Devon Funds Morning Note - 01 May 2024

US stock markets reversed course ahead of the Federal Reserve meeting on Wednesday with the Dow declining 570 points, the S&P500 falling 1.6%, and the Nasdaq 2% lower. With inflation proving persistent, the relative resilience of the economy is affording officials some time in cutting rates, and this has been reinforced by the earnings season. Conglomerate 3M and pharmaceutical giant Eli Lilly both jumped over 5% on their results. A segment of the drug sector did even better – cannabis stocks soared on reports the Biden administration plans to reclassify marijuana and ease restrictions nationwide. After the bell, Amazon beat on earnings, with quarterly profit more than tripling.

April has been a choppy month for markets, with the S&P500 down around 3% in April, as is the Nasdaq, snapping a 5-month winning streak. Nonetheless markets have had a very strong run this year, and indeed since last October – the S&P500 is up 25% in that period. The AI theme has driven the super-cap technology stocks, but the overall rally has been relatively broad in many respects.

There is no denying the influence of the megacaps, and the buzz around AI. Amazon has reported that quarterly sales jumped 13% to US$127.4 billion, while net income more than tripled to US$10.4 billion. Growth in earnings is outpacing that of revenues with cost-cutting measures. Amazon Web Services accounted for 62% of total operating profit but the company noted that growth was slowing as businesses trimmed their cloud spend. Executives are looking for generative AI to provide a new boost. Interestingly, Amazon backed up reports from other tech companies that the advertising market is rebounding – sales were up 24% over the quarter, with Amazon now running ads in Prime Video.

The world’s largest economy has held up better than expected in the face of higher interest rates but there will be a tipping point for activity, and confidence. This is the balancing act for the Fed. The Conference Board reported on Tuesday that confidence deteriorated for the third consecutive month in April to the lowest level since July 2022. US consumers are less positive about the current labour market (even though it remains strong when looking at job additions) and more concerned about future business conditions, job availability, and income.

A cost of living challenged consumer is becoming increasingly selective, even for what have been very defensive consumables. McDonalds has delivered its first quarterly profit miss in two years, and sales growth fell for the fourth straight quarter. Executives commented that consumers have turned "more discriminating with every dollar they spend". There was a similar message from Coca-Cola, which reported a 1% lift in quarterly global case volumes, but North America was flat. The top line has been propelled by price rises, which were up 13% on a year ago (albeit half of that came from hyperinflation in places like Argentina). The company sees revenue growth of 8-9% this year. 

Americans are now also cutting back on lattes. Starbucks reported that same store sales fell 4% during the quarter, with foot traffic down 6%. The shares have fallen 12% after hours. The Devon Global Sustainability Fund sold Starbucks last year after sustained efforts to engage with the new CEO on ESG concerns did not deliver the outcomes sought. 

Stocks rallying hard on their results included 3M. The share advanced as the industrial products manufacturer topped estimates at the top and bottom line. The company has spun of its healthcare unit, which will see it cut its dividend, bringing to an end a stellar record – 3M’s dividend has been raised for 64 consecutive years. 

Eli Lily rose as well after delivering quarterly net income of US$2.24 billion, on revenues which soared 26% to US$8.77 billion. It was weight loss treatment Zepbound’s first full quarter on the US market, while sales of blockbuster diabetes drug Mounjaro were strong. The drugmaker raised its full-year earnings guidance. Not such a good session for GE Healthcare Technologies – the shares fell 14% after the medical device maker missed first-quarter revenue estimates due to weaker sales in China and lower imaging demand. 

Cannabis stocks were on steroids, with Canapy Growth soaring 80% while Tilray surged 40%. There have been reports of the Biden administration loosening federal restrictions on marijuana. Since 1971 marijuana has been in the same category as heroin, methamphetamines and LSD. While the drug has been legalised in 24 states and decriminalised in several others, a reclassification under the Controlled Substances Act would mark first acknowledgement of Federal government of the potential medical benefits of the drug.

Crypto stocks were going the other way. Bitcoin is below US$60,000 as risk assets have retreated and is down 15% this month, which would be the worst performance since November 2022. The billionaire founder of the world’s largest cryptocurrency exchange was meanwhile sentenced to four months in prison for compliance failures that allowed cybercriminals and terrorist groups to trade freely. CZ Zhao is worth over US$40b, meaning he will be the richest person ever to serve time in the US. 

On the subject of tycoons and jail, Donald Trump was held in contempt of court on Tuesday and fined US$9,000 for repeatedly violating a gag order that barred him from making public statements about witnesses, jurors and the like connected to his “hush money case”. The judge warned he could be jailed if he does it again. Shares in Trump Media jumped 6%. 

European markets were also weaker. The STOXX50 declined 1.2%. Preliminary data showed that Eurozone inflation held steady at 2.4% in April, in line with estimates. The European economy is also on a better keel, with GDP rising 0.3% over the first three months of the year, following a 0.1% contraction in the last quarter of 2023.

In Asia the Nikkei jumped 1.2%. The Bank of Japan has evidently intervened to support the yen with the currency at a 34-year low against the US dollar. The Hang Seng rose 0.1%. Factory activity in China climbed faster than expected in April, with the Official Purchasing Managers Index coming at 50.4 against estimates for 50.3. A private survey showed China’s manufacturing activity expanded at the fastest pace in 14 months, driven by new export orders. Good news for China.

The Kiwi market was higher on Tuesday, with the NZX50 rising 0.35% to 11,957. Fisher & Paykel Healthcare jumped 1.7% as did Merdian and Mercury NZ. Genesis Energy jumped 2% and Spark NZ gained 1.3%. A2 Milk surged 3.1%. Mainfreight was 0.7% lower. Serko was the standout on the upside, soaring 17% following the announcement of the contract extension with Booking.com (see yesterday’s note).

The latest ANZ Business Outlook survey (titled ‘Autumn Chill’) has showed that the post-election bounce in sentiment is well and truly waning. Business confidence fell eight points to +15 in April – and was lower across every sector. Expected own activity fell nine points to +14 with widespread falls – retail is now in negative territory. Past own activity dropped 13 points to -20 – this has a correlation to GDP and it dropped sharply. Residential construction fell from 7.4 to -8.6. Profit expectations fell from -3.8 to -9.8. There is a clear weakening in activity, and profitability indicators. Cost pressures are persistent, with possible factors are increase in oil price and a lower NZD affecting import prices.

There were however some positive aspects around inflation. Pricing intentions increased two points, while inflation expectations were unchanged at 3.8%. Wage pressures appear to be abating. It looks and feels like there is demand pressure which will translate into lower inflation eventually. With GDP growth set to be lower this year, easing inflationary pressures could well set the RBNZ up for a rate cut in the middle of the second half, which market participants are already expecting. 

There was an interesting update from Restaurant Brands this morning. The operator of KFC, Pizza Hut, Carls Jnr. and Taco Bell franchises said that total sales for the first quarter to 31 March 2024 were $333.0 million, up 7.9% on a year ago. There have been some role reversals on prior updates with strong sales growth in the New Zealand (+11.4% on a same sales basis) and Hawaiian (+6.7%) markets offsetting weak sales growth in Australia (-2.7%) and negative sales growth in California (-7.7%) (weakness here is not new). 

The company though said that cost of living pressures, driven by inflation and elevated interest rates, continue to impact consumer spending in all markets. As global titian McDonalds noted overnight, fast food consumers are becoming more discerning, but it seems are now proving a touch more resilient in NZ than they were.

In another announcement this morning, the chair and co-founder of Synlait has stepped down. Synlait has been battling a host of challenges. The shares have halved this year and are trading around record lows.