Devon Funds Morning Note - 17 April 2024

Wednesday 17th April 2024

More progress

Global

The S&P500 tried to rebound at various points in the session, but closed slightly lower as Fed Reserve Chair Jerome Powell said in a speech that more progress was needed with inflation before interest rates could be lowered. He noted that inflation has been little changed this year, while the economy has remained resilient – a point noted by the IMF which expects the US economy to grow at double the rate of G7 peers this year. Bond yields rose with that on the 2-year US Treasury going above 5%. Europe meanwhile seems much closer to a rate cut although ECB President Christine LaGarde said she was watching energy prices closely. Oil held steady overnight with US officials saying that expect a “limited” response from Israel to Iran’s missile attacks.

The S&P500 closed 0.2% lower, while the Nasdaq declined 0.1%, despite AI-related names performing strongly. The Dow rose 0.2%, supported by a 5% surge in United Health with the multinational health insurance company beating on earnings estimates. Investor sentiment overall was dampened by the comments from Powell, which is providing a further cause to push out the timeline for rate cuts.

Central bank policymakers had pencilled in 3 interest rate cuts in the dot-plot forecasts last month, but markets are now pricing in one to two reductions, and much later in the year. The Fed Chair said overnight “We’ve said...we’ll need greater confidence that inflation is moving sustainably towards 2% before [it will be] appropriate to ease policy… recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.”

A resilient economy continues to afford the Fed the luxury of time in terms of pushing the button on rate cuts. But there are some signs of weakness, and this may increase with the passage of time as rates remain elevated, potentially forcing the hand of officials more.

US industrial production rose 0.4% in March, in line with market expectations, though it fell 1.8% for the first quarter of 2024. Capacity utilization (a measure of total output potential) was 78.4%, below its long-run average of 79.6%. Separate data showed that new construction and permits to build homes missed expectations in March. Privately owned housing starts totalled 1.32, down some 14.7% from February and 4.3% lower than a year ago.

The International Monetary Fund though remains upbeat around the US and other advanced economies. The organisation said that the US was already “exceeding its pre-Covid-19 pandemic trend” while the eurozone was showing strong signs of recovery (although prospects were less bright for China). The IMF raised its global growth forecasts for 2024 to a consistent 3.2% (the same as 2023 with a similar forecast for 2025), up slightly from forecasts made in January, but adding that the global economy had proved “surprisingly resilient”, with the implication a “soft landing” beckons.

The IMF said it sees global headline inflation falling from an annual average of 6.8% in 2023 to 5.9% in 2024 and 4.5% in 2025. Downside risks to economic growth included China, geopolitical and trade tensions, while looser fiscal policy, falling inflation and advancements in artificial intelligence were cited as potential growth drivers.

A reasonable start to the earnings season (outlook statements aside) is also an indicator of the health of corporate America. Of the company’s reporting to date (albeit less than 10% of the S&P500), 80% have exceeded consensus earnings estimates. In this bucket overnight included United Health, drugmaker Johnson and Johnson (although the shares slipped), and United Airlines.

Morgan Stanley also beat first-quarter earnings expectations, underpinned by strong results in wealth management, trading and advisory. Quarterly revenues of US$15.1 billion were US$500m more than expected. The shares advanced, but those in Bank of America fell despite a strong quarter. Provisions for bad loans at the country’s second-biggest lender jumped 40% to US$1.3bn.

AI was capturing headlines again. Advanced Micro Devices rallied 2% after

unveiling new AI processors which is said were “the most powerful chips yet” for business PCs. Microsoft meanwhile is continuing to invest in the AI race. The tech titan is investing US$1.5 billion into G42, an artificial intelligence firm based in the United Arab Emirates. Data centre operator G42 will run its AI applications and services on the Microsoft Azure cloud service, as well as deploy Microsoft’s cloud offerings. The US and UAE governments appeared to be heavily involved in the deal.

Across the Atlantic European stocks were weaker, with the STOXX50 falling 1.4%, primarily in reaction to Powell’s comments. Those from ECB President Christine Lagarde provided more cause for optimism around the proximity of rate cuts. LaGarde said, “we are heading towards a moment where we have to moderate the restrictive monetary policy.” Markets are pricing in an ECB rate cut in June.

Stock wise, Adidas shares were on the up. The company raised its annual profit targets amid strong demand for classic sneakers such as “the Samba” and as it continues to unload its diminishing stockpile of Yeezy footwear after the split with rapper Ye/Kanye. The German sportswear company now expects to generate operating profit of around €700 million, well ahead of a previous target of €500 million. Not so good news for another shoe company Dr Martens – the shares fell nearly 30% to a record low as it announced the departure of its CEO and flagged a challenging outlook, with wholesale revenues in the US expected to down by double-digits year-on-year. The FTSE100 fell 1.8%.

