Devon Funds Morning Note - 21 March 2024

Friday 22nd March 2024

Global

Markets surged following the Fed meeting, with the central bank holding the benchmark overnight borrowing rate at 23-year highs in a range between 5.25%-5.5%, where it has been since July last year. Investors were buoyed by officials appearing to indicate that they are set to tolerate inflation being a little bit higher for longer than was previously the case. Growth projections for 2024 were lifted, while core inflation estimates were revised upwards slightly. The Fed “Dot Plot” held steady, indicating that the central bank is still primed for three rate cuts this year. Fed Chair Jerome Powell said in his address that a strong jobs market wouldn’t stop the central bank from cutting rates.

The main indices all rose around 1% post the Chair’s address. Officials appear to remain committed to getting inflation back to target, but perhaps tolerating this occurring over a slightly longer timeframe, while also looking to engineer a soft economic landing. US GDP growth for 2024 has been revised up to 2.1%, significantly higher than the 1.4% estimated in December. Unemployment is expected to be 4%, compared to the 4.1% projection at the end of last year.

On inflation, the headline estimate for this year has held at 2.4% (despite a lift in oil prices this year). Core PCE (which strips out volatile items) for this year has been revised upwards to 2.6% from 2.4% in December (and below the most recent level of 2.8%). The Fed still sees its primary gauge of inflation reaching 2.0% by 2026. The central bank appears to have not been unnerved by hotter than expected inflation prints over the last two months, with more weight on the progress made over the course of last year.

The Dot Plot (projections from the 19 officials who make up the Fed’s Open Market Committee) meanwhile indicates that officials are comfortable tolerating slightly higher levels of inflation in the near term, while economic growth remains resilient. This would seem to be a positive scenario for investors. The Committee sees three more reductions in 2026 and then two more in the future until the Fed Funds Rate settles in around 2.6%, near what policymakers estimate to be the “neutral rate” that is neither stimulative nor restrictive. Jerome Powell said that the first rate cut would be “highly consequential.” This also appears to suggest that the first cut will be followed quickly in succession by others.

Chip stocks remained in the limelight on Wednesday. Intel is said to be in line to receive as much as US$8.5 billion in direct funding from the federal government as part of the CHIPS Act. The company could also receive up to US$11 billion in loans tied to the legislation, which was passed in 2022. The moves highlights the Biden administration’s push to make the US a centre for semiconductor manufacturing. Officials also have clearly noted the differences between Intel and the likes of Nvidia. Intel operates chip factories (‘fabs’) in addition to designing processors, while AMD and Nvidia are (ironically given the latter company’s “magnificent” tag) “fabless”, which means they design the chip, then send computer files and staff to Taiwan for the manufacturing of the device.

Samsung shares meanwhile soared 5% in Asia as Nvidia reportedly said the South Korean chipmaker’s high bandwidth memory chips were in the “qualifying” stage for use in Nvidia’s graphics processing units. Nvidia’s execs were reported to say that “Samsung is very good, a very good company.”

Asian markets were generally higher on Wednesday. The Nikkei gained 0.7% and the CSI300 rose 0.2%. Fixed asset investment in China rose 4.2% in the January-February period from the same period a year earlier, beating forecasts for a 3.2% gain. Shares of Chinese tech titan Tencent rose 1.3% as the company posted a 7% rise in fourth-quarter revenue. China’s economic slowdown is having an impact but the world’s largest video game company and operator of the WeChat messaging platform said it was expecting to at least double its share buybacks this year to over HK$100 billion. Tencent’s core gaming business saw revenues dip 3% but revenue from online ads rose 21%.

European markets were mixed. The FTSE100 was flat as UK inflation fell to its lowest since September 2021 at 3.4%, down from 4% in January. The largest downward contributions came from food, restaurants and cafes, while the largest upward pressure came from housing and fuel. Month-on-month, the headline CPI rose by 0.6%, returning to positive territory after a -0.6% print in January. The Exchequer Secretary to the UK Treasury said “we have turned a corner on inflation.” The Bank of England meets on Thursday and is expected to keep interest rates unchanged.

Luxury stocks were on the back foot on Wednesday. Shares in Gucci-owner Kering fell 12% after it warned on profits with first-quarter revenues likely to be down 10% year-on-year. The decline was largely attributed to Gucci, with particular weakness in Asia-Pacific. Gucci sales are expected to be down nearly 20% year-on-year. Gucci accounted for around two thirds of group operating income last year. The announcement was in contrast to recent quarterly numbers from LVMH and Hermes showing a jump in sales.

New Zealand

The kiwi market recovered during the session to finish higher, with the NZX50 closing up 0.13% at 11,832. Fisher & Paykel Healthcare was flat but the dual listed banks were both higher. Mercury NZ jumped 2.4% while Auckland Airport gained 0.9% as did Summerset. A2 Milk had a strong session, surging 1.2% while cinema software group Vista put in a good showing, up 2.1%. On the downside, Meridian was 0.7% lower while EBOS declined 2.1%.

