Devon Funds Morning Note - 21 June 2024

Friday 21st June 2024

Flying burritos

Global

The Dow Jones outperformed on Thursday with a gain of around 300 points while the S&P500 pulled back 0.25% at the close after passing the 5,500 mark during the session for the first time ever. The Nasdaq also retreated from record highs, dipping 0.8%. Most of the Magnificent 7 were lower. Energy stocks were higher. Various economic data prints included a softening of the US economy, increasing the case for rate cuts by the Fed. Other central banks are already doing so. The Swiss National Bank cut rates for the second consecutive meeting overnight. China kept rates on hold as did Norway and the Bank of England, with officials at the latter saying it was a “finely balanced” decision.

Inflation is coming down in most parts of the world, but at varying speeds. The need to move rates lower is also being guided by the durability or otherwise of economies, but also the natural inclination of officials – some appear to have a propensity to ease in their “DNA” while others do not.

Many economies have demonstrated resilience amidst the tightening phase of the past year or so, and especially the US. The employment market has remained robust in a historical context, and any talk of stagflation (increasing inflation, high unemployment and slowing growth) indicators are fairly easy to dispute. The “misery index” as show below is well below its long-term average.

However, the US economy is softening, and there will be a tipping point at which rate cuts are needed to steady the ship. Weekly unemployment claims came in higher-than-expected last week at 238,000. Continuing claims totalled 1.828 million, up 15,000. US housing starts fell 5.5% last month to 1.277 million. Building permits fell 3.8% to 1.386 million, also below estimates. A Fed index of manufacturing activity in the Philadelphia region remained in positive territory for the fifth straight month in June, but dipped from May and was below forecasts. New orders were negative and an increasing number of firms reported a decline in employment.

The evolvement of artificial intelligence meanwhile remains an unknown risk to employment numbers. AI was in the headlines of course again overnight. Elon Musk commented on social media that Dell and Super Micro Computer will provide servers to help his artificial intelligence startup xAI develop his “Dojo” supercomputer. Musk founded xAI as a competitor to OpenAI (which he also founded).

Musk is not alone. Another OpenAI co-founder is starting a rival AI start-up focused on “building safe superintelligence”, just a month after he quit OpenAI following an unsuccessful coup attempt against CEO Sam Altman. A more established competitor in Anthropic (also founded by ex-AI execs) has announced Claude 3.5 Sonnet, its most powerful AI model yet. It’s free on the company website and the chatbot is said to “show marked improvement in grasping nuance, humour, and complex instructions, and is exceptional at writing.”

Sticking on the theme, shares in consulting company Accenture jumped 7%. The company missed on earnings estimates, but investors were buoyed by reports of more than US$900 million in generative artificial intelligence bookings for its third quarter. Nvidia had an off day, falling 3.5%. The gain this year still stands at 170%, with a market cap of US$3.22 trillion. Nvidia is worth more than the entire stock markets of Germany, France and the UK. The AI darling’s market cap is in fact bigger than the value of every individual stock market globally except India, Japan, China and the US.

Elsewhere shares in Gilead Sciences soared over 8% after the biopharma said a late-stage trial showed that its drug lenacapavir demonstrated 100% efficacy for HIV prevention in women. Not such a healthy day for Trump Media & Technology – the shares fell 15% after its registration of additional shares (potentially a US$247m boost) was declared effective by the SEC. The shares have fallen ~50% since Trump was convicted on 34 felony counts in his “hush money” trial.

Across the Atlantic, there is a lot of focus on the European Football Championships, but the Swiss National Bank was kicking goals for those looking for lower rates on the Continent. The central bank started easing in March and cut its benchmark rate by a further 25bps to 1.25%. Officials lowered their inflation forecasts from 1.3% to 1% in 2026, and the Chair said officials were “willing to be active in the foreign exchange market as necessary”. The franc has appreciated in recent weeks on safe haven appeal following European political uncertainty, and the snap election call in France.

Norway’s central bank kept rates on hold, saying the first rate cut was not likely until next year. The Bank of England kept rates steady as well, even though it has been mission accomplished on inflation which is back at the 2% target. Two of nine officials favoured a cut. Some saw inflationary pressuresin services, strong domestic demand and wage growth. The CPI is expected to rise slightly in the second half, as last year’s decline in energy prices falls out of the annual comparison. The central bank upgraded its GDP growth forecast for the second quarter to 0.5%, up from the 0.2% it predicted in May. It looks a 50/50 call on a cut in August, with ”Swiftflation” one factor, and the outcome of next month’s election another. A poll has shown that the left-of-centre Labour Party is on course to win a whopping 516 out of 632 seats.

