be nothing compared to the turn out for the “decent life” marches. They might even turn into riots, and then the demoralised police, will have to turn on the public to restore order.
There is a chance, remote admittedly, that they won’t have the stomach for the task. I doubt you would have a police force that is prepared to deal with Springbok rugby tour level civil unrest in the same forceful manner today. The army then might have to be called in, but we don’t have one. In a worst case scenario the poor who have been used to spending $1.50 and now being forced to live on a third less might just decide to take what they can’t buy. In short anarchy.

Could this really happen? Maybe. The poor today are not the poor of the 1930’s. A substantial minority of our population have been brought up with an expectation of being able to pull money out of an ATM machine without doing anything to put it in, in the first place. Our grandparents expected nothing but the right to work.

I am not sure who would want to win such an election.

But whoever wins the election this year will have a number of unpleasant tasks to complete.
The first might be to restore order. This means the usual unpleasant stuff; expect that they might hire overseas mercenaries for the task.

Then they have to stabilise the haemorrhaging dollar. This means the Reserve Bank will have to support it and they will need crown funds to do it. The chance of taking it out of taxes is nil. So crown assets will be sold out of necessity, which in reality is what Roger Douglas and David Lange confronted in 1984, but way worse.

Then they will have to restore middle NZ households’ spending capacity. Maybe there will be debt moratoriums including a regulated inability to charge interest on household debt. Savers confronted with high inflation and low interest will then have no choice but to buy property and shares to preserve their wealth and so the cycle will begin to reverse.

To stimulate employment employers will be offered subsidies and benefits will be reduced. Universal national super will be abolished with all crown benefits means tested.

The lower dollar won’t be enough to get the value add labour employing sector going again. So expect research and development incentives to be increased further, corporate tax rates cut further to attract inbound foreign investment and a return to export incentives.

The free trade agreement with China will die a natural death as will our involvement in the Kyoto Protocol.

These tough moves should within 3 years turn the asset deflationary cycle around, employment levels will rise, the tax base will increase and we should be through the worst in 3 years.

But we are dealing with politicians and MMP so don’t expect any of these tough decisions to be made. As a result we will languish in a recession much longer until eventually Australia makes us an offer we can’t refuse, and Tasmania gets a promotion.