UniSuper's Chief Investment Officer, John Pearce, provides a market update for UniSuper members.
Returns are for periods to 30 November 2012.
||3 Years p.a.
||5 Years p.a.
|Australian Shares (ASX 300)
|US Shares (S&P 500)
|Asian Shares (MSCI Asia)
|Australian Dollar (AUD/USD)
|Australian Fixed Interest (UBSA Composite)
|Cash (UBSA Bank Bill)
Past performance is not an indication of future performance.
The small positive returns recorded in November belie the fact that the month was reasonably volatile, with stock markets in Australia and the US trading in a range of 4.1% and 5.5% respectively. The attention of the market has (at least temporarily) shifted from Europe to the US. The initial positive reaction to Obama’s re-election was soon overtaken by fears of the so-called ‘fiscal cliff’.
In essence, the fiscal cliff refers to the automatic cessation of various government spending programs, combined with automatic tax increases, in the event that the Republicans and Democrats cannot work out a more palatable way of reducing the budget deficit. The ‘cliff’ metaphor has been applied because if no compromise is reached, the impact on the US economy would be akin to it falling off a cliff.
At the time of writing, markets appear to be pricing in a compromise, so a failure to reach a compromise would certainly eliminate any hope of a ‘Santa’ rally. On a positive note, the Asian markets have been bolstered by data on the Chinese economy pointing to an upturn in growth prospects.
Assuming that the American politicians do the right thing, it appears that returns for 2012 are set to be the strongest for some time. Year to date, the Balanced option has returned close to 13%. If the gains are held over the next few weeks, this will represent the best year since 2009. Visit our Options and Performance page for information on all options.
In early December, the RBA delivered the much-anticipated cut in the official cash rate, from 3.25% to 3%. In justifying the cut, the RBA cited such factors as “global growth a little below average … risks to the outlook still seen to be on the downside … Asian growth dampened by the more moderate Chinese expansion and the weakness in Europe … a peak in resource investment approaching … inflation outlook consistent with target, etc.”.
The RBA commentary was unsurprising. What is somewhat surprising is the fact that they have not cut rates sooner, given that all of the reasons cited above have been prevalent for quite some time. Nothing of any significance has changed in the last month, yet rates were not cut in October.
We certainly didn’t need to wait for the results of a survey to realise that capital expenditure in the resources industry was getting close to a peak. At a time when households and corporates are reducing debt, the consequences of maintaining borrowing costs well in excess of nominal economic growth rates could become quite severe.
In fact, the latest national accounts show that real disposable incomes for the first nine months of the year actually fell – an ‘income recession’ so to speak. The RBA appears to be a reluctant cutter, but they may have no choice if present trends continue. Further cuts will have adverse consequences for the many people who have opted for bank term deposits over other investments.
Company Focus - Apple
At a current market capitalisation of $515 billion, Apple is now the largest company in the world. The Apple success story is well known, and the company continues to deliver on its reputation as one of the greatest innovators in modern corporate history.
However, we have recently seen a significant weakening in Apple’s share price, from a high of $702 to a low of $525, which equates to a $163 billion fall in market value. To put this in context, the reduction in Apple’s market value over the past month is larger than the total market value of CBA and Telstra combined!
One school of thought is that Apple is following the typical corporate lifecycle of all technology companies, as they move from rapidly-growing innovator with first mover advantage to a mature company with solid cash flows but a much lower growth outlook (witness Microsoft, Cisco, Intel, etc.). The more positive view is that we are simply seeing a healthy correction in the share price after such a stellar run.
Apple’s performance will have an impact on UniSuper’s portfolios.
As mentioned in previous reports, Apple is a major holding in all of our growth portfolios. The allocation to Apple in the Global Companies in Asia and International Shares options are 3.5% and 6% respectively. While the performance of these options ranks favourably compared to their respective benchmarks, the recent fall in Apple’s share price has adversely impacted short-term performance.
The following provides a brief outline as to why UniSuper is planning to hold, and possibly acquire more Apple shares at current prices.
Balance sheet strength and profitability
With net cash holdings of about $120 billion, Apple has one of the strongest balance sheets in the world. If anything, Apple can be (and is) accused of holding far too much cash. Apple has responded by announcing its intentions to pay a dividend of $2.65 per share (or a dividend yield of 2%), which many see as a token effort. Looking into the future, all analysts agree that profit and cash flows will continue to be very robust, as the right hand graph shows. The green bars represent projected free cash flow, which is cash generated in excess of that required to reinvest in the business; i.e. cash which could potentially be distributed to shareholders.
Brand and product innovation to continue
Historically, Apple has been an innovator that has constantly silenced the critics with the next revolutionary product. Apple semi-revolutionised the PC market, it found a new way to store and listen to music, it has completely overhauled telecommunications and now has reinvigorated computer usage with the introduction of the tablet. In doing this, it has amassed a vast army of loyal followers and was recently placed number 1 in the inaugural Forbes list of the 'World’s Most Powerful Brands'.
The technology industry epitomises the ‘creative destruction’ feature of market-driven economies, and the question must be, Without Steve Jobs, can Apple continue to innovate? We believe that with such a powerful brand behind it and huge financial resources, Apple is in a strong position to continue on its path of growth. Our external fund managers who also hold the shares have direct access to Apple’s senior management, including Tim Cook, and they are impressed by what they see. The culture of innovation is living on.
The most common metric for share valuation is a company’s price to earnings ratio (‘P/E’). The ratio captures how much an investor is willing to pay (Price per share) for a claim on a company’s profits (Earnings per share). A high growth company will, all things being equal, trade on a higher P/E ratio than a low growth company. Apple’s P/E is currently 9, which compares to the US stock market average of 13. In other words, the market price is currently implying that Apple’s growth prospects are less than the average. This is extraordinary considering that it has managed to grow by a compound growth rate of 47% per annum for the past five years!
Notwithstanding the very positive outlook we have for Apple, such an investment does not come without risks. Success attracts competition and Apple is being attacked from all sides by the likes of Google, Amazon, Samsung and Microsoft. Apple’s gross profit margins are still a healthy 40%, although they have declined from a high of 47%. Whether or not Apple can sustain such high margins in the face of such strong competition is debateable. However, it all comes back to valuation and we are of the view that Apple’s current valuation implies a far too pessimistic outlook for sales volumes and margins. Therefore, we intend to hold firm.