Investment update with John Pearce - February 2023

Hello and welcome to this investment update. I'm John Pearce, Chief Investment Officer. 

Today, I'd like to briefly recap on 2022, how investment markets panned out; I'd like to try and make sense of the amazing rebound we've seen in markets in 2023; then briefly summarise what UniSuper's investment approach has been throughout these volatile times. 

Late October last year when I gave this update, I put up this slide. It showed the US stock market, the S&P500, in a steep decline over the year—about a 25% decline. The slide was titled ‘The Bears are Winning’ because the bears, with their claws, were dragging prices down.

Image 1: Image showing the movement in the S&P500 between January 2022 and the end of September 2022.

I could have actually put up a slide showing the ASX, the Australian stock market, and it would also have shown a decline. Not by the same percentage amount, but once again, the bears were definitely in control.

There was a lot of bad news in that price, and there was a lot of bad news expected, and it turns out the markets were right. Have a look at some of these key data points we've seen over the last few months. Australian house prices down about 9% on average, that's a big number. Multi-decade highs in the inflation rate—7.8%. The Reserve Bank of Australia is embarking on the fastest rate-hike cycle since the 1990s.

Image 2: Image showing the movement in the Australian Stock Exchange between January 2022 and the end of September 2022.

This is all pretty bad news, do you agree?

Let's roll the clock forward and see exactly what the Australian market has done.

Image 3: Image showing the movement in the Australian Stock Exchange between January 2022 and the end of January 2023.

Wow. We are now pretty close to our all-time highs. Are you confused? Well, you wouldn't be the only one. 
It does remind me of a famous quote by one of our greatest physicists of all time, Sir Isaac Newton. In 1720, in the midst of an irrational stock market bubble, Sir Isaac was reported to have muttered, “I can calculate the motion of heavenly bodies, but not the madness of people”. It turns out Sir Isaac was a brilliant physicist but not a great investor, he lost a lot of money, but that's another subject. 

Before we get on to explaining exactly why this market has rallied, let's have a look at what's happened to investment option returns because after all, that's what's really important to all of you. If you look at 2022, we have to bear in mind it was an extraordinary year. In the last 100 years, the US market—the stock market and the bond market, the ten year Treasury yield market—has fallen only five times in the last 100 years in the same year, and last year was one of those years, so it shouldn't be surprising when we see, across the board, poor results. International shares were hardest hit, and you see our International Shares option down around 17%. Bonds were not the safe haven they usually are, and our bond option was down around 9%. Our Balanced option was down around 5%. We don't like to see negative numbers, that's only human. But I would hardly call 5% a disaster given what happened in other markets.

Image 4: Image showing the investment returns of the following UniSuper investment options for calendar-year 2022: International Shares (-17.1%), Australian Bond (-8.9%), Australian Shares (0.7%), and Balanced (-5.4%).

Balanced options have generally come in for a bit of criticism. Well, I think that is unwarranted. Over the past few decades, the Balanced option, as a default option, has served most Australian superannuants pretty well, and I have no reason to believe that that won't be the case going forward.

Let's roll the clock forward to the end of January, and what are we seeing to those option returns? Once again, a rally in everything. 

Image 5: Image showing the investment returns of the following UniSuper investment options in January 2023 (International Shares 3.8%, Australian Bond 2.5%, Australian Shares 5.8%, and Balanced 3.3%), compared to calendar-year 2022 returns.

Let's see if we can make some sense of this. 

There's a couple of reasons, both technical and fundamental. On a technical basis, we say that the market got itself too short. Now, what do we actually mean by that? Well, in simple terms, the market got so bearish that when bad news actually came out, there were no new fresh sellers to actually sell—so when good news came out, we had all this scramble, this ‘short covering’ as we call it. And what sort of good news did we actually see? Well, there was a bit.

First, US inflation seemed to have peaked in about December, and this has given the market some confidence that we are now potentially close to the end of the US federal rate-hike cycle. This is really important for the reasons we've discussed over many of these updates. 

China. China has done an amazing U-turn. It's pretty much abandoned its zero-COVID policy—fortunately, because it was a futile policy—and it's now going all out for growth. And this, of course, is extremely important for Australia, given the dependance we have on China as an export destination. And indeed, it's one of the main reasons why the Australian market is holding up and doing a lot better than many other markets around the world. 

And finally a big one—the consumer is in pretty good shape. And it’s in pretty good shape because employment is so strong. If we look at unemployment rates around the world—US, Australia—we're talking about multi-decade lows. Think about another statistic. If you look at unemployment in Australia, the number of people unemployed? That's roughly matched by the number of job vacancies. In the US, it's an astounding 2:1. So for every person unemployed, there's roughly two vacancies. So job markets are tight, people have confidence, and they are spending.

The bottom line is that the market has now lost all its fears of an imminent recession. In fact, over the last few months, we've moved from being concerned about a hard landing to a soft landing. And now I'm even hearing talk about no landing at all. And how is this manifest in terms of the equity market? Well, the fear of losing money has been replaced by FOMO—the fear of missing out. 

Let's now turn to UniSuper's approach to investing over these very volatile times, and I will label it ‘cautiously opportunistic’. That might sound a bit oxymoronic, so let me explain myself. We are still cautious, and we are cautious because while inflation may have peaked, it is still very high and central banks are still tightening.

We can't discount the possibility of some sort of recession later on this year, and we still believe there are certain sectors of the market that are vulnerable such as unprofitable companies. But we are still investing, and if we go back to when volatility really started, we entered that period with a lot of cash. And there is no point in holding elevated levels of cash unless you’re prepared to use it when market opportunities arise, and indeed they have. So we're not spreading investments across everything, but we are selectively looking at opportunities. And the best opportunity I can give you an example of is the issuance of bonds—‘tier 2’ or subordinated bonds, as we call them—by our very strong major banks. We've accumulated over $2 billion of these bonds at yields in excess of 6%.

To put that in context, about 18 months ago, these bonds were yielding around 1.2%—that is an incredible leap. So we think they are fantastic value because our banks are in great shape. We've been working very hard for the last few months on high-quality, large forestry and infrastructure assets, and we hope to be making an announcement on those pretty shortly.
We think the next couple of years could be good years for investing in private equity. We're talking to a couple of really good players in that market and hope to be making announcements in the near future. 

So we're in a fortunate position. While many large pension funds and investors around the world are finding themselves in a capital-constrained outflow position, UniSuper is in a great position. I mean—large, plenty of liquidity, in inflow, and we're looking for opportunities. 

Finally, I'd like to make a comment on a very topical issue at the moment. We've seen a lot of media and indeed many of our members have written about this, and I'm talking about the involvement of superannuation funds in nation-building social infrastructure. The two areas in particular that are getting attention at the moment is affordable housing and the energy transition. Both of them are obviously essential for Australia, and UniSuper is committed, and will always be committed, to being involved in the dialog with the politicians, with the other leaders, in terms of these nation-building projects. However, regardless of how worthy these projects are from a social impact perspective, the financials have to stack up. So, whether or not the conversation actually leads to real investment decisions will very much depend on our assessment as to whether it is in your best financial interests.

Thank you very much for listening.