Investment update with John Pearce – April 2024

Hi, welcome to this investment update. I'm John Pearce, Chief Investment Officer. Today, I'd like to update you on what's happening in markets and indeed some options this financial year. I'd also like to explain why markets were so strong until the end of March, but then have turned very jittery in April. And finally, I'd like to highlight a couple of key investments that we've recently made that we're pretty proud of.

A couple of months ago when I addressed you, we were talking about the performance of markets up until the end of January this year, and I said that markets were ripping. Now, that is a non-technical term for saying that they were very strong. And it turns out that in February and March, they continued to rip. In the US, we saw the US stock market up around 9% and the Aussie market up a bit above 4%, which is pretty good for two months.

Now every bull market needs a supporting narrative, and this is what the narrative was. Firstly, strong employment means strong incomes. We also had the prospect of not just rates being on hold, but rates actually being cut. And then we had that all important pervasive thematic of the day, the AI revolution. You add these three together and you've got a source of a market rally.

What about some of our options? Once again, it's a similar story to the one I showed a couple of months ago. Top of the pile, Listed Property. It continues its strong run. It's bounced back from a very poor start to the financial year, where it was actually in negative territory. Property benefits from the prospect of rates on hold and falling rates and therefore we're seeing those results.

At the bottom of the spectrum, we see Global Environmental Opportunities down by more than 10%. GEO, as we call it, has been a very volatile product. It's a thematic product. Fortunately, the months of February and March, it did show signs of life and it kept up with the market rally. I will say though, you can expect it to continue to be volatile and you've got to take it into consideration when you're making your choices. It's always a case of buyer beware with Global Environmental Opportunities.

Moving down to our Balanced option, which of course is our default option, a solid 8.5%. And we have the Sustainable Balanced option, which is up about 11% to the end of March. Why the big difference? Well, the Sustainable Balanced option screens out many sectors, so it finds itself being overweight in the USA, overweight in technology, underweight in the relatively underperforming sectors being resources and Asian markets. Hence the difference in performance.

Chart 1: Table displaying the returns of several UniSuper investment options for the financial year to 31 March 2024. Listed Property is at the top of the list at 17.3%. The lowest performing option is Global Environmental Opportunities at -10.5%. Sustainable Balanced is 10.9%, and Balanced is at 8.5%.

What's been notable about that rally to the end of March is the broadening. You might recall when we talked about last financial year, it was all about the Magnificent Seven. These were the seven market darlings, the hi tech related stocks that pretty much accounted for all of the bull market rally in the previous financial year. This one, there's been a broadening. As a matter of fact, if you look at the US, the boring old financial sector has outperformed the technology sector.

In fact, if you look at the Magnificent Seven, a couple of them have been far from magnificent. Up till the end of March we have Tesla being down by more than 30%, even Apple down double digits or more. Of course, at the other end of the spectrum, we have the big beneficiaries of the AI revolution and there's no bigger beneficiary than this company called Nvidia.

Chart 2: A graph showing the financial year returns to 31 March 2024 of the ‘Magnificent’ Seven. Telsa: -32.8%. Apple: -11.6%. The S&P 500: 18.1%. Microsoft: 23.5%. Alphabet: 26.1%. Amazon: 38.4%. Meta: 69.2%. Nvidia: 113.6%.

Nvidia is an extraordinary company. It's basically the market leader when it comes to the microchips required to power these AI machines. I just want to show you a graph that shows you the enormity of what's happening with this company.

In 21st of February of this year, Nvidia announced its results. Now, at the time, the company was trading at a market value of around 1.7 trillion USD, and many pundits were saying this is already way too expensive. It cannot meet the lofty expectations of the market. Well, Nvidia announced those results and it didn't just meet expectations it blasted them. In fact on that day, on a single day, the increase in the market value of Nvidia was about 270 billion USD. To put that in perspective, that is equivalent to the combined market value of BHP, Macquarie, Woolworths, Coles and Telstra in a single day.

It's an incredibly impressive company, it's forecast to make about $60 billion US in profit next year. So we're talking about a real company with real earnings.

Chart 3: A graph displaying the market value of Nvidia on 21 February 2024 at 1.7 trillion, with an increase in value one day later of $270 billion. This increase is equivalent to the market value of BHP, Macquarie, Woolworths, Coles and Telstra combined.

