Reporting season kicks off

Greg Smith is the head of retail at Devon Funds www.devonfunds.co.nz and a regular opinion contributor.

OPINION: Falling dairy prices provide a material backdrop for the earnings season which is getting underway, and the Reserve Bank’s rate decision on Wednesday. Food prices generally are highly topical, with those for fruit and veges now in retreat, providing additional context to the government’s recent pledges around GST.

The United States indices were mixed on Friday, with the Dow adding 105 points while the S&P500 and Nasdaq were 0.1% and 0.7% lower respectively. Technology names sold off, with the semiconductor sector down 5% (although still up about 45% year to date). A key US consumer survey showed that inflation expectations are falling, adding to the deflationary story in a week when the CPI printed much lower than forecast. Factory gate inflation though came in higher than estimates in July, suggesting some challenges remain. It is another busy week, with the release of the Fed minutes, while US retail sales numbers and earnings reports from retail giants Home Depot, Target and Walmart will give further insights into the well-being of the US consumer.

The S&P500 closed the week down around 0.3% while the Nasdaq fell 1.9.%. Older economy stocks held up better, with the Dow advancing 0.6% over the five sessions. The US earnings season has once again been better than feared – around 80% of S&P500 companies have beaten earnings expectations.

The June Consumer Price Index provided much cause for cheer, with core CPI (which strips out food and energy) coming in at the lowest since October 2021. Inflation is coming down, however there are areas which remain “sticky” – notably the services sector. US Producer Price Inflation ticked up more than expected in July, increasing 0.3%, from a flat reading in June. Expectations were for a smaller rise at +0.2%. Services inflation rose 0.5%. Annually, headline PPI increased 0.8% in July, up from +0.2% in June.

On balance the prints last week still have increased bets that the Fed will leave rates alone at the next meeting in September. The fact that expectations of inflation (often a self-filling prophecy) are coming down is also helpful. The University of Michigan’s survey showed that consumer inflation expectations unexpectedly fell in early August, ticking lower by a tenth of a percentage point to 3.3%. Over the longer term, price gains held at 2.9%. While long-run expectations remained “elevated” the inflationary situation is clearly improving and helping the mood of consumers. Consumer confidence was relatively unchanged in August but is now over 40% above the record lows seen in June last year.

There was some positive news around the UK economy as well which expanded more than expected in the second quarter. The UK economy grew 0.2% between April and June, with growth picking up from 0.1% in the first quarter. This was the strongest quarterly growth rate in over a year, and much better than the flat reading that was forecast. In June alone, GDP growth picked up to 0.5% month-on-month, although an extra bank holiday in May (celebrating the King’s Coronation) may have been a factor.

A surprisingly resilient UK economy still has some challenges, with interest rates at the highest in 15 years, and large numbers of mortgage holders set to drop

off low rates in the coming months. All eyes will now be on the UK inflation numbers this week. CPI is expected due to fall from 7.9% in June to 6.7% in July. The FTSE dipped 1.2%.

European indices were lower on Friday as was Asia. The CSI300 in China fell 2.3%. There is a new name of concern in the Chinese property sector, with Country Garden, one of the largest developers in the country saying it had underestimated the market downturn. The company is expecting a half year loss of up to US$7.6b from a profit of US$265m last year. The company has appointed a “special task force” to look for ways to turn the business around.

The Australian market was 0.2% higher for the week, after dipping 0.2% on Friday. Most sectors were weaker on Friday, with the energy sector pacing the declines, falling nearly 2% after a strong run recently.

The Reserve Bank of Australia (RBA) minutes are due this week, which are set to give further clues as to the next move on rates at the start of September. RBA governor Philipe Lowe testified before Parliament on Friday that borrowers were holding up well despite the mortgage rate cliff which he felt was peaking. Lowe said a million borrowers have shifted so far and another million will shift in the next 12 months. Lowe though described it as the most “telegraphed” rate in living memory and is more concerned that it will be sticky rents which will prove problematic. The testimony was seen as dovish and at this stage markets are pricing in just a slight chance of another rate rise next month.

