Devon Funds Morning Note - 06 May 2024

Monday 6th May 2024

Goldilocks

Global

Markets rose sharply on Friday as the Non-Farm Payrolls report showed that the US economy added fewer jobs than expected last month. The labour market is cooling, as is wage growth, boosting hopes of a couple of rate cuts by the Fed this year. This would be a relief to investors after the timeline for, and quantum of, rate cuts have been pushed and reduced respectively from where it sat at the start of the year. The Dow Jones soared 450 points, the S&P500 had its best session since February, rallying 1.3%, and the Nasdaq leapt 2%. Shares in Apple jumped 6% following the iPhone maker’s better than expected results. Oil prices declined further on signs of easing geopolitical risks in the Middle East.

The world’s largest economy created 175,000 jobs in April, below estimates for 240,000. This was well down from the upwardly revised 315,000 jobs added in March. It was the first downside payrolls surprise in several months. Bond rates dropped on the report with the 10-year US Treasury briefly falling below 4.5%. Rate-sensitive stocks rose, including the Mag7.

The healthcare sector led job creation, with 56,000 additions. Overall workers holding full-time jobs soared by 949,000, while part-time workers fell by a similar number. The unemployment rate though ticked higher to 3.9%, the highest since January 2022, against expectations it would hold steady at 3.8%. A more encompassing jobless rate which includes discouraged workers and those holding part-time jobs for economic reasons edged up to 7.4%, the highest level since November 2021.The labour force participation rate, or those actively looking for work, was unchanged at 62.7%.

The US employment market is easing up a bit, and this is also helping ease inflationary pressures as well. Average hourly earnings rose 0.2% from the previous month and 3.9% from a year ago, both below consensus estimates and an encouraging sign given recent concerns around the stickiness of inflation. The US jobs market is cooling, but not too much. This provides support for the well-worn financial market cliche about a “Goldilocks” scenario where the economy glides to soft landing, and where growth continues but not at such a rapid pace to force the Fed to tighten policy further or hold off too long on rate cuts.

The labour market “porridge” for April was “not too hot or cold”. The release comes following last week’s Fed meeting where officials noted that progress on inflation had stalled but the central bank remains in data-dependent mode. This was a “good” piece of data for the markets, which are now pricing in a strong chance of two interest rate cuts this year, with the first in September.

Adding to the prospect of the Fed bringing forward rate cuts was a release showing that the US services sector contracted in April for the first time since December 2022. The ISM Services Index fell to 49.4, down two points from March and below estimates for 52. Inventories and order backlogs also saw gains as did prices, while production, employment and new orders declined. A hot services sector has been driving the US economy, so bad economic news here is possibly good news from the market’s perspective.

Apple shares jumped 6%. As noted on Friday the quarterly result was stronger than expected, particularly in China. The iPhone maker raised its dividend and announced a record share buyback of US$110 billion. The company gave no formal guidance on the outlook, but things appear to be picking up. The services sector posted record 14% growth - the App Store now has over 1 billion subscribers. Apple CEO Tim Cook said overall sales would grow in the “low single digits” during the June quarter. Apple’s product line will get a boost this week with a new iPad lineup to be unveiled – the first update in nearly 1½ years.

Apple was also a topic of discussion at Berkshire Hathaway’s annual shareholder meeting over the weekend. Berkshire has cut its investment by about 13% to US$135 billion. Warren Buffett said the sale was for tax reasons (he thinks tax rates may be going up given US fiscal deficits) and not any judgement of his long-term view of the stock. That would be music to the ears of Apple CEO Tim Cook who sat in the front row. Even with the sale, Apple is still Berkshire’s biggest holding by far. Berkshire is also still Apple’s largest shareholder outside of exchange-traded fund providers.

It was the first meeting without Buffett’s right hand man Charlie Munger who passed away in November. Buffett also joked about his own mortality saying “I know a little about actuarial tables.” He reassured investors that a plan was in place and revealed that Greg Abel, his successor, would be making the call on investment decisions. Abel has been overseeing Berkshire’s energy, railroad and retail businesses. Buffett said his own investing record was not perfect, including a recent bet on media company Paramount that went south.

Berkshire though continues to deliver for its shareholders (albeit not in the form of dividends as Buffett prefers share buybacks). Berkshire’s first quarter operating profit rose 39% to US$11.22 billion from a year ago. Cash has climbed to a record US$188.99 billion from US$167.6 billion at December. Buffett told investors that the cash hoard could climb to US$200 billion given a lack of large attractive opportunities. He did hint though Berkshire was looking closely at an investment in Canada.

Buffett said renewable energy was of interest but needed time to develop, and solar would never be the world’s only electricity source. On AI he commented that he didn’t particularly understand it that well, but that it could be the growth industry of all time in the way its enabled IT scamming (think deep fake and the like). He said AI has “enormous potential for good and enormous potential for harm.”

Across the Atlantic, the STOXX50 jumped 0.6% and the FTSE100 in the UK added 0.5%. UK service sector output grew in April at its fastest pace since May 2023. The S&P Global Services PMI Business Activity Index rose to 55.0 from 53.1 in March. The composite PMI ticked up to 54.1 in April from 52.8 the month before. This marked the sixth consecutive month in positive territory and signalled the fastest expansion of private sector business activity since April 2023. The survey results are consistent with the UK economy growing at a quarterly rate of 0.4% and therefore pulling further out of last year's shallow recession. The Bank of England meets this week and is expected to remain on hold.

In Asia, Japan and Mainland China markets were closed. The Hang Seng rallied 1.5% on Friday.

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