So that's a US story. What about the Australian story? Well, up until the end of March, the Australian market was also hitting all-time highs and that's despite the fact the Australian household sector should have been on its knees. Why? Because we happen to have one of the most indebted household sectors in the world. Take a look at this graph. It shows that our debt relative to our annual income, in aggregate, is about 200%. To put that in perspective, in the US, the equivalent number is about 100%. So we're about twice as leveraged as the typical US household. It puts us right at the top in terms of the developed markets in the OECD. So why haven't these higher interest rates crippled the household sector? Well, I think there are a few reasons. Firstly, it turns out that only about a third of Australian households actually have a mortgage. Secondly, our employment market has been very strong, so people are confident that their job prospects are pretty good. But here's another thing, it's called the “wealth effect” by economists. It turns out that our assets are also growing very strongly in value. Look at this graph, it shows that assets relative to our debt, in aggregate, is about six times. So, in aggregate and on paper, we've actually never been richer, and maybe that's giving us the confidence to keep spending.

Chart 4: A graph showing the debt to income ratio of Australian households at 200%, whilst the assets to income is at 6 times.

So that's the good news. What about April? Well, the markets have actually turned quite sour. The US and Australia as we speak, down about 4%. Why the turn around? Well, a few factors. Firstly, there's been an escalation obviously in geopolitical tensions in the Middle East. I personally do not think that is a key reason for the market turndown. What we have is a pretty sticky inflation outcome at the moment and sticky inflation means that those prospects of rate cuts are quickly diminishing day by day. Most importantly, however, the market has pretty much got ahead of itself. Valuations are now incorporating really good news and they become stretched for risky assets such as shares relative to their historical average, but also relative to the valuations of safe assets.

I want to demonstrate this by what I believe is a simple example. If you look at Commonwealth Bank shares. Back about three years ago, the CBA shares were trading at around $86. At that price, we had a dividend yield of around 6.5%, so that's the dividend income you're getting from shares, and you've also got the prospect of share price appreciation, but share price falls. You could also opt for CBA bonds, and they were returning somewhat less than 3%, so the safety of bonds less than 3%, or the riskiness of shares. Now at the time you know, that would have been a pretty good bet to take that risk. Lately, CBA shares got as high as $120. They're down to about $112 as we speak, and that equates to a dividend yield of close to 6%. That's still a pretty healthy yield. But look at the yield you're getting on the ultra-safe assets, CBA bonds. They're above 6%, so we see now the trade-off becomes a lot more difficult.

Chart 5: A table showing the CBA share price, dividend yield and bond yield in March 2021, as well as current figures. The share price at March 2021 is $86.10, the dividend yield 6.23%, and the bond yield at 2.76%. The current share price is $112.20, the current dividend yield 5.83%, and the current bond yield 6.60%.

You can see now why buying shares, you're not immediately getting rewarded for that risk. That risk premium, as we call it, has really diminished. I'm not suggesting that CBA shares are not a bad option. After all, you still have the prospect of capital growth. What it does mean, though, for any shares is that when they're priced to perfection, the slightest bit of bad news can have a magnified impact on share prices. And I think that's what we're seeing now. So short term, yes, like the rest of the market, I'm pretty nervous. But long term, I think that this rally is on pretty solid ground. I'm not one of these proponents of the bubble theory. I think we're in for a solid correction, but it's a healthy correction.

Finally, a couple of our key investments, and one of the beauties of working for UniSuper, regardless of our short-term concerns, we have the ability to take long term investments in quality assets. I'd like to highlight two. The first one is investment in Burra Park, a $450 million investment in a big block of vacant land. Now why would we do that? Here's the reason. This is where it's located; adjacent to Western Sydney Airport. What do we know about Western Sydney Airport? Well, it'll be operating in 2026, 24 hours a day. And the government has a vested interest in making this successful because I do not believe the government is a natural long-term holder of the airport. Another important fact, Burra Park is on the M12, a toll road that we will actually have an interest in via our holding in Transurban.

Chart 6: A picture showing the location of Burra Park, a vacant block of land which is adjacent to Western Sydney Airport.

What we actually have in Burra Park is a block of vacant land that is perfectly positioned for the development of manufacturing, logistics and maybe even data centres. Most importantly, it wasn't a particularly competitive bidding process. We were able to acquire this block of land at a pretty good price. What you find, what I've found, anyway, if you buy high quality assets at good prices, over time, you're bound to make money.

And finally, a very exciting opportunity. We're investing around $600 million in Macquarie's Green Energy and Climate Opportunities Fund. When it comes to the energy transition, Macquarie is a leading global player in the financing of it. Macquarie has a pipeline of wind, solar, battery storage assets all around the world, including of course, Australia. Macquarie will be investing alongside us and other major investors. We believe that this is an excellent way of playing a role in the energy transition while at the same time achieving great financial outcomes for our members.

You'll be hearing a lot more about this opportunity in the future. Thank you very much for tuning in.

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 April 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 16 April 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.