The Warehouse Group surged 7.4%. Half year numbers from the retailer were better than expected. Continuing sales fell 4.9% but net profit after tax from continuing operations jumped 18.9% to $30.7m. Margin gains (250bps) at the Red Sheds in particular have supported the bottom line. Management have sought to focus on costs and also inventories.

A pivot towards groceries (now 20% of turnover) has proven fruitful given cost-challenged consumers, and mitigated the overall weakness in turnover. Sales at The Warehouse were down 4.7% to $965.6m (and Warehouse Stationary was 5% lower at $117.9m). Sales at Noel Leeming (half year sales down 2.2% at $544.4m) appear to be doing better than feared, particularly given a move away from big ticket items (think whiteware and plasma TVs) by consumers over the past year.

The Warehouse has also made good progress on debt reduction (down from $48.1m six months ago to $18.7m), while there was also a dividend. The revelation that another loss-making business (The Market.com) could be exited before the year is out was also well received. The sale of the loss-making Torpedo7 for $1, and associated write-downs, weighed on the bottom line but won’t do so going forward. Market reaction also though needs to be placed in the context of a share price which has been trading at record lows.

Ahead of the GDP numbers, Stats NZ released details of the current account deficit for the year ended 31 December 2023, which came in at $27.8 billion (6.9% of GDP). A current account deficit indicates that New Zealand is spending more than it is earning overseas. The deficit was $5.6 billion narrower than the $33.4 billion deficit in the year ended 31 December 2022 (8.8%). In the year ended 30 September 2023, the annual current account deficit was $29.8 billion (7.4% of GDP).

This was one of the more problematic economic indicators previously. At nearly 9% of GDP, this was potentially a problem for rating agencies and therefore the cost of issuing debt. It is improving, but this is still out on the edges of where would be described as comfortable, and the numbers are still pretty big. We are importing less, which speaks to demand. The return of tourism is also helping, but interest payments on our debt are going up.

On a slightly different slant, yesterday marked the first NZU carbon auction of the year. There was a great deal of uncertainty in the market over exactly what the previous Government was going to do in the carbon space. Financial markets react strongly to uncertainty – and the response last year was to not get involved in the auctions – as the “rules of the game” were unclear. Some confidence has returned, with 84% of the units on offer yesterday sold, or around 2.97 million units. This is equivalent to $190 million so this means there is some confidence in the market. The price struck was $64, against the spot market after the auction at $55. This will be one revenue line item that the Budget will have to make assumptions on.

Australia

After trading higher through most of the session, the Aussie market closed down slightly on Wednesday, with the ASX200 closing 0.1% lower at 7,695. Sector performances were mixed. Gold stocks corrected from their recent run, while the tech sector dipped 0.5%. The banks eased, but the big iron ore miners edged up following Chinese data, and a 3% gain in iron ore futures back to ~US107. BHP rose 0.5%, and Rio Tinto rallied 0.8%. The energy sector had a good session as oil continued to strengthen (WTI was down 2% overnight however). Woodside added 0.3%. Coal stocks performed, with Whitehaven surging 2.7%.

Investors have digested the RBA meeting this week, and appear to have reached the conclusion that while optionality has been retained for another hike, there was a dovish slant. Markets are fully priced for the first cut in September, with an 80% probability of it occurring in August.

Stock-wise, packaging giant Amcor fell 3.6% after CEO Ron Delia announced his retirement because of health reasons. Delia has been at the helm for nine years, and also steered the company through the US$6.8b merger to create the largest listed packaging company.

In the miners, South32 declined 4.2% after the company said that cyclone Megan has caused significant damage to a remote port in the Northern Territory with a pipeline destroyed. Operations have been suspended, and the company has withdrawn output guidance for its Australian manganese division as a result. The Groote Eylandt port supplies 10 to 15% of the world’s manganese.

In the lithium space, Mineral Resources eased 0.5%. The company has partnered with Lord Resources to expand its “Horse Rocks” project in Western Australia in a farm-in agreement to earn 40% of the asset, speeding A$1m on the tenement. Rio meanwhile has announced it will invest US$350 million at its Rincon lithium plant in Argentina in an effort to achieve production by the end of the year. Rio purchased the project in 2022 for US$825 million, and plans to develop a battery-grade lithium carbonate plant with an annual capacity of 3,000 tons.

There were some acquisitive moves in some very different spaces. Gold miner Perseus declined 3.8% after increasing its takeover offer for Tanzanian explorer OreCorp. Pathology services provider Sonic Healthcare (-0.5%) has meanwhile announced plans to buy Swiss-based Dr Risch laboratory group for 117 million Swiss francs. Dr Risch has 13 clinical laboratories across Switzerland and a laboratory in Vaduz, Liechtenstein, and generated 100 million Swiss francs in revenue last year. This continues a strategy of Sonic expanding its global footprint through acquisitions in recent years.

Elsewhere, healthcare stocks were mixed, but ResMed had a positive session, up 0.1%. Shares in the sleep apnea treatment provider are held in a number of the Devon funds, and are up 15% year to date.

Comments from our readers

No comments yet