The FTSE rose 0.8%. Deal-talk was in the air, but not well received. Tate & Lyle fell 9% after the sugar maker said it would buy US speciality ingredient maker CP Kelco in a transaction worth US$1.8bn. UK technology and grocery company Ocado fell 11% after it said that a deal to open a fourth robotic warehouse for Canadian supermarket Sobeys was paused and the tie-up was no longer exclusive. Ocado has staked its future on selling its software and robots to traditional supermarket chains around the world to help them sell online.

Shares in Natwest though rose 2% after agreeing to buy £2.5bn of assets, including unsecured loans and credit card deposits, from Sainsbury’s. UK supermarkets are getting back to their core functions - in February Barclays agreed to buy most of Tesco Bank’s assets for £600mn.

In Europe the STOXX50 jumped 1.3%. On the subject of UK banks, fintech Revolut is targeting a valuation exceeding US$40bn in a reported share sale. The challenger bank would be worth more than Natwest or SocGen, but is still awaiting a UK banking licence.

In Asia, the Nikkei rose 0.2% but the CSI in China fell 0.7%. China’s central bank held steady the one-year and five-year loan prime rates (which are used to benchmark corporate loans and mortgages) respectively. Mainland property developers led losses and the China’s currency hit a 7-month low.

New Zealand

Bang! New Zealand is out of technical recession. GDP for the March quarter rose 0.2% which was slightly above expectations, and 0.2% higher than the year ago quarter. This comes after the economy registered two successive quarters of negative growth. The primary sector was a big driver, with export activity rising. Agriculture, forestry and fishing production grew by 0.4%. There was also a lift in tourism spending. Private consumption in the data has risen 1.6% in Q1, which seems out of step with other data, but we do seem to be favouring lower cost imported items – so we are substituting spending.

While being out of a recession is good technically, there were still some sobering aspects of the release. Half of the 16 industries saw a fall. Growth overall is still anaemic, and the economy is 0.5% smaller than the September 2022 peak. This is despite an unprecedented period of population growth. GDP per capita is still negative and has been so now for six consecutive quarters. So whatever growth we are getting, it is being shared amongst more people.

Will this all change the RBNZ view? Probably not for now, and certainly won’t accelerate cuts. That said the March quarter numbers are fairly out of date, and more current temperature checks on the economy will be forthcoming in the next few months which show more of the real-world impact for what the economy is facing as opposed to a somewhat dated GDP print, and as the optimism over the “out of recession” headlines wears off and the real world kicks in.

The Kiwi market responded positively to the news, with the NZX50 rising 0.86% to 11,771. Gentailers were strong, with Genesis Energy surging 3.4%, while Mercury NZ (+1.9%) Contact (+0.7%) and Meridian (+0.6%) all on the up. Economic bellwethers were well supported. Auckland Airport and Port of Tauranga both rallied 1.7%. Ryman Healthcare rose 3.3%, Spark NZ gained 2%, EBOS jumped 1.3% and Infratil added 0.9%. Freightways though fell 1.4% and Channel Infrastructure dipped 1.3%.

This morning KMD Brands is out with an update. The company said the consumer environment was still challenging. In the second half to date Kathmandu sales are down 9.4%, Rip Curl is down 5.9% and Oboz footwear is 21.8% lower. Overall group sales are 8.4% lower. The group now expects underlying earnings (EBITDA) to be around $50 million – that is less than half of the $105.9m achieved in FY23. “Pre-emptive” action has been taken with respect to covenants and costs.

Australia

The Australian market was fairly flat, with the ASX200 holding at 7,769. NAB was flat, but CBA, ANZ and Westpac were higher. BHP was flat. Mineral Resources fell 1% after announcing it would close some high-cost iron ore mines in WA. Healthcare dipped 1%. Property stocks performed strongly with Mirvac rising 1% and Goodman Group adding 0.4% - the stock has risen over 40% year to date.

One stock dominated the headlines in the Australian market on Thursday. Burrito chain Guzman y Gomez got off to a flying start following the biggest IPO in three years. Investor appetite was immense with the shares soaring 36% to A$30 and a A$3 billion valuation. Not a bad effort for a company that started in 2006, and has around 185 stores – the company plans to use the capital to grow the store footprint to over 1,000, expanding at home and abroad.

With a long time since such a listing and the company a well-known brand in Australia, there was arguably a degree of FOMO yesterday. Time will tell if the company’s share price lives up to the exuberance. At the current market cap, the company is valued nearly as highly as Domino’s Pizza Enterprises, the leading franchise globally of the pizza chain, with more than 3,800 stores. It will also be interesting to see how much early investors take off the table. Early backer, venture capital firm TDM Growth Partners, initially invested A$40m at a A$150m valuation in 2018 - its current 26% stake is worth ~A$860m.

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