Markets continued on an upswing last week with the US S&P 500 up nearly +4% year to date and the Nasdaq Tech index gaining +7% in January so far reporting its third weekly gain in a row, driven by i) consensus that inflation has ‘peaked’ and ii) markets assuming a rate hike of 25 bps by the Fed next week.
While inflation is markedly lower, so far US growth indicators have not fallen as quickly as previously expected, which could support the case for a “soft landing” in the economy/mild recession. At the same time, growth in the rest of the world is turning the corner. Economic sentiment in the euro area is improving, driven by plunging gas prices which are now well below the level prevailing before Russia invaded Ukraine. China’s reopening, along with increased stimulus and more market-friendly policies, could also support global growth in 2023.
We wrote last week that we expect markets to have a bullish first half to the year with a bearish second half, and we continue to hold this view. Why? The short answer is, the Fed needs to get inflation to 2%. Whether this is accomplished by a series of rate hikes that are smaller, at 25bps, or larger, at 50-75 bps is really a matter of mechanics. Regardless, markets are currently pricing in a terminal Fed fund rate of 4.75-5% – it’s just a matter of how we get there.
China
Lots of talk about China’s reopening. Markets are forward looking instruments, so keep this in mind when looking at the following chart.
China data looks weak. We like this, because the weaker data is on a year-end basis, the better things look on a forward basis. It doesn’t take much to move the needle – a small amount of growth from China would move the needle a lot. It’s the equivalent of “under promise and overdeliver”. And if we look at the chart next – of China’s household savings – it’s indicative that China has a lot of firepower. A nominal change from ‘22 to ‘21 savings levels (what is the likelihood of that with reopening?) would create good momentum for CHN.
The catch – there’s always a catch – is exported inflation. We highlighted this last week and we’re going to continue to hammer home the point. All that money has to go somewhere. Burberry and Richemont reported less than stellar earnings last week on the back of impeded sales in China (an average of -24% YoY) with the assumption that sales would pick up due to reopening. That may act as a useful yardstick, next quarter, for seeing how quickly the pace of spending has picked up.
Tech layoffs (or: how I stopped worrying and learnt to love Google)
Much has been made of yet another round of tech-related layoffs last week. Microsoft slashed another 10,000 employees and Alphabet 12,000. This is a correction to pandemic-over hiring and in our view is a much-needed antidote to a decade of tech largesse.
We’re not overly worried about this. The figures are roughly in line with November’s round of layoffs, but they’re a drop in the bucket when the college educated job market remains secularly high (see below). Data suggests most unemployed are finding work within 1-3 months and we’re going to see some delayed output here, because most tech layoffs come with 12-16 weeks of severance – we will reexamine the data in 3 months as that severance pay starts to wane.
We’re not overly worried about this. The figures are roughly in line with November’s round of layoffs, but they’re a drop in the bucket when the college educated job market remains secularly high (see below). Data suggests most unemployed are finding work within 1-3 months and we’re going to see some delayed output here, because most tech layoffs come with 12-16 weeks of severance – we will reexamine the data in 3 months as that severance pay starts to wane.
S&P 500 firms are priced in to have their 6th straight quarter of net profit margin decline — earnings move relative to expectation, so companies which surprise on EPS may experience a slight boost. Longer-term, though, we have a strong preference towards companies which can maintain strong and consistent margins.
NZ & Aus
Fisher and Paykel Healthcare guided revenue for the 2023 financial year to come in at $1.55B to $1.6B, representing a +7% in revenue to market expectations. The revenue upgrade was attributable to, increased sales of hardware and consumables in China on COVID surges, an early start to flu season and RSV in North America, and continued strength in OSA sales from the Evora Full mask. We expect the focus to shift from short-term features (covid related demand) back towards underlying clinical adoption and health trends, and note China demand flagged by management presents an untapped opportunity.
We continue to be buy-rated on the stock, though it is not “cheap” but comfortable with long-term growth and quality of the stock.
Briscoes managing director Rod Duke indicated that the company will likely face lower gross margins amid more competition and higher discounting – he expressed confusion at the labour market, noting it was still “very, very difficult” filling retail positions – another indication the labour market remains secularly tight in NZ as well as the US. Polar Capital director Colin Neal sold off the bulk of his personal stake in Jucy, with Polar holding just 7.5% of the remaining shares.
