Devon Funds Morning Note - 15 May 2024

Wednesday 15th May 2024

War of the roses

Global

The Nasdaq (+0.8%) hit a record high on Tuesday while the S&P500 (+0.5%) and Dow (+0.3%) also rose despite US wholesale inflation coming in higher than forecast in April, and as March’s number was revised lower, easing concerns over the persistence of pricing strength. Jerome Powell presented no surprises at a speaking engagement, saying that patience was needed on the timing of rate cuts. There will be significant interest in the CPI print which is out on Wednesday. Home Depot was flat as quarterly sales fell but earnings at the DIY chain topped estimates. Meme stocks continued to evoke pandemic era memories – GameStop soared a further 60% and theatre chain AMC spiked another 30%.

The producer price index gained 0.5% from April, higher than forecasts for around 0.3%. The index was up 2.2% on an annual basis, the biggest gain in a year. The PPI measures what producers receive for the goods they produce and is effectively “factory gate” inflation which can then flow down the line to consumers. Services prices boosted the wholesale inflation reading, climbing 0.6%, the biggest gain since July 2023, and accounting for about three-quarters of the headline gain. Stripping out volatile food and energy prices, core PPI also rose 0.5% above estimates for a 0.2% read.

The April numbers did little to dispel the notion of the persistence of inflation, however there was better news with respect to the March reading which was revised from an initially reported 0.2% gain to a decline of 0.1%. The appearance of deflation was not lost on Jerome Powell who told a group of bankers in Amsterdam that “The headline numbers were higher, but they were backward revisions…we are disassembling it taking it apart and looking at it.”

Also on the podium on Tuesday was Joe Biden who was in electioneering mode. The US President unveiled sweeping tariff hikes on a range of Chinese imports, somewhat bluntly saying “when you make tactics like this, you’re not competing, it’s not competition, it’s cheating. And we’ve seen damage here in America.” Biden is raising levies on semiconductors, batteries, solar cells, and critical minerals, in addition to previously reported increases on steel, aluminium and EVs (despite China not exporting these to the US in any material way). The changes are projected to affect around US$18 billion in current annual imports.

“Protecting” the economy is likely to be a big theme as Biden and Trump go head-to-head later this year. Speaking from the White House Rose Garden Biden said his new tariffs were a "smart approach…compared to what the prior administration did…my predecessor promised to increase American exports and boost manufacturing…he failed."

There may also be an increasingly political element to the timing of Fed rate cuts, and the pressure that higher interest rates are bringing to bear. US credit card default rates have hit their highest level in nearly 13 years. The Fed’s Quarterly Report on Household Debt and Credit showed the share of “seriously delinquent” debt (at least 90 days behind) rose to 6.86% of outstanding balances in the first quarter of 2024, the highest since Q2 of 2011. Auto delinquencies moved to 2.78%, the highest since Q2 of 2010. The increases came despite total credit card balances falling by US$14b to US$1.12 trillion. However, total US consumer debt rose 1.1% to US$17.69 trillion. Americans appear to be pivoting to lower rate debt where they can.

US consumers in historical terms though remain healthy from a financial perspective, a point that was reiterated by management at DIY giant Home Depot. The company’s CEO said customers “do have the ability to spend…they’re just deferring projects given higher rates.” Home Depot reported that earnings and revenues fell for the fifth straight quarter, down 5% and 2.3% respectively. Revenues are 6% lower than two years ago. Earnings for the quarter though were ahead of estimates.

Tech stocks were buoyant. Alphabet shares ticked higher as Google announced new additions to its AI model series Gemini at its annual developer conference, Google I/O. Gemini 1.5 Pro can quickly summarize conversations, caption images and videos and extract data from large documents and tables. The unit responsible for development is aptly named “Google DeepMind.”

Across the Atlantic, the European indices were slightly positive. German investor sentiment kicked higher in May, hitting a two-year high. The ZEW indicator came in at the highest level since February 2022, when Russia invaded Ukraine. The assessment of the current economic situation in Germany – Europe’s biggest economy - also improved, rising 6.9 points to -72.3.

The FTSE100 in the UK gained 0.16%. Shares in Vodafone surged 5% as full earnings from the telco beat expectations. Operating profit fell 74.6% to €3.7bn, but this was as a result of disposals in the prior financial year, in particular the €8.6bn gain on disposal of the Towers business. The results excluded Vodafone’s Italian and Spanish operations, which it has agreed to sell for a combined €13bn, which will see billions of euros in buybacks as a result. Revenues grew 2.8% with growth in all regions, including Germany (its biggest market). While Vodafone has been “decluttering’ the company is set to be bigger again with a £16.5bn merger with rival Three expected to close by the end of this year - if approved by regulators.

Anglo American is also in divestment mode, with the miner announcing plans to exit diamond, platinum, and coal mining as it seeks to ward off BHP’s approach.

Asian markets were mixed, with the Nikkei 0.5% higher as Japanese producer prices came in line with forecasts in April. Chinese markets were 0.2% lower. Alibaba’s earnings fell 86% on a year ago. The Chinese e-commerce giant has been challenged by a cautious Chinese consumer but saw some improvement in the March quarter. There have been high hopes for the company’s cloud business, but growth has been muted. The company is targeting a boost from AI with its own large language model (“Qwen”) having over 2.2m corporate users.

