Devon Funds Morning Note - 18 July 2024

Thursday 18th July 2024

Cutting to the chase

Global

The rotation away from the technology sector gathered pace on Wednesday, with the Nasdaq posting its worst session since late 2022, with a 2.8% decline. Chip stocks drove the weakness after reports that the Biden Administration is looking at clamping down on companies exporting critical chipmaking equipment to China. The sector is at the epicentre of escalating trade tensions and comments from Donald Trump on the matter also weighed on sentiment. Nvidia fell 6.6%, while the China-focused ASML sank 13%. Weakness in tech saw the S&P500 fall 1.4%. Strength in older economy stocks meanwhile helped drive a 0.6% gain for the Dow, United Health, and Johnson & Johnson both gained around 4% following expectations-beating results.

Yesterday’s note contained observations about the rotation that is occurring away from technology stocks, and the potential impact of a Trump Presidency. Both were in evidence overnight. Geopolitical tensions are not particularly new, but it appears things are heating up, with trade set to be a hot topic in the US election, and not just from the MAGA camp. There are reports that the Biden administration is set to focus more intently on tech sector trade with China and make use of a foreign direct product rule to put controls on foreign-made products even if they use minor amounts of American technology (separately there was another interesting interview with Joe Biden who said he would quit the Presidential race if a “medical condition” emerged – he has also just tested positive for Covid.

Comments from Donald Trump also caused a stir amongst semiconductor stocks. In an interview, he said that Taiwan should pay the US for defence. He also claimed Taiwan took “about 100%” of America’s semiconductor business. Trump’s running mate JD Vance also has strong similar views around China and is in favour of increasing tariffs.

Shares in chipmaker Taiwan Semiconductor were another that didn’t react well, falling 8% in the US. Dutch firm ASML also fell heavily despite results beating forecasts, with net bookings up 24% year-on-year. The company produces machinery that is used to make advanced chips and is very exposed to China where it makes nearly half of its sales. Dow-constituent Intel was slightly higher though and is one company that might benefit from the pushback against firms exporting to China. Intel has manufacturing capabilities in the US which it is looking to grow with the support of the US government.

Other market darlings under pressure included weight loss drug companies. Novo Nordisk and Eli Lilly both fell 4%. Roche has revealed promising results from early-stage trial data on its obesity drug candidate, which it gained from an acquisition earlier this year. Roche said its experimental once-daily pill showed an average weight loss of 6.1% in four weeks. Roche’s pill would likely see some preferential demand relative to competitors’ offerings which require injections.

Older-fashioned names were doing quite well overnight. United Healthcare shares jumped, with the number of broker upgrades following its results yesterday. Drugmaker Johnson and Johnson also delivered an earnings and sales beat driven by strong sales of its drugs, including cancer treatment Darzalex and blockbuster psoriasis drug Stelara (sales of US$2.9 billion for each in the quarter). After hours, United Airlines ascended slightly as earnings jumped 23%. Third-quarter forecasts though were below estimates with excess industry capacity weighing on airfares.

Data wise there was more support for the soft economic landing scenario. US industrial production rose at a faster-than-expected 0.6% pace in June. Quarterly production accelerated 4.3%, the quickest since the fourth quarter of 2021. Capacity utilization was 78.8%. Housing data in June for new construction came in better than expected, with starts totalling 1.35 million in June. Building permits were up 3.4% in May at 1.44 million. Both permits and starts for May were revised higher.

US consumers have been resilient but have also been adjusting their behaviours for inflation. The Fed’s Beige Book (a period update of conditions in 12 districts) noted increasing trends of retailers discounting items or “price-sensitive consumers only purchasing essentials, trading down in quality, buying fewer items, or shopping around for the best deals.” The central bank though sees growth as rising at a “slight to modest pace,” though five districts saw “flat or declining activity.” Uncertainty around the upcoming election, domestic policy, geopolitical conflict, and inflation were all factors. There were also some encouraging comments from Fed Governor Christopher Waller who said that the economy is nearing a point where interest rate cuts would be appropriate. He also noted that the labour market was in a “sweet spot.”

There has also been some good news on inflation across the Atlantic. UK inflation was unchanged in June at 2%, which is in line with the Bank of England’s target. There has been a degree of expectation that it might have been lower, but on the other side, it will be a relief that the Taylor Swift effect and her Eras tour didn’t give things a big bump. That said restaurant and hotel prices did rise strongly and were the largest upward contributor to inflation. However, discounting by clothing retailers was helpful. Food and beverage inflation also dropped to 1.5%. The lowest since October 2021, and some distance from a year ago, when it was 17.4%.

UK headline CPI is also some way from the 11% that it peaked at in October 2022. Core CPI, which excludes things such as energy and food was also stable, rising by 3.5% in the 12 months to June, unchanged in May. This will be welcomed by the Bank of England (and the new government), but it remains a bit of a line ball call whether the cut comes in August or September. While the CPI is at the Bank’s long-term inflation target, there is some concern from officials that services sector inflation remains persistent – inflation here held at 5.7%. Currency markets cast their view that the cut will be pushed out – the pound hit US$1.30, the highest level in a year.

The FTSE100 rose 0.28%. Gainers included HSBC which has appointed a new CEO. On the downside, miner Antofagasta fell 6% after warning that full-year production would likely hit the lower end of its forecasts. In Europe, the STOXX50 fell 1.1% with Novo Nordisk weighing. Adidas though sprung higher by 2%. The company has raised FY24 earnings guidance from €700 million to €1 billion after a strong performance in the second quarter with sales up 11%. Low-rise multi-coloured Samba and Gazelle sneakers have been flying off the shelves. Sponsorship of the Olympic Games may provide another spring in the step for the company’s sales.

There was also good news on the inflation front for Europe. It declined to 2.5% in June from 2.6% in May, consistent with earlier estimates. Inflation is running at less than half the levels of a year ago. The ECB meets on Thursday and is expected to leave rates alone after cutting them last month.

In Asia, the Nikkei was 0.4% lower. The Hang Seng and CSI300 both closed up slightly. The “third plenum” in China wraps up today, and it will be interesting to see if any material policy announcements follow.

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