Investment update with John Pearce – October 2024

Hi. I'm John Pearce, Chief Investment Officer. Welcome to this investment update. Today I'd like to update you on recent market movements and option returns. I'd like to discuss where Australia is in the financial economic market cycle, and I'd like to contrast it with the US. And that'll lead me to conclude that when I look forward, I think the US is in a much better position than Australia to deliver stronger returns.

Last time when I briefed you was in July this year, and we talked about the financial year. We mentioned how strongly that financial year finished, to the point where a number of our growth options recorded double-digit returns. So a pretty good result, and I'm pleased to say that this financial year has also kicked off very strongly. Take a look at this table, we have a few results up here. Now, caution—it is only about three and a half months of returns, so we're still early in the piece. Up the top of the list, Listed Property. Down the bottom, Cash. That range of results is the sort of pattern that we like to see whereby those who are taking risk are getting rewarded for taking that risk.

Chart 1: Two tables showing returns of UniSuper options and key market indices from 1 July 2024 to 11 October 2024. The first table shows Listed Property, 11.0%, Global Environmental Opportunities, 7.9%, Balanced, 3.9%, and Cash, 1.2%. The second table shows an ASX200 return of 7.1% and an S&P500 return of 5.6%.

In terms of the Balanced option, a pretty solid result. If you think about Balanced options, anywhere around high-single-digit returns for a full year is, to me, a good result—so we are on the way to that but as I said, early days. Listed Property—that came on the back of last financial year where it recorded up 13%, so the recovery continues. Property is an asset class that really benefits from stable or falling rates, and that is the driving force behind these sorts of numbers. Global Environmental Opportunities or GEO as we call it, and you will recall that last year was a torrid year for GEO, last financial year down about 16%—great to see a recovery there. What's underpinned that recovery? Firstly, the option has benefited from cuts in interest rates in both the US and China. It's also benefited from the fact that valuations became quite depressed. If we look at the companies in GEO—strong growth profiles, but share prices were really hammered. And at certain valuations, they just attracted support. And finally, the prospect of Kamala Harris becoming president of the US is positive for the renewable sector, and that, of course, would be positive for GEO. It is nice to see this recovery, but I just want to remind viewers that GEO is a specialised, concentrated option, so we can still expect it to be more volatile than the general market

Speaking of the general market—how have they performed? Let's look at the ASX, the Australian market, versus the US market. And we see this financial year—is that a misprint? No, it's not. The ASX has actually outperformed. We don't see that very often. Why has this happened, and can it be sustained? I've got my doubts, and this is why.

Think about the drivers. Why has Australia done pretty well in the last few months? It's all about China. At the end of September, China announced some very significant stimulus packages to get the economy out of its slump that it currently finds itself in. The impact on Australian stocks was quite dramatic—particularly, as you’d imagine, our resources sector and mining companies. In fact, at one point there, it reversed a very strong trend that we've seen this year whereby investors have been piling into our bank stocks and shunning our resources stocks. Look at this graph here, I think it illustrates it really well. Here we have the performance of Commonwealth Bank, our biggest bank, versus BHP, our biggest miner. And up to the point China announced those stimulus packages, CBA was up around 60%—BHP negative for the last financial year. Massive difference.

Chart 2: Graph comparing the total returns of CBA and BHP from July 2023 to 14 October 2024, showing the positive correlation between China’s September 2024 stimulus announcement and BHP returns.

You'll note that that trend of buying BHP and selling CBA is now being tempered because the market is getting a little bit cautious, and I think the market's right to be cautious. Why? The reality with China is that it finds itself in a real slump. It’s fighting deflation; property prices and construction, down between 30% and 40%. That is GFC proportions. And if you look at what it took countries to get themselves out of those GFC type situations—stimulation measures of about 10% of GDP. China is throwing about 2% at the problem. Nobody thinks that's enough and that's why the market is indeed a bit sceptical. If China doesn't get serious about more stimulation, it could potentially be looking at one or two lost decades as Japan experienced.

Let's change tack and move to Australia, and where are we in the business cycle, and I just want to remind you what the business or the financial cycle actually looks like. Now, I've been putting up this nice graph for many years, the first time was in January 2021, and we had our crisis, the Covid crisis. At this time, you can remember that we were throwing everything at getting out of the crisis. Governments were spending and central banks were loosening rates. At the time we said ‘normal cycle, markets should recover’, indeed the market was rallying by then. Then June 2021, the economy, the real economy started to recover. Employment rose and things looked pretty good. But of course, then, a problem emerged, and in February 2022, the problem was inflation.

Now with inflation—markets don't like it because they figure central banks are going to start tightening, and indeed they did. You roll the clock forward to October 2022, and this is the picture—we're right in the middle of aggressive tightening.

