Devon Funds Morning Note - 5 April 2023

Central banks have been seeking to achieve price stability, post the surge in inflation as a by-product of the economic response to the pandemic. This necessarily involves cooling the economy down, but not too much so that it freezes to a halt and engineers a steep slowdown (a ‘Goldilocks’ outcome is the ideal scenario). As part of this process officials are effectively trying to engineer unemployment, with an ultra-tight labour market that has increased the possibility of a wage price spiral.

The Fed and many other central banks appear to be winning the war against inflation as evidenced by recent declines in CPIs, and will also likely welcome the news that labour market pressures are showing signs that they may abate. The number of US job openings decreased to 9.9 million in February. Consensus expectations were for 10.5m openings. The number of hires was little changed at 6.2 million, but vacancies have dropped to the lowest level since May 2021.

To give some context, however, there are still 1.7 job openings for every unemployed person in the US. Friday’s jobs report is also expected to show that employers added nearly a quarter of a million workers in March, with the unemployment rate holding at historic lows. The US employment market is still very strong.

A data dependent Fed will add employment prints to the deck of data used in making rate decisions in the coming months. The banking sector crisis though appears to be becoming less relevant with regulators, the government and the industry taking steps to eliminate contagion risks. On Tuesday Credit Suisse Chairman Axel Lehman apologised to shareholders for the bank’s collapse and emergency takeover by UBS.

Sector wise, healthcare stocks were in demand, while technology was less so. Tesla fell another 1% after disappointing delivery numbers, and with concern that further price cutting will be needed to stoke volumes. An early mover, Tesla had its own way a few years ago, but seemingly can no longer rely on being an aspirational brand, with the EV space a lot more crowded.

Tech companies generally have been right-sizing their workforces in recent years as the reality of a sustainable growth outlook set in. An extreme example overnight is Virgin Orbit, with the satellite launch company filing for bankruptcy protection, and ceasing operations for the “foreseeable future.” The company though maintained that its cutting-edge launch technology has wide appeal to buyers in the sale process.

The Kiwi market was higher on Tuesday, with sentiment lifted by the RBA pushing a pause on further interest rate hikes. The NZX50 rose 0.5% to 11898. Mainfreight gained 0.6% to $70.50, while Fisher & Paykel added 0.2% to $26.58. Infrastructure and activity related names were in demand - there were 2%+ gains for Infratil, Fletcher Building and Vulcan Steel. Port of Tauranga sailed 1.6% higher.

In the gentailers, Contact added 1%, while Meridian jumped 3.5%. Mercury NZ was 0.5% higher after agreeing on a long-term Corporate Power Purchase Agreement with Amazon for renewable energy for the tech titan’s Web Services unit’s Auckland data centres, planned for launch in 2024. Amazon will purchase around half the real time output of Turitea South (the southern section of Mercury’s Turitea wind farm) for an undisclosed price. Turitea South is 103 megawatts and expected to produce 370 gigawatt hours per annum. Mercury has a strong pipeline of renewable development, and an anchor customer the scale of Amazon will be highly reassuring as the company looks to develop renewable projects “at pace”, and will help Mercury get there faster.

It's the RBNZ decision this afternoon. The central bank is widely expected to put through a 25bps increase in interest rates, taking the OCR to 5%. This would be the 11th consecutive rise since October 2021 and comes as inflation at 7.2% has not fallen significantly. The floods and cyclone will have stoked inflation further.

A complicating issue however is that inflation prints are not (unlike Australia and other countries) monthly. Monetary policy operates with a lagged impact and this is being acknowledged by other central banks. The NZ economy has already slowed down significantly, with the December quarter GDP showing a contraction, when the RBNZ was forecasting an expansion. The NZ economy is probably already in recession and will not have been helped by the weather events in recent months. 

Consumer confidence is at a low ebb, which is no surprise given the cost of living pressures and the impact of mortgage holders going onto much higher rates. The number of Kiwis defaulting on their mortgages, while below pre-pandemic levels, is rising. The price of petrol is set to rise in the coming months. The property market has fallen, and the wealth impact could impact consumer spending (a key driver of the economy) further in the coming months.

