Devon Funds Morning Note - 13 May 2024

Monday 13th May 2024

When the tide goes out

Global

European indices were buoyant on Friday, with the STOXX600, Germany’s Dax, and France’s CAC40 all hitting record highs. The FTSE100 also ascended to unchartered territory. The champagne corks were popping as the UK exited its recession, with the economy growing at the fastest rate in nearly 3 years, and expectations rising of rate cuts by the Bank of England and ECB as early as next month. The broader US indices were also firm despite a consumer sentiment survey showing a big jump in inflation expectations. It is a big week ahead on that front with the release of the April consumer price index in the US, while Jerome Powell is also due to speak again.

London hit its highest temperature this year at 26C over the weekend, and spirits are also high with respect to the UK economy which is no longer in recession. GDP grew by 0.6% in the first quarter of this year, ahead of expectations for 0.4% growth. On a monthly basis, the UK economy grew by 0.4% in March, following 0.2% expansion in February.

Driving the turnaround was the UK services sector where saw growth for the first time since the first quarter of 2023, with output ahead 0.7%. There was broad-based strength across the retail, health, and hospitality sectors. The transport services industry saw its highest quarterly growth rate since 2020. Car manufacturers also had a good quarter with production sector output growing 0.8%. At the other end the construction sector saw a 0.9% fall.

The data shows the UK recession was a shallow one and lends support to the view that the recovery will be stronger than most anticipated. This is good news for the government in an election year. PM Rishi Sunak (whose Conservative Party was recently pummelled at the local elections), said in a post on Friday that “the economy has turned a corner” and that while things were tough for many people, the government’s plan was working, and must be stuck to.

The data is also good news for the Bank of England with the economy having proved resilient in the face of elevated interest rates. The central bank last week held rates but said that inflation indicators “are moving in the right direction”, while a June cut was neither “ruled out nor a fait accompli." Markets are now seeing ascribing a ~50% probability to a rate cut next month, with a reasonable prospect of one in Europe as well. The FTSE100 and EUROSTOXX both rose 0.6% on Friday to record levels.

The timing for a rate cut by the Fed seems somewhat further out. The latest University of Michigan’s consumer sentiment survey provided a double-edged sword. The preliminary May reading for the index came in at 67.4, down from 77.2 for April and well below estimates of 76, marking the lowest reading in about six months. The survey’s director said that American consumers “now perceive negative developments on a number of dimensions. They expressed worries that inflation, unemployment, and interest rates may all be moving in an unfavourable direction in the year ahead.” The survey showed that year-ahead inflation expectations jumped to 3.5% from 3.2%. Long-run estimates also went up to 3.1% from 3%.

A couple of Fed officials (from Minneapolis and Chicago) reaffirmed that that they were adopting a “wait and see” approach to rate cuts given surprisingly strong inflation data this year. The Fed remains data dependent and there will be significant interest in inflation data this week. Results from retailers Walmart and Home Depot will provide a further temperature check on the state of, and outlook for, the US consumer.

The Dow added 0.3% on Friday, and registered a 2.2% gain for the week, its best this year. The S&P500 (+0.2% Friday) and the Nasdaq Composite (flat on Friday) both posted a third consecutive winning week, rising 1.9% and 1.1%, respectively.

Financials and healthcare stocks were strong. Goldman Sachs hit a record high. Novavax shares doubled after signing a multibillion-dollar deal with French drugmaker Sanofi to co-commercialize the company’s Covid vaccine starting next year. Part of the deal allows Sanofi to use Novavax’s Covid shot and flagship vaccine technology to develop new vaccine products beyond Covid. The US$1.2b licensing agreement will allow Novavax to lift its “going concern” warning, which it first issued in January 2023 due to having “substantial doubt” about its ability to continue operating. The deal marks a turning point for Novavax, whose protein-based shot is viewed as a highly credible alternative for people who don’t want to take MRNA jabs.

In Asia the CSI300 in China was flat. The Biden administration added 37 Chinese entities to a trade restriction list on Thursday. Property shares though were firmer as Hangzhou and Xian, two Chinese provincial capitals, lifted all home purchase restrictions, raising the prospect of other megacities following suit. The Hang Seng soared 2.3%, with energy stocks higher. Sentiment was also boosted by rising jobless claims in the US, and reports that China is considering a proposal to exempt individual investors from paying dividend taxes on Hong Kong stocks. The Nikkei gained 0.4%, with gaming stocks in demand, and air-conditioning manufacturer Daikin breezing 9% higher.

Chipmaker Taiwan Semiconductor saw its shares jump 5% in the US after April revenues surged 60% ottor on year – AI was a big driver. Earnings are due this week from Chinese tech titan Alibaba and export powerhouse Sony.

New Zealand

The Kiwi market added 0.07% on Friday to close at 11704. Meridian gained 1.2%, while Contact Energy rallied 1.8%. Fisher and Paykel Healthcare rose 1.1%. At the other end Freightways and EBOS both declined over 3%. Auckland Airport dipped 0.9%.

