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Devon Funds Morning Note - 7 June 2024

Friday 7th June 2024

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European markets closed at record highs on Thursday as the European Central Bank delivered the first interest rate cut since September 2019. The STOXX600 surged 0.7%. A statement accompanying the decision noted that inflation has continued to recede over the past few years and the “inflation outlook has improved markedly.” This makes things more interesting ahead of US inflation numbers and the fed’s meeting next week. US markets were relatively subdued. The S&P500 and Nasdaq closed fairly flat while the Dow added 0.2%. Nvidia eased back below the US$3 trillion market cap threshold. 

Policymakers in Europe lowered the benchmark interest rate (by 25bps to 3.75%) for the first time in nearly five years. The Bank of Canada also cut rates earlier this week on a moderating inflationary picture, but the ECB decision (while widely expected) is an even more momentous one, with the world’s second largest central bank showing the way on policy loosening. President Christine Lagarde commented that the inflation outlook had improved “markedly” and envisioned a “strong likelihood” that the central bank was moving to a “dialling-back phase”.


The Fed meanwhile meets next week and appears to have positioned for rate cuts later in the year. This timeline though could potentially change if supported (one way or the other) by further data. US inflation numbers are out next week, and the non-farm payrolls report is out tonight.


The US economy has clearly slowed down. Job openings are the lowest in three years, albeit these were unsustainably high coming out of Covid. Other data on Thursday showed a rise in jobless claims. Initial filings for unemployment benefits rose 8,000 last week to 229,000, above estimates for 220,000. Continuing claims were little changed at 1.79 million. Nonfarm productivity was meanwhile up 0.2% for the first quarter, while unit labour costs increased 4%, less than the 5% rise anticipated. Expectations for the jobs report on Friday are for additions of around 190,000 jobs in May but a rise in the unemployment rate to 4% (the jobless rate has been below this mark for 27 consecutive months – the longest stretch since the 1960s). 


The US trade deficit for April also rose to an 18-month high of US$74.6 billion, up US$6 billion from March, although slower than the US$76.5 billion estimated. The trade picture is also very relevant should the Fed keep rates where they are while large trading partners such as Europe and Canada (around 20% and 17% of US exports respectively) are cutting them. Any ongoing weakness in the euro and Canadian dollar against the greenback would have an impact on US trade competitiveness and further increase the trade deficit. It meanwhile is an election year, and while politically agnostic in theory, the implications are unlikely to be lost on policymakers. There is now extra spice going into next week’s Fed meeting. 

 On the stock front, Nvidia eased 1.2% from record highs. As noted earlier in the week, one of the greatest risks to the AI frenzy maybe the ability of governance and regulation to keep pace. Another move has been made. US antitrust regulators evidently plan to investigate Nvidia, OpenAI and Microsoft over their roles in the AI industry. The US Department of Justice has reportedly agreed to take the lead in investigating whether chip maker Nvidia violated antitrust laws. The Federal Trade Commission will meanwhile probe ChatGPT-creator OpenAI and partner Microsoft. The FTC launched a probe into OpenAI last year over claims it had put personal data at risk, and earlier this year ordered OpenAI, Microsoft, Alphabet and Amazon to provide information on all deals involving generative AI companies and cloud service providers. Regulatory oversight could well ramp up. 


On the company front, shares in Lululemon jumped 4.8% after beating first quarter earnings estimates on revenues of US$2.2b. The yoga-pants maker has seen demand cool since Covid and amid cost of living pressures. Sales in the Americas increased 3%, versus a 17% jump in the year-ago period. Investors were though encouraged by a lifting of the outlook amid strong demand in China, and a US$1b increase in buybacks. The shares are still down 35% year to date. 


The market’s liking for buybacks was also demonstrated elsewhere. Food delivery platform Instacart leapt 9% after it flagged stock repurchases of up to US$500 million. In Asia shares in Japanese firm Softbank pushed higher as activist investor Elliott Management rebuilt a stake worth more than US$2 billion, and is pressing for a US$15 billion share buyback.


Activism is also a theme at Salesforce whose shares rose 2.6%. An activist board member took his stake in the software company to just under US$1 billion. The move was made after the company reported its first revenue miss since 2006. Amongst the desires are evidently a plan to push for acquisitions to reinstall growth. 


Former pandemic favourites were in the spotlight. Brokerage firm Robinhood jumped 6% after announcing an acquisitive US$200m raid on crypto exchange Bitstamp. Shares of GameStop soared 50% after meme stock champion “Roaring Kitty” scheduled a livestream on YouTube, his first in almost four years. The investor hosted three-hour livestreams in August 2020 explaining his investing thesis behind the bricks-and-mortar video game retailer. “The kitty” posted screenshots of his brokerage portfolio over the weekend which included 120,000 call options which if exercised, and at the May highs, would take his stake to more US$1b. Some incentive there. 


