Investment update with John Pearce - January 2021
From the pandemic to global politics and everything in between, it’s been a turbulent 12 months.
But as vaccine rollouts begin, markets recover and a new era in US politics dawns, what might 2021 have in store?
Key points in Chief Investment Officer John Pearce’s latest video:
- The Australian stock market finished the year not far from where it started—about 1% up—but this disguised the turbulence of 2020 and the enormous dispersion between companies and sectors. For example, Wesfarmers (owner of Bunnings) and Coles were up about 20% during 2020, whereas Sydney Airport, Qantas and Scentre Group (shopping centres) were down about 30%.
- At UniSuper, the difference between our best- and worst-performing investment options was about 60%. The reason for this is that our best performer, the Global Environmental Opportunities option, focuses on technology and decarbonisation. Our worst performer, the Listed Property option, is heavily invested in shopping centres, which have suffered during the pandemic.
- Our Balanced investment option returned almost 6% in 2020. This is an important result because it’s our default investment option and most of our members invest in it.
- Our increasingly popular Sustainable Balanced option returned almost 9% in 2020. It benefited from relatively low exposure to energy, no exposure to fossil fuels, and relatively high exposure to technology.
- Fears about the US coming to a ‘fiscal cliff’ should now be off the table following President Biden’s announcement of a USD $1.9 trillion stimulus package (on top of the USD $900 billion package already implemented).
- Over the last 100 years, on average, a Democrat presidency has been better for markets than a Republican presidency. Overall, we have nothing to fear from a Biden presidency.
- Markets have rebounded very strongly from the pandemic because we’re learning to live with COVID-19 and have developed effective vaccines.
- It’s not clear whether the pandemic will disrupt the usual economic cycle. There are currently no signs of sustained inflation, and therefore uncertainty as to whether central banks will react and tighten rates. Only time will tell.
Read the transcript
John Pearce: Hi, it’s John Pearce here, Chief Investment Officer. I’d like to give you a brief investment update. I’d like to briefly go over 2020 and see how that panned out, discuss the implications of a Biden presidency, and then we’ll move to 2021 and see what that has in store.
Well, 2020. There’s nothing I can really say that hasn’t already been said, but quite incredibly, the Australian stock market actually finished the year not far from where it started—about 1% up. This flat result, of course, belies the fact that during the year, it pretty much went to hell and back. It was down about 37% from its highs at one point.
The flat result also disguised the fact that we saw enormous dispersion between companies and sectors within the market. For example, we had companies that actually benefited from the crisis. Wesfarmers (the owner of Bunnings), Coles—they were up about 20% during the year. At the other end of the spectrum, we had Sydney Airport, Qantas, Scentre Group, down about 30% during the year.
Australia has handled the virus a lot better than most other countries in the world, but we what we saw in our markets pretty much reflected what happened globally. This manifested in quite a dispersion in the outcomes in our investment options. In fact, the difference between our best performer and our worst performer was about 60%. Right up the top of the league table, we have Global Environmental Opportunities, heavily invested in companies that are benefiting from two pervasive themes—technology and decarbonisation. At the bottom of the table, we have Listed Property, heavily invested in shopping centres—and we know how shopping centres have fared during this crisis.
If we look at our Balanced option, we nearly got to 6%, which is a very respectable return, given what transpired during the year. Our Balanced option is our largest option, and our default option for our Accumulation members. So it’s a pretty important result.
We move to Sustainable Balanced, which is becoming an increasingly popular option—almost 9%.
It benefited from the fact that it has a relatively low exposure to energy, having no fossil fuels, and a relatively high exposure to technology.
Chart 1: The 2020 calendar year returns of four UniSuper investment options. Global Environmental Opportunities: +49.7%. Listed Property: -9.2%. Balanced: +5.9. Sustainable Balanced: +8.8%
On Sustainable Balanced—we also have a Sustainable High Growth option, and we have Global Environmental Opportunities, which really rounds out our ESG-themed investment options. We’ve recently hit a milestone, we now manage over $10 billion in those options. That makes us the largest manager—certainly super fund manager—in the country, by a significant margin, of ESG-themed strategies.
Moving on now to the US elections. We’re not just talking about a Biden presidency, we’re talking about a blue wave, a Democrat clean sweep. Because not only does Biden have control of the White House, the Democrats also control Congress.
The knee jerk reaction to this might be negative as it relates to the share market, because Democrats might be perceived to be anti-business. I think this is too simplistic a view. Biden himself is a moderate, and the Democrats, in some respects, do have a reasonably narrow mandate. They won about 51% of the popular vote, and the majority in the Senate comes by virtue of having a tiebreaker vote. So the Senate is currently 50/50, and the tiebreaker vote gives them a 51 to 50 majority. While that’s important, changes to legislation as it relates to some big areas—competition policy, energy policy, minimum wages—requires 60 votes in the Senate. And Biden doesn’t have that, so he will require the support of some Republicans, and that might be difficult to achieve.
However, most importantly, the Democrats have control of the purse strings. They can spend, and they can tax. Indeed, Biden has wasted absolutely no time in announcing a USD $1.9 trillion stimulus package. This comes on top of a USD $900 billion package that has already been implemented. So the talks or fears of the US coming to some sort of fiscal cliff are now off the table. The US economy will not be suffering from a lack of government spending. Economists have already upgraded their forecast for economic growth in the US to around 5.5% - 6% this calendar year. That’s a big number for the world’s largest economy. Rising growth, lower unemployment should lead to better corporate profits.