Alibaba shares fell 6% in US trading but Sony’s jumped 6% after as quarterly revenues rose 14% and earnings jumped 57%. Both were lower for the full year.

Full year PlayStation 5 sales of 20.8m were only slightly below downwardly revised targets. Sony said PS5 sales this year would be even weaker at 18 million, but that it was mainly its financial services business which was weighing on the bottom line.

New Zealand

The Kiwi market was lower on Tuesday, with the NZX50 easing 0.3% to 11618. Freightways declined 2.3%, and Infratil dipped 2.2%, while Fletcher Building fell a further 4.7%. Fisher & Paykel Healthcare though rose 0.2% and EBOS jumped 2.3%. Contact rose 0.1% but Meridian eased 0.3%. There was renewed buying in Ryman Healthcare which saw heavy volumes, and leapt 4.1%.

There were plenty of data releases highlighting the headwinds, and also a tailwind, that the economy is dealing with. Card Spending stats showed spending in retail industries decreased 0.4% in April. On an annual basis retail spending fell 3.8%, and this number isn’t adjusted for inflation and is despite strong population growth. Spending in core retail industries decreased 0.7%

Apparel continues to get hit harder than other categories and fuel and durables were also notably weak. When you include non-retail, the figures look a bit better – spending increased 2.2% from March 2024 – this includes medical and other health care, postal and courier delivery. The services category had a strong lift – but this may reflect higher prices. There is clear evidence here that households are rationing their spending. Higher interest rates are the obvious reason for this – but there will be an increasing role to play of uncertainty around the labour market – as unemployment rises.

High Migration has been buttressing the economy is some ways (although also placing pressure in other ways – housing/job demand), however this is slowing Stats NZ reported that net migration totalled 4,910 for March and 111,100 for the year. There have now been six consecutive sub 10k numbers. More concerning is the brain drain of kiwis leaving. The net migration lass of NZ citizens was 52,500 in the year ended March, the first time the net loss has been over that number. That’s basically over 1000 more Kiwis leaving (long-term) every week than are returning. Just over half the migrant departures are going to Australia.

The Kiwi housing market meanwhile picked up slightly in April, but remains very subdued overall according to REINZ. The total number of properties sold decreased by 17.3% compared to March, but increased by 25.3% year-on-year. Days to Sell decreased by a marginal 3 days. The national median sale price increased by 1.3% year-on-year to $790,000 and decreased by 1.3% compared with March.

This morning there have been a couple of announcements. Auckland Airport has reported an 8% increase in total passenger volumes in April compared to a year ago. International passengers increased by 9% and domestic passengers increased by 5%. Total passenger volumes of 1.53 million are down on the 1.69 million seen in March, with April the first month of the off-peak Northern Summer season. The airport noted that demand on mainland China routes continues to improve with passenger movements doubling compared to last year. Another direct Auckland to mainland China route was added during the month, taking the total to seven, with six airlines now operating.

Contact has issued its monthly update. Controlled storage is running at 96% of the mean in the South Island and 83% in the North. National electricity demand was up 4.4% in April. Tauhara has progressed to power station commissioning while Te Huka 3 is 85% complete.

Australia

The Australian market was lower on Tuesday, with the ASX200 easing 0.3% to 7726. Most sectors were lower, with consumer discretionary and healthcare the bright spots. Weakness though was contained with no sector down more than 1% as investors awaited the Federal budget.

The mining and resources sector appears to have been looked after in the budget, with the Federal government outlining A$17.6 billion in tax credit support for the critical minerals sector, along with a A$6.7 billion tax incentive for green hydrogen. The Federal government is providing a production incentive valued at 10% of relevant processing and refining costs for the 31 critical minerals mined in Australia.

Treasurer Jim Chalmers has forecast a A$9.3 billion surplus for this financial year, up from the A$1.1 billion deficit forecast in December, boosted by tax receipts. The coffers are full, and are now being spent - the budget is loaded with initiatives to appease voters. There is a A$7.8 billion cost-of-living package. This includes A$300 in power bill discounts for every household and A$325 for small businesses. There will also be another A$1.9 billion for rent assistance. The Treasury claims these moves will cut inflation by 0.5 percentage points next financial year.

On the other side there will be deficits on the cards from next year for a decade. Net spending has been increased by more than A$24 billion over the next four years, including. The deficit for next year though is forecast to be A$28.3 billion, $10 billion more than forecast in December. Cumulative deficits over the next four years are estimated at A$112 billion and will run for a decade.

The budget also forecasts the economy will slow more than estimated six months ago, downgrading growth forecasts by 0.25 percentage points for each of the next three financial years. Unemployment forecasts remain unchanged, with the jobless rate (3.8% currently) expected to peak at 4.5% in FY25. The budget assumes the cash rate will not begin to ease until mid-2025.

The Aussie market is set to rise on the open. BHP’s US listing rallied 2.8%. May and June Copper futures have hit a record high above US$5 a pound.

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