For the week the kiwi market was 1.5% lower. Markets are in something of a holding pattern from a domestic perspective until the earnings season gets underway next week and the RBNZ also meets. The RBNZ will release its quarterly survey of expectations this afternoon. This week there are a few data points of interest including card spending, and the quarterly producer price index print.

The challenges facing the economy were evident in a couple of fronts on Friday. The update from the Warehouse highlighted how discerning consumers have become with third quarter sales down 9.2%, and in stark contrast to Briscoes (shares up 2.3% on Friday) which last week reported a 1% gain in first quarter sales, with sporting goods sales up over 4%.

There is a saying that “when the tide goes out you see who is swimming naked.” The Warehouse did well during Covid, as did most retailers, but when economic conditions go south, as they are currently, we are seeing a real divergence in how retail businesses are performing. The cycle is highlighting management teams, and as consumers have become more selective.

The Warehouse appears to have its work cut out, with real confusion over the customer proposition, which hasn’t evolved enough for today’s value conscious consumer. There is a quality perception, and the company has arguably lost connection with customer. This is also while competition has increased with the likes of Briscoes, Costco and Kmart. It is a crowded landscape.

Against this backdrop the Warehouse is looking to reduce costs, but also improve focus on core businesses, with the sale of Torpedo 7 and closure of the TheMarket.com. Amazing to think at the time of launch in 2019, the company had versions of the digital marketplace being NZs version of Amazon. The craziness of Covid didn’t help to dispel these hopes, but the tide now is well and truly out.

Warehouse shares rose 2.4% on Friday and perhaps on the view that things could have been worse, and the record lows are now priced in. The shares are down 20% this year, and 70% lower than their late 2021 peak.

Unevenness in our economy was also evident in a release on the manufacturing sector. The BNZ -Business NZ performance of manufacturing index picked up in April but remained in contraction. The index settled at 48.9, up from 46.8 in March but still lower than 49.1 in February. Our manufacturing sector has now been in contraction for 14 consecutive months.

There were some positives. Production (even if flattened by the timing of Easter) returned to expansion for the first time since January last year with a reading of 50.8. Employment and finished stocks were in expansionary territory.

However new orders remained firmly in contraction at 45.3, and well off the long-term average of 54.3. It fits with the idea that demand for many manufactured goods has been falling. Household budgets have been under pressure, and a softening labour market is also reducing purchases of durable goods. High interest rates have dampened expenditure on big ticket items. Lower corporate profitability has seen reduced capital expenditure and intentions to invest. Against this backdrop, the proportion of negative comments from the survey increased to 69%. An overall lack of sales and orders was the dominant theme in the comments, along with a struggling economy.

There were some positives, but certainly some negatives for the survey. One would think weakness in the manufacturing sector would go into the cocktail of considerations for the RBNZ next week.

As will the construction sector where activity is also falling.

Fletcher Building has downgraded full year earnings (EBIT before significant items) guidance this morning in a range of $500 million to $530 million inclusive of $10 to $15 million of restructuring costs related to cost out initiatives. This is down from a range of $540 million to $640 million given at the interim results in February.

The company said that market conditions across the Company’s Materials and Distribution divisions have weakened throughout FY24. In New Zealand, market volumes to date in 2H24 have moved ~5% lower than 2Q24, and in Australia market volumes to date in 2H24 are ~10% lower compared to 2Q24. The concrete division has been resilient, but the building products unit has seen weaker revenues and gross margin pressure. Fletchers sees year end debt at $1.9 billion to $2.0 billion, with $2.8 billion of debt facilities in place.

Australia

The Australian market was higher on Friday, with the ASX200 gaining 0.35% to 7749. It was the fourth gain in five sessions and took the benchmark’s advance for the week to 1.6%, and the third straight up week. Momentum on Friday was driver by the gold and energy sectors which were both up around 1.8%. Santos and Woodside both gained around 2% with oil prices rising on encouraging Chinese trade data. Sentiment generally was helped by soft US employment data.

The big four banks were all higher. QBE Insurance added 0.1% after reaffirming full year guidance. Suncorp though eased 0.7% after reporting an A$85 million increase in 90+ days past due loans in the March quarter, from the December period, to A$510 million. Commercial and residential loans were both higher. Home lending grew 1.4%, above system, while business lending grew 0.6 % during the quarter.

BHP and Rio were both slightly lower. Anglo American’s key South African shareholders (who collectively hold more than 15% of the company) are reportedly open to a higher, “more straightforward” offer from BHP, possibly with a cash component.

The big event this week in Australia is tomorrow’s federal budget, a big surplus (potentially > A$10b) is expected, and in contrast to the small deficit forecast in December, on the back of stronger than expected tax receipts, commodity prices and employment. Cost-of-living relief measures are set to be at the forefront, along with some caution given inflation remains a challenge.

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