A resilient consumer was also in evidence in results from furniture retailer Nick Scali. The shares surged 13% after the company reported a 34.9% jump in full-year net profit to A$101.1 million, ahead of expectations. Sales jumped 15% to A$507.7m, and underlying net profit climbed 4.6%. Chief executive Anthony Scali however said that the year ahead could be “tough.”

The chips though were up for Star Entertainment which surged 18%. The New South Wales government has said it will amend casino duty rates, which will help ensure the Sydney casino remains viable. Star will pay a transitional rate of 20.9% from July 2023, rising in annual increments to 22.91% from July 2027 onwards. The new plans are a significant improvement for Star on former proposals to levy a 60.7% tax on poker machine revenues.

There are lots of earnings out this week in Australia. From an economic perspective, Thursday’s jobs’ numbers will be in focus.

The Kiwi market was 0.9% lower for the week. Fonterra shares (both the Shareholders Fund and Co-op) finished the week strongly, as the co-op lifted earnings and dividend guidance. Fonterra is returning 50 cents per share to unit holders and shareholders this week following the sale of certain offshore assets, including the Soprole consumer business in Chile. This is good news for farmers who have been battling lower farmgate milk prices.

Synlait was flat after reducing its forecast milk price to $7kgMS (per kg milk solids), down from $8. Also feeling some pain from China was A2 (-2.7%) as infant milk competitor Feihe warned earnings may drop more than a third, citing a low birth rate in China and competition as key factors. We will get another read on the health of the dairy sector with the latest GDT auction this week.

Falling dairy prices aren’t great news for dairy farmers or the economy, but wider falls in food prices are good for consumers battling cost of living pressures. Stats NZ has reported that annual food prices were 9.6% higher in July 2023 than in July 2022. Grocery prices led the way higher, increasing 11.9% while fruit and vege prices also increased 6.2%. However, the peak now looks to be in.

A key point was that on a monthly basis, food prices fell 0.5% in July compared with June. After adjusting for seasonal effects, prices were down 1.1%, only the third monthly decline since December 2021. Fruit and vegetables prices declined sharply (although they are 6.2% more expensive than this time last year). This is all fairly topical with the Government pledging to knock off GST on fresh fruit and veges.

This has opened up a can of worms (or beetroot) in many respects about the practicalities of administering, and the relative extent to which lower income households will benefit, and whether supermarkets may absorb the savings anyway. In any event the news that fruit and vege prices are already on their way down is good to hear.

Downward moves in inflation will be a big factor for the Reseve Bank to consider when it meets on Wednesday. After lifting the OCR from a low of 0.25% during the pandemic, the central bank is expected to remain on pause at 5.5%. Opinions about whether we will see another rate hike this year are split, and some are even expecting a rate cut. Falling milk, and now food prices generally, are certainly taking further heat out of the inflationary equation. A patchy recovery in China, our largest customer, is also a potential handbrake for our economy.

The earnings season meanwhile arrived in earnest this week.

Contact has come out with full-year results on Monday. The gentailer made a one-off non-cash provision following a review of the capacity of the Ahuroa gas facility of $84m which weighed on net profit. However, underlying earnings (Ebitdaf) increased by 5% to $573m. Management noted there have been the highest nationwide hydro inflows in post-market history, while North Island rainfall was the highest on record. The company reiterated that decarbonisation plans were on track with generation set to be more than 95% renewable by FY27.

It will be interesting to see how the earnings season unfolds over the coming weeks. Covid beneficiaries will be in the spotlight again to see how they are handling the return to a normalised trading environment, while reopeners including the travel sector should be continuing to ride some reasonable tailwinds. Outlook statements generally though are likely to be somewhat conservative, and particularly given a host of prevailing uncertainties across the broader economy.