Tesla shares were 1.7% higher and Elon Musk had another reason to be chipper. SpaceX completed a test flight of its Starship rocket for the first time on Thursday.

Starship is both the tallest and most powerful rocket ever launched. Fully stacked on the Super Heavy booster, Starship stands 397 feet tall and is about 30 feet in diameter. The 33 Raptor engines at its base together produce 16.7 million pounds of thrust – about double the 8.8 million pounds of thrust of NASA’s Space Launch System rocket. 


Across the Atlantic, the European indices were higher, with tech and healthcare leading the way. Shares in Novo Nordisk rallied 4% to an all-time high amid continuing strong demand for its blockbuster Wegovy weight loss drugs. Like Nivida though, competition is about to heat up. Chinese drugmakers are reportedly working on 15 generic versions of the popular drug.


The FTSE100 rose 0.5%. The UK construction sector grew in May at its fastest pace in two years, according to a survey. In Asia the Nikkei rose 0.6%, and the Hang Seng rose 0.3%. The Sensex in India rallied 1% as investors adjusted to the fact that PM Modi’s nationalist party has lost its outright majority. 

New Zealand

The Kiwi market fell on Thursday, with the NZX50 down 0.2% to 11,973. Sky City Entertainment was a big drag, falling 15% to a 24-month low in the wake of another earnings downgrade and as dividends were put on ice. Fisher & Paykel stepped back from its recent run, declining 2.4%. Auckland Airport dipped 0.9%. EBOS fell 0.6%, Spark NZ was 1.2% softer. Mainfreight though rose 1.1% and Infratil jumped 3%. Contact Energy leapt 1.7%.

Sky City’s announcement (see yesterday’s note) provided more evidence of the squeeze on discretionary spending. The outlook remains challenged, with dividends not set to resume until 2026. The casino operator has faces other challenges, including across the Tasman. This morning the company announced that the High Court of Australia has granted special leave to appeal the South Australian Court of Appeal’s judgment on the interpretation of the relevant provisions in the Adelaide Casino Duty Agreement. These provisions determine the treatment of loyalty points converted to gaming machine play for the purpose of calculating casino duties. 

The matter is a longstanding contractual dispute. There will be a full hearing of the appeal later this year. The question of the applicable interest rate for outstanding duty, and whether the contractual interest provision in the Casino Duty Agreement is enforceable, remains to be determined by a single judge of the Supreme Court at a later date. 

If that decision is unfavourable SkyCity Adelaide may be obliged to pay penalty interest on the additional casino duty, which could be up to around A$22.8 million. If however SkyCity Adelaide is successful in its appeal of the substantive issue to the High Court (but unsuccessful in its application to the Supreme Court regarding penalty interest), then penalty interest may still be applicable but would be reduced to an amount of up to around A$2.4 million.

Building activity has meanwhile also confirmed the sluggish nature of economy. Stats NZ reported yesterday that the seasonally adjusted volume of building work fell 4% between the December and March quarters to $8.3 billion. Residential work is feeling the pain to a greater degree – down just under 5%, and approx. 14% from peak. This compares to a smaller fall in non-residential work – only down 2.8%. But the residential slice of the pie is larger. The total volume of building work in the March 24 quarter is the lowest quarterly volume in 2 years. The pipeline of work is falling if you extrapolate building consent data, so these numbers look set to weaken further over the year ahead.

But there’s still plenty of demand for NZ government bonds. There were $3.5 billion of May 2028 bonds sold with a yield to maturity of 4.62%. Bids totalled $15.5 billion.


In The Australian sharemarket rose on Thursday, with the ASX200 leaping 0.7% to 7,821. Every sector was in the green. Gold glistened 2.2% higher. Shares in Commonwealth Bank, the country’s largest bank, rose 1.1% to a record high. The shares are up 30% over the past year. BHP added 0.3%. Iron ore prices ticked up 2% to US$108 a tonne. The tech sector followed the Nasdaq’s lead. Data centre operator NextDC rose 1% to a record high. Intelligent software firm WiseTech Global rose 2.8%.
Not such a good session for international student placement business IDP Education. The shares fell 7.5% as the company maintained full year earnings guidance, but warned of a large reduction in business due to tighter immigration policies proposed in Australia and around the world for international students. IDP expects that the size of the international education market will decline by 20 to 25% over the next 12 months. The firm’s student placement volumes are set to fall 15-20%. Cost reduction plans are underway. IDP is the second most shorted stock (17% of the float) on the exchange. The Devon funds have no exposure to IDP.

The Aussie trade picture remains strong, but has moderated somewhat. Exports fell 2.5% year on year in April to $43.3b, the lowest since 2021. Metal ores and minerals were the key driver of the decline. Imports fell 7.2% year on year, which meant the trade surplus surged to A$6.55 billion, up $1.7b on March, and comfortably beating estimates for around A$5.4 billion.

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