A final word on the Biden presidency. You might recall that last year, I presented this bar chart showing the outcomes throughout history of the US share market under different configurations of the White House and Congress. It turns out that the best outcomes were achieved when they had Democrats in control of the White House, and a split Congress.
Chart 2: Performance of the S&P 500 under Democrat versus Republican presidencies. Democrats returning ~14 – 16% p.a. and Republicans returning ~9-10% p.a.
Well, this time, we’ve got the second-best outcome, with the Democrats controlling both the White House and Congress. So nothing really to fear from a Biden presidency.
Net-net, I see this as neutral to positive, and indeed, if you see the reaction of the stock market since the election results, that pretty much confirms that optimism.
Let’s now have a look at what 2021 might have in store. Once again, the backdrop—enormous government spending, interest rates pretty much around zero, for most parts of the world. The enormity of this fiscal stimulus in totality cannot be overstated. Whether you’re talking about world wars, the Great Depression, the GFC—this is actually bigger. You’ve got the prospects of an economic rebound.
These conditions are very supportive for risky assets, such as shares and property. But you may be thinking, ‘the virus is still rampant, we just hit two million deaths, infections are increasing in major countries around the world—how can the share market rise in these circumstances?’ There are a couple of reasons why the share market is looking past this.
The first reason is that we are learning to live, in many respects, with the virus. Have a look at these economic statistics. Global trade—look at the bounce back in global trade to pretty much pre-COVID levels, and compare it to how long it took to bounce back after the GFC.
Chart 3: Global trade rebounded to pre-COVID levels within approximately six months of the COVID-19 pandemic, compared to the 24-month rebound of the Global Financial Crisis.
If we look at the US—look at the rebound in industrial production, in retail sales.
Chart 4: US industrial production has rebounded to pre-COVID levels of around 105 on the Industrial Production Index.
Chart 5: US retail sales have rebounded to pre-COVID levels (approximately USD $210 billion).
It’s pretty impressive. So people are getting on with lives, they’re getting on with business.
But most importantly, why the markets are looking through the current spread of this virus is the development of effective vaccines. This has been pretty much nothing short of a miracle. If you have a look at the vaccines we have for other diseases, if you look at this bar chart, we have a variety of diseases on the bottom there. Look at the efficacy of the vaccines that we are rolling out in the developed world—Pfizer, AstraZeneca and Moderna. They’re around that 90% level. That compares to around 45% for the vaccine we have for influenza. Hepatitis was discovered in 1965, yet the efficacy of the vaccine that we use for hepatitis is around 80%—lower than the 90% we have for the COVID vaccines.
Chart 6: Efficacy levels of around 90% for the Pfizer, AstraZeneca and Moderna vaccines for COVID-19, compared to vaccines for other diseases and viruses. Influenza ~45%; shingles~76%; hepatitis B ~80%; rabies ~80%; tuberculosis ~80%; typhoid fever ~80%; yellow fever ~80%; meningococcal ~82%; mumps ~85%; chicken pox ~ 85%; polio ~85%; whooping cough ~85%; hepatitis A ~85%; smallpox ~85%; diphtheria ~90%; measles ~90%; rubella ~90%; rotavirus ~95%.
So what could go wrong?
There are always plenty of risks. And I’m not planning to go through all the risks, but a couple of key ones potentially in the short term. Firstly, we could encounter a problem with the virus. I’m not talking about a problem with the production or distribution, because I expect that there will be hiccups there, and the market will see through that. I’m more concerned about the efficacy of the vaccine as the virus mutates. We’re told by the scientists that they’re not overly concerned about that, so let’s hope they’re right.
The second big risk is the prospect of having too much of a good thing, and let me explain this with reference to the economic finance cycle.
Chart 7: The economic / financial 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.
We start the crisis, recession, unemployment rises, we have this massive fiscal and monetary policy response. Share markets rise in response to that, and then we have recovery. We’re seeing early signs of that—unemployment falling and indeed prospects of economic growth are improving.
Then we have the fears of inflationary pressures—higher wages, supply constraints—and usually the fears of inflationary pressures is enough to get share markets frightened, because share markets, forward looking, are figuring that central banks will start tightening rates. And there’s no better way of stopping a share market rally than higher interest rates. The question is whether this cycle will indeed play out this time around in any short time.
What we’ve seen since the GFC, is despite the concerted efforts of central banks to keep rates pretty much close to zero with ample liquidity, there’s no signs of sustained inflation. So that link seems to be tenuous at best. And then even if we do get a couple of rogue inflation numbers, it’s not clear to me at all that the central banks will react and tighten. I think the central banks will allow inflation to trade above their target of 2% for some time, before they react with tighter policy.
Chart 8: Uncertainties in the economic / financial cycle (of recession and higher unemployment followed by: policy stimulus and market rallies; a recovery in growth and a fall in unemployment; inflation and market falls; policy tightening). Even with a recovery in growth and unemployment falling, there are currently no signs of sustained inflation, meaning it is unclear whether central banks will react and tighten policy.
The bottom line is that I personally don’t see this cycle playing out in the next 18 to 24 months. We could have a couple of rogue numbers with inflation, and the market could take fright. It will probably represent a buying opportunity. So this is the reason that I’m staying reasonably positive on risk markets.
Having said that, that’s just a personal opinion. It’s certainly not advice. If you do want advice you’ve got to see one of our excellent advisers.
Thanks very much for watching.
This video discusses UniSuper’s investment performance and recent investment decisions designed to suit UniSuper, which may not be appropriate for you personally. We’re not suggesting you should make the same decisions.
This information is current as at 22 January 2021 and isn’t intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects our view at a point in time, having regard to factors specific to us and our overall investment objectives and strategies.