Chart 3: Image showing the economic / financial market cycle. Typically, recession and higher unemployment is followed by: policy stimulus and market rallies; a recovery in growth and a fall in unemployment; inflation and market falls; policy tightening. Then the cycle repeats. In October 2022, the next stage of the cycle could have been a recession, but as at October 2024, we are yet to see this.

The cycle was playing out exactly as I had predicted and quite frankly, I was feeling a bit chuffed with myself. I also mentioned at the time, these typically end badly, and when I say badly, it means recession. But that was two years ago, and we haven't had a recession. So rather than being chuffed with myself, I'm starting to think I've got to concede defeat.

However, there is a twist. Think about the Australian economy. Yes, we have been experiencing positive GDP growth, but that's in aggregate. And that's been driven by population growth, which has been driven by immigration growth. So it’s an aggregate number, and aggregates can actually disguise the true picture. What if we looked at GDP growth or income growth per head of population, per capita?

Take a look at this graph. We've been going backwards. The Australian economy, on this measure, is looking a bit sick. Seven out of the last eight quarters, we've been going backwards. Now contrast this with the US economy—all positive bars.

Chart 4: Bar charts showing the quarter on quarter changes in GDP per capita of Australia versus the US. Australia looks ‘sick’ with shrinking GDP per capita for seven of the last eight quarters, while the US appears 'healthy’ with growing GDP per capita for the last eight quarters.

The US economy is doing well. If you think about interest rate policy—the Australian economy looking sick, US economy doing pretty well—Australia should be easing rates and the US should be tightening. Well, that's not the case. In fact, the US has eased rates by 50 basis points, and the reserve Bank of Australia is actually on hold. Why is this the case?

First reason—have a look at this graph. It turns out that the US hiked rates faster and higher than Australia. So the Fed Reserve has actually got a bit more scope to cut rates. That's the first reason.

Chart 5: Chart showing the interest rate cycles of Australia versus the US from January 2022 to October 2024. The Fed hiked rates faster and higher than the RBA. The Fed delivered its first rate cut of the cycle in September 2024 while the RBA continued to hold.

The second reason—probably more importantly—look at inflation. Here we have the US getting down to that target, that magical 2% mark, and the Australian inflation rate still way above target. Still too high.

Chart 6: Chart comparing the Australian and US year on year inflation rates from January 2022 to October 2024. Australian inflation remains above 3%, ‘still too high’ compared to the RBA’s target, while US inflation is dropping to the Fed’s 2% target.

So I would actually describe the US as being in a ‘Goldilocks’ scenario. It's got a strong economy, it's got inflation that's behaving, and we have a fed that's actually cutting rates. These are classic ingredients to sustain a market rally, so we shouldn't be surprised that the US market is indeed rallying. Can it be sustained? After all, it's been going for two years, isn’t it getting a bit long in the tooth? Not if history is any guide. One of my favourite graphs—we're showing the last ten bull markets in the US going back to 1950. And what does it show? It shows that bull markets tend to last a lot longer, and go much higher, than the current bull market that we're in.

Now this is history, and I'll get in trouble if I don't remind you that past performance is no indicator of future performance. But the point I do want to make is that this rally is not going to die of old age, per se.

Chart 7: Chart showing the length of the most recent ten S&P500 bull market runs. Historically, most bull market runs have lasted longer and achieved greater highs than the current bull market run.

I also don't think this rally is going to die because of geopolitical disturbances or the US political situation, the presidential election. The fundamentals of the US are pretty strong. US corporates, their balance sheets are in great shape. We have a situation where productivity in the US is leading amongst the developed world. And finally, the technology revolution. It really is the US that's driving the tech revolution. I personally think the death of US exceptionalism has been exaggerated.

Of course, there are things that can derail the rally, and I think the main one, and maybe the only one, is a reemergence of high inflation. That is not our base case. We believe that inflation will remain under control, and if indeed it does, we also believe that the current rally can be sustained.

Thank you very much for watching.

This video provides general information and may include general advice. It doesn’t take into account your financial situation, needs or objectives. Consider your situation before making financial decisions, because we haven’t, as well as the PDS and TMD relevant to you at unisuper.com.au/pds, and whether to consult a qualified financial adviser. Past performance isn’t an indicator of future performance. Information is current as at 16 October 2024. Comments on the companies we invest in aren’t intended as a recommendation of those companies for inclusion in personal portfolios. Holdings are current as at 30 September 2024 and are subject to change without notice. Prepared by UniSuper Management Pty Ltd (ABN 91 006 961 799, AFSL No. 235907) on behalf of UniSuper Limited (ABN 54 006 027 121) the trustee of UniSuper (ABN 91 385 943 850, AFSL No.492806) the fund.