Devon Funds Morning Note - 14 August 2024

Wednesday 14th August 2024

Greener pastures

Global

The US indices jumped on Tuesday as the case for rate cuts by the Fed grew. US wholesale price inflation came in well below forecasts in July, with a 0.1% rise, half of what was expected. Inflation is under control and consumers are also crying out for some rate relief. DIY giant Home Depot beat estimates but lowered its forecast, saying customers had become “more concerned” about the economic outlook. The Dow Jones gained 1%, the S&P500 surged 1.7% and the Nasdaq roared 2.4% higher. Monetary easing is imminent it seems. Treasuries rallied as the US 10-year yield fell to 3.84%.

The Producer Price Index for July came in around half of the 0.2% forecast. Excluding food and energy the index was flat. On a year-over-year basis, headline PPI rose 2.2% which was a sharp drop from the 2.7% reading in June. There were some elements of strength - final demand goods prices rose 0.6%, primarily due to a 1.9% surge in energy, including a 2.8% increase in gasoline. However, this was countered by a 0.2% fall in services, the biggest decline since March 2023. Trade services prices fell 1.3% while margins for machinery and vehicles wholesaling tumbled 4.1%.

The numbers are encouraging on a number of counts. While price increases have moderated from peak levels, service inflation has been persistent. It is encouraging that this is now cooling. Also PPI is effectively factory gate inflation and a leading indicator of the inflation that is coming down the line. We will see what the latter looks like with the Consumer Price Index print due out tonight. Market expectations are for a 0.2% monthly increase for both headline and core CPI. The producer price print opens the door further for a Fed rate cut next month. Tomorrow’s CPI might help determine whether it is a 25bps or 50bps reduction.

Also crying out for a rate cut are US consumers. DIY giant Home Depot beat quarterly earnings estimates but comparable sales missed and the company lowered its full-year outlook. Management note that customers had been deferring projects since 2023 due to rising Interest rates but were now doing so due to a “sense of greater uncertainty in the economy.”

The home improvement retailer said it now expects full-year comparable sales to decline by 3% to 4% compared to prior guidance of a 1% dip. During the quarter net sales rose 0.6% to US$43.2 billion, while net income fell US$100m to US$4.6 billion. The company though reiterated a strong long term outlook for home improvement, given the country’s aging homes, shortage of houses and significant property value gains seen in the years of the pandemic.

Home Depot shares ticked higher. We will get further clues on the state of the US consumer with Walmart reporting this week and retail sales numbers also out.

Another stock in the new overnight was Starbucks which has ousted its CEO. The reins will be taken by the CEO of Mexican burrito chain Chipotle. Activist investor Elliott Management recently acquired a stake and will clearly have had a say in the matter. Starbucks has been facing headwinds of its own amid a cost-of-living challenged consumer in the US, while China, its second largest market, has also been weak. Same-store sales were down 3% at the last quarter. Starbucks shares perked up by 25%, the best day since the company’s IPO in 1992 (and recouping most of the decline since the outgoing CEO took over in March 2023). Shares were heavily traded and over 10 times the 30-day average.

Chipotle’s share price went the other way, falling 7% with its CEO having had a successful six year stint at the burrito chain and seeing the shares soar nearly 800% during his tenure. One of Chipotle’s strengths has been its app, so look out for a change here with Starbucks’ one, and an improving of mobile orders and long wait times for a latte.

In the UK, the FTSE rose 0.3%. The UK unemployment rate declined to 4.2% from 4.4% in May, coming in below expectations for a reading of 4.5%. Data also showed that growth in average earnings fell to 5.4% from 5.8% in May and versus expectations of 4.6%. This marked the slowest pace of growth since May to July 2022. Despite the fall in the jobless rate, the UK employment market continues to ease, with job vacancies declining, albeit still above pre-pandemic levels. The numbers support the notion of further rate cuts by the Bank of England. UK inflation numbers are due tomorrow.