Businesses (particularly in construction and retail) are not feeling particularly optimistic. The NZIER survey of business opinion for the first quarter showed a mild pick-up in confidence and activity from a record low, but 61% of respondents still expect conditions to deteriorate in the coming months. An interesting point from the survey was that concerns around sales (41% of firms) have supplanted those over the availability of labour (29%). Immigration and open borders are helping the latter, and should also negate concerns over a wage-price spiral.

Will the RBNZ follow the RBA in pausing, and letting the lagged effects of previous rate hikes work their way through the system? Probably not, and we are unlikely to get a deep dive into what officials are thinking given today is a Monetary Policy Review as opposed to a statement. Still, expectations from where the terminal OCR will end up have shortened from 5.5% to 5.25%. Time will tell if the RBNZ, as one of the first central banks in the world to raise rates (beaten only by Norway), is one of the last to end the tightening process.

Pressure facing parts of the retail sector have been laid to bear with catalogue operator EziBuy put into administration this week by its Australian owner Mosaic. The once darling of retail database marketing (Woolworths, a previous owner, bought EziBuy for $350 million a decade ago) has been hit by a confluence of factors. The retailer has become less chic it seems, and after having a purple patch briefly during the pandemic, is now wearing the pain of a move from on-line to off-line, and also a cash-strapped consumer.

Pressing pause. The Australian market rallied strongly as the RBA pressed pause on rate hikes after increasing them for 10 consecutive meetings since May last year.  The ASX200 gained for a seventh consecutive session, rising 0.18% to 7,236. Consumer stocks were in the green, while gold, energy and technology led the way higher. Materials were softer.

The RBA left the cash rate at 3.6% but did not rule out further tightening of monetary policy in the months ahead. Effectively officials are adopting a “wait-and-see” approach, conscious of the lagged impact of the tightening work that has been done to date. Helping in matters is that monthly CPI prints show inflation is coming down, and likely peaked at 8.4% in December last year – February’s CPI was lower than market expectations at 6.8%.

Officials also acknowledged that the economy is slowing down, and that the combination of higher interest rates, cost-of-living pressures and a decline in housing prices is leading to a substantial slowing in household spending. The accompanying statement noted that “while some households have substantial savings buffers, others are experiencing a painful squeeze on their finances”. RBA Governor Philip Lowe said the decision to hold interest rates steady this month provides the board with “more time to assess the state of the economy and the outlook.”

The labour market meanwhile remains very tight, although officials note that some firms report an easing in labour shortages and the number of vacancies has declined a little. The RBA expects unemployment to increase as the economy slows. On a related note, employment portal Seek (-1%) reported that FY23 revenue will be about A$15 million lower than forecast, at around A$1.245 billion as job ad volumes soften. The company is however lowering operating costs, and reiterated its guidance for A$560 million in earnings (EBITDA). 

Elsewhere, the ACCC, Australia’s competition regulator is calling for further submissions before it makes a decision on where to approve ANZ’s proposed takeover of Suncorp’s banking arm. The regulator said that given muted competition between the big banks in recent years, any acquisition of a potential rival by one of the major banks “must be closely considered.” A final decision is due in June.

One deal going through however is the acquisition of Australian founded skincare group Aesop which has been sold by its Brazilian parent, Natura & Co, to skincare giant L’Oreal in a US$2.5 billion deal, the largest for any luxury brand in Australia. Aesop, which uses plant-based ingredients for its skin, hair and body products, had sales of US$537b in FY22, has been growing strongly, and has net profit margins approaching 25%. Will the fable continue a while longer yet? Notably, L’Oreal sees Aesop as a means to tap into today’s “ascending currents,” particularly in China and travel retail.

Also staying in fashion yesterday was Telstra. Shares in the telco added 0.7% to $4.25, the highest level since 2017. Investor sentiment continues to be stoked by the prospective monetisation of infrastructure assets via a spin-off or trade sale. Telstra is held across a number of the Devon funds.