In Asia, the Nikkei fell 1.9%, the Hang Seng declined 2.1% and the CSI300 fell 1.1%. The Chinese economy growing 5.3% in the first quarter compared to a year ago, up from 5.2% in the fourth quarter and faster than the 4.6% growth expected. On a quarter-on-quarter basis, China’s GDP grew 1.6%. Manufacturing was strong, holiday spending helped as did easier policy settings. The annual growth rate is ahead of Beijing’s 2024 target of 5%. However, industrial output growth of 4.5% missed estimates for a 6% expansion and was down from 7% in the previous month. Retail sales growth of 3.1% year on year, were similarly below estimates, of around 4.6% growth, and slowed from the prior month’s reading of 5.5% growth. The industrial output and retail sales prints raise questions about whether economic activity is tailing off.

New Zealand

Geopolitical concerns and rising bond yields also took the kiwi market lower, but the index outperformed regionally on higher defensive appeal, with the NZX50 down 0.9% at 11804. Fisher & Paykel Healthcare declined 0.9%, while Spark NZ and Summerset were down just 0.1%, and 0.2% respectively. EBOS, Fletchers and Freightways saw declines of 1-2%. A2 Milk retreated 3.3%. The dual listed banks fell with Westpac down 3.5% and ANZ around 2% lower. The kiwi dollar fell to a 4-month low against the US dollar, a positive for exporters.

Auckland Airport dipped 1.1%. The airport reported March passenger volumes of 1.69 million, up 12% on a year ago, and higher than the 1.6 million recorded in February. International passengers jumped by 22% to 894,616. International load factors were in line with last year at 81%, while seat capacity was up 24%.

Meridian rose 0.7% after its monthly update (see yesterday’s note). Contact gained 0.1% and has this morning has reported that monthly controlled storage in the North Island is running at 110% of the mean, while that in the South Island is 75%. Mass market electricity and gas sales rose from 252 GWh in February to 297 GWh in March. National Electricity demand was up 4% on a year ago – as noted yesterday it was a cold March, with temperatures nationally averaging 14.7 degrees Celsius, 1.1 degrees lower than a year ago. The Tauhara and Te Huka 3 projects are progressing on target.

Mercury (-0.3% yesterday) has also had an update this morning. The company noted that lower national inflows during the last quarter resulted in higher spot electricity prices averaging $195/MWh in Auckland.  Generation output was strong on above average inflows to the Waikato. Commercial & Industrial yields remained strong. National demand was 4.6% higher for the quarter relative to prior comparable period. Mercury also noted growth in telco products, with 13,000 new telco and mobile connections during the quarter.

Out with an update as well this morning is Sky City Entertainment. The casino operator has appointed a new CEO. Jason Walbridge is currently a Strategic Advisor to Aristocrat Leisure Limited on its proposed acquisition of NeoGames S.A, and Executive Chairman of National Entertainment Network, the largest amusement route operator in the United States. He also held roles with the online gaming supplier NYX Gaming Group Limited and its acquirer Light & Wonder, and before that he spent 18 years with Aristocrat Leisure Limited where he held executive leadership roles in NZ and the US.

We had another dairy auction overnight, with the index eking out a 0.1% gain. Skim milk powder prices were flat, but whole milk picked up 0.4%. Cheddar prices weighed, down 8.5%.

Source: GlobalDairyTrade

There was also another read on the housing market. The REINZ reports more listing activity but accompanied by short-term pressure on house prices. On a 1-year view the NZ House Price Index is up 2.6% - but prices fell over last month and in last three months growth is minimal. While population growth and slowing construction are tailwinds for price, in the short erm we may see continued downward pressure on prices.

There will also be a lot of focus over to what extent inflation is falling. The CPI release today is expected to show a 0.6% rise quarter on quarter and 4% annually, down from 4.7% at the last print. Looking ahead the recent rise in oil prices and shipping costs could be problematic for Q2 inflation, with implications for the timing of rate cuts by the RBNZ.

Australia

It was a risk-off session in Australia as well, with the ASX200 down 1.8% to 7612. All sectors were in the red by 1%-2.4%. The miners and banks weighed on proceedings. Rio fell 2.9% and BHP declined 1.8% despite the better than expected GDP data out of China. CBA, Westpac, and ANZ were all down over 2% while National Australia Bank dipped 1.7%. Consumer discretionary was the weakest sector, down 2.4%.

Star Entertainment was the biggest decliner, down 14%. Also up in front of an inquiry are the supermarkets. Shares in Woolworths and Coles both fell 1.2% with things somewhat “testy” at the Senate hearing around pricing and profits. The outgoing Woolworths CEO declined to answer questions about profit metrics and was threatened with jail for contempt. Mr Banducci declined to confirm whether Woolworths’ return on equity was 26%, similar to the big miners but double that of the big banks, claiming it was not the best way to measure the profits and return on capital was a better indicator of business profitability.

The head of Coles meanwhile confirmed that the company’s net profits last year were over A$1b and return on equity was 31%, while returns to capital were 15%. Both CEOs pushed back on claims of price-gouging, amid rising cost demands from suppliers. Some Senators have suggested the inquiry is a waste of resources, and accused others of “grandstanding,’ and an attempt to shift blame for the cost of living crisis.

Elsewhere, computing and data centre services provider Macquarie Technology was out with a capital raising announcement. The company is looking to raise A$100 million to fund the acquisition of buildings in Macquarie Park. Suncorp also has new A$300 million note out, with the accompanying documents revealing a prudential breach. The Funds from the capital note will form additional Tier 1 capital.

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