The ECB also had a case to ease further. Business sentiment in Germany took a significant hit in August. The ZEW economic sentiment index dropped sharply by 22.6 points from July, landing at 19.2, the lowest since July 2022. Additionally, the assessment of Germany's current economic situation worsened, with the corresponding index falling by 8.4 points to -77.3 in August. The STOXX50 jumped 0.5%.

In Asia the Nikkei played catch-up, soaring 3.5%. The Hang Seng gained 0.4% and the CSI300 in China rose 0.3%.

New Zealand

The Kiwi market was also higher with the NZX50 gaining 0.3% to 12,319. Freightways rose 0.6% and the dual listed banks rallied. Summerset rose 3.7% and Spark NZ gained 1.6%. Vista Group rallied for a fifth session, up 3.6%. Fletcher Building gained 2.2%. Fisher & Paykel Healthcare fell 1.3% as did A2 Milk. Gentailers were in demand with Meridian up 1.3% and Mercury rising 1.4%.

Contact gained 1.7% and Genesis Energy rose 1.4% as the duo secured gas supplies from Methanax which will temporarily idle its manufacturing operations until the end of October. Genesis has secured up to 3.2 PJ of gas which will allow Unit 5 at Huntly Power Station, New Zealand’s largest electricity generation unit, to return to full capacity for the first time this winter. The company noted the move comes as the NZ electricity system faces unprecedented pressure due to low water levels, extended periods of light wind and a limited supply of gas to support back-up thermal generation. Around 10% of the country’s electricity has been generated using gas in recent years. “More power needed Scotty.”

Contact has secured ~3.5PJ from August through to October, or the equivalent of ~350GWh of electricity and means it will be able to run its Taranaki Combined Cycle gas-fired power station through the remainder of 2024. Contact noted that the step was taken due to national hydro storage levels at just 46% of the average for this time of year, and an ongoing decline in domestic gas production. This morning Contact released its monthly operating report, noting that South Island storage was 44% of the mean and North Island was 52% of the mean. It is dry out there.

It is decision day today for the RBNZ. There was a further reminder of another sector doing it tough with results from PGG Wrightson. Shares in the agricultural supplies business fell 9.5% as full year revenues fell 6.5% to $915.3m (the first drop since FY18) while net profit after tax was some $14.5m lower at $3.1m. No dividend was declared. The company’s numbers reflect the headwinds facing the agricultural sector. Sheep farmers are experiencing soft export demand and weaker commodity pricing, and the rural real estate market is soft. Farmers and growers are cutting back where they can and deferring discretionary spend. Management noted that the sector is “in the grips of a period of austerity.”

Meanwhile Stats NZ also provided some concern in a release of migration and tourism numbers.

Net migration is cooling, with the country posting a gain of 73,000 in the June 2024 year, which is down quite a lot from the peak of 136,000 in the 12 months to October 2023. On a monthly basis, the 2,700 in June was down from the upwardly revised 3,400 in May. It was the smallest monthly flow since August 2022, and below the average of around 4,000 per month in years before the pandemic.

Migrant arrivals have continued to ease, with a gain of non-NZ citizens of 128,500 in the June 2024 year driven by citizens of India, the Philippines, China and Fiji. The overall number was 50,000 lighter than the October 2023 peak.

Then there is the definitively bad news. Departures of New Zealand citizens are at record levels, and a net 55,300 in the June 2024 year. For every kiwi that came back to these shores we had over three leave. Over 80,000 kiwis sought greener pastures, and particularly younger ones. …38% were aged 18-30 years.

Arguably lower levels of net immigration will put less pressure on housing and inflation, but the “brain drain” we continue to see is not ideal for our economic prosperity, particularly if people never return. Quality of life is one thing we have in spades, but a high cost of living and low rates of pay are not great attractions.

We’ve also had some good and not so good news on the tourism front. Overseas visitor arrivals rose 27% to 3.2 million in the June 2024 year, driven by Australia, the US, China and the UK. However, despite the increase, overseas visitor arrivals in the June 2024 year were 17% lower than the record for a June year of 3.9 million in 2019.