NZ Rural Land Company reported stronger gains on property revaluations; suggesting the rural sector continues to be insulated from larger recessionary forces (one can’t help but wonder how a National-led government might affect property values if the foreign buyer ban is repelled – we have exposure to Kiwi Property as a way to play this potential situation, as KPG continues to be undervalued when compared to peers).
Across the ditch Myer sits at a 5 year high as PE circles competitors like David Jones. We remain underweight retail, as we think secular pressures are likely to hit retail first. Preference towards holding some exposure to Aussie commodities (BHP, Woodside) and big banks. We note Australia sits at a relatively higher valuation in aggregate to the rest of the world, and we think investors should position accordingly.
Portfolio positioning
For our US equities model portfolio we remain net cash with minimum equity exposure, however we added +1% to Disney in the global equities portfolio (2% DIS weighting) as the stock continues to trade around five year lows and i) the return of Bob Iger acts as a good management signal and ii) Nelson Peltz’s activist campaign, despite being ineffective, continues to juice the stock price (in which case you may ask, is ineffectiveness sometimes effective?) We also established two new positions. Activision-Blizzard at a 1% weighting, and Manchester United also at a 1% weighting (football fans rejoice). We consider this small positioning – 2% – to be our “special situations” part of the portfolio. Activision is being acquired by Microsoft, pending approval. Here the situation is asymmetrical: if the company isn’t acquired we think it still trades at fair value, whilst acquisition represents a nice arbitrage opportunity — MSFT has offered $95 per share for ATVI to our ~$74.48 cost basis.
Manchester United is a different kettle of fish, and we encourage you to read our full report. The company is an acquisition target – both the Saudi govt and INEOS billionaire Jim Ratcliffe have entered into formal bids for the team. Chelsea was acquired for $5.4B under distressed circumstances, whilst Manchester Utd trades for ~$3.85B as of writing. “Trophy” assets like this command a hefty premium – we think a $5B acquisition price is likely, representing a +23% gain for shareholders. “Big money” is involved here — UK fund Lindsell Train owns 20% of the company, whilst US-based Ariel Investments own another 20%. They’re going to be keen for a deal. We think Ratcliffe is likely to win the bidding — he’s a Brit, as well as having an interest in successful sports clubs before (Nice, Mercades Benz F1).
As of market close on Friday the US equities model portfolio has returned 1.14% with approximately 80% cash positioning. Cash will continue to be deployed.
Week ahead
S&P 500 firms are priced in to have their 6th straight quarter of net profit margin decline — earnings move relative to expectation, so companies which surprise on EPS may experience a slight boost. Longer-term, though, we have a strong preference towards companies which can maintain strong and consistent margins.
A whole host of big earnings this week. Visa and Mastercard report results: we expect strong earnings as consumer spending continues somewhat unabated, while we’ll be looking at the shift in credit/debit mix. Microsoft also reports earnings – last quarter the company guided down to $52.35-53.5B in revs – we err on the low side, and expect largely flat growth in the company’s lucrative Microsoft 360 segment. Tesla reports, alongside staples like Colgate and chipmaker Intel. We look at Colgate as a proxy for consumer spending (key questions: how much did prices increase vs. how much did volume fall?). We stay well clear of Tesla whilst Elon is at Twitter – there are better, and cheaper car companies. Intel has been left for dead for the last several quarters, as chipmakers like Nvidia overtook them; we may see a slight surprise for Intel in light of recent on-shoring trends and government incentives directed at local chipmakers.
What Markets will be Watching this Week (UTC +13)
Monday
Tuesday
Aus NAB Business Confidence Report
Earnings From Microsoft. Johnson & Johnson,
Auckland International Airport Monthly Traffic Update
Wednesday
CPI (Inflation) data for Australia and New Zealand
Earnings from Tesla
Quarterly updates from Fortescue, Woodside Energy and Mineral Resources
Thursday
Bank of Canada Interest rate decision
Earnings from Visa, LMVH, Mastercard
Friday
US fourth Quarter GDP
Earnings from ResMed