The US is back at pre-Covid levels, and Aussie isn’t too far off, but one of the most sluggish to recover has been China – visitors from here are only just over half of their levels in the June 2019 year. It has been suggested the New Zealand has made it less attractive to visit than other destinations. China for one is not on the list of visa waiver countries. China has just scrapped visas for kiwi visitors but we are going the other way. Proposals were announced last week to increase visitor visas here by 61 percent to $341. Yes we’re getting $500m in revenues over the next four years, but for each visitor that doesn’t come here, the economy is losing out, and potentially much more in total. Our economy is doing it tough as it is without seeing tourism go backwards too.

This morning Napier Port has released results. Revenues for the third quarter increased 27.9% to $36.5 million, driven by volume increases of 7.4% for bulk cargo and 29.6% for container services. Underlying net profit after tax increased 156.7% to $4.8 million. Revenue for the nine months rose 15.5% to $107.1 million helped by growth in log exports and cruise revenue. Underlying net profit after tax for the nine month period increased 70% to $15.9 million. The port has left full year guidance for the results from underlying operating activities unchanged of between $50 million and $53 million, excluding insurance recoveries. Some 18 months ago now, the port has certainly bounced back from Cyclone Gabrielle. However the company noted that most regional businesses continue to face “a challenging economic environment.” Two of the port’s largest cargo customers have had to undertake temporary shutdowns of either all or part of their timber and pulp processing facilities.

Australia

The Australian market was higher on Tuesday with the ASX200 closing up 0.17% to 7,826. The banks were strong, with CBA (+1.5%), Westpac (+1.1%) and ANZ (+1.6%) all up more than 1%. BHP gained 0.3%. Energy stocks rose on gains in the oil price.

Shares in bottle maker Orora soared 19% after a A$3.3b takeover approach from US buyout firm Lone Star at a 34% premium to its previous traded price. The Board has rejected the offer which is says undervalues the company. Orora’s buyout of French bottle maker Saverglass from private equity for A$2.2b last year (Lone Star was the underbidder) appears to have contributed to its vulnerability.

CSL and James Hardie though weighed following their respective results (see yesterday’s note), declining 4.6% and 2.9% respectively. Recruitment platform Seek was also out of favour following its results, falling 6.7%.

Seek is the biggest jobs portal in Australia (it also operates in NZ) and delivered something of a shock yesterday, saying that the volume of paid advertisements on the online jobs platform had fallen 20% last year. The company reported a 14% fall in earnings and also downgraded earnings guidance for next year. The company’s high cost base has also been a factor.

Seek said that job openings still above pre-pandemic levels, but overall ad volumes are clearly moderating.

A strong labour market, along with higher wages (and a hotter climate) are attractions for those kiwis heading across the ditch (and driving the migration outflows noted above), but the greener pastures may be becoming slightly less green.

The labour market is softening, and wage growth is easing. The ABS reported that wages rose 0.8% in the June quarter, down from 0.9% in March. The market and the RBA had expected it to hold steady. Private sector wages grew by just 0.7%. Tt was the equal lowest rise for any quarter since December 2021. Annually growth was 4.1% which followed three consecutive quarters of 4.2%.

The public sector is stronger with 3.9% growth following pay increases in March and the abandoning of salary caps. It was the biggest June rise in public servant pay since 2012, and the first time it has outstripped the private sector in three years.

But the private sector jobs market is clearly slowing down. The unemployment rate has climbed to 4.1% (still below NZ’s) from a multi-decade low of 3.5%. This is also while the RBA has ruled out rate cuts this year on concerns over inflation and productivity growth.

A better economy, and lower interest rates may have fostered the brain drain across the ditch. The cash rate in Aussie is 4.35% compared to 5.5% for the OCR in NZ. We will know in a few hours whether Adrian Orr and his colleagues will do us a favour here and hear the broader economic call.

Comments from our readers

No comments yet