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Angela O’Brien: Welcome to Five questions for the Chief Investment Officer, John Pearce. Today we’ll be touching on current hot topics including the prospect of negative cash rates in Australia, the mini bust in tech, the rally in gold, the opportunities in the market, and the US election. Let’s kick off with cash rates. John, is there really a chance that cash rates can go negative in Australia?

John Pearce (JP): There’s certainly a lot of talk about it Angela, and somewhat not surprisingly, if you look at the central banks that have gone down that path, European, Japanese, Denmark, Switzerland—and we’ve even heard the UK and New Zealand both intimating that they’re seriously considering it. Fortunately, our central bank, the Reserve Bank of Australia, is very reluctant to go there. We’ve had the Governor, Phil Lowe, actually saying that he doesn’t think that negative cash rates work. Now I know this doesn’t count for much, but Governor, I totally agree with you so please hold the line.

There’s certainly a lot of talk about it Angela, and somewhat not surprisingly, if you look at the central banks that have gone down that path, European, Japanese, Denmark, Switzerland—and we’ve even heard the UK and New Zealand both intimating that they’re seriously considering it. Fortunately, our central bank, the Reserve Bank of Australia, is very reluctant to go there. 

Source: Bloomberg
Central Bank Target Rate
Australia 0.25%
US 0.00-0.25%
Japan −0.10%
ECB −0.50%
Denmark −0.60%
Switzerland −0.75%

We’ve had the Governor, Phil Lowe, actually saying that he doesn’t think that negative cash rates work. Now I know this doesn’t count for much, but Governor, I totally agree with you so please hold the line.

"...I just don't think negative interest rates work..." - May 2020

"[Negative interest rates] are extremely unlikely...: - August 2020

Governor Phil Lowe.

That’s potentially the good news. The not-so-good news is that, in reality, the Reserve Bank is targeting a 0.25% cash rate. What’s happening is that the banks, because there’s so much cash around, they’re receiving around 0.1% (or 10 basis points) on the deposits that they hold with the Reserve Bank, and that limits what they can pay to institutions such as UniSuper. And that of course impacts the rate that flows through to our Cash investment option—which, after fees, will be flirting with a zero rate. Now, we’re all being forced to take more risk to get extra return. But let me be very clear: we will not be doing that in the Cash option. The Cash option only invests in the highest quality credits. We will not be changing that strategy. The Cash option is there to preserve capital, not to grow capital.

A pie chart showing the cash option only in invests in highly rated borrowers.  80% Australian Major Banks, 9% Australian Commonwealth Government, 6% International banks, 5% Regional Australian Banks.
Source: BNP Data Navigation Analysis

If indeed our members want to take more risk to achieve more return, they really should have a chat to one of our financial advisers.

AB: The tech sector has led the market up, and now it looks like leading the market down. Is this a correction, or the bursting of a bubble?

JP: September’s been a pretty tough month, particularly for the tech sector. If we look at the NASDAQ Index—and this is a pretty popular index, it’s full of technology stocks—it’s had a correction of around 15%. I think this is a healthy correction, and I say it first and foremost because have a look where it’s been over the last five years. It’s had a fantastic run, so a correction was due.

A graph charting the NASDAQ from Sep 2015 at 5,000 to Sept 2020 at approx 10,000, highlighting the recent 15% sell off.
Source: Bloomberg

This is not the dot-com crash replayed. The main reason is the profits of the underlying companies. About 40% of the NASDAQ is comprised of the famous ‘FAAANM’ stocks—that’s the Facebooks, Apples, Amazons, Alphabets, etc. Look at the profits that these companies are making (leave Netflix out, it’s a bit of an anomaly). We’re talking about profits in the tens of billions of dollars.

Big tech...they are still cash machines

Source: Bloomberg, company reports
Company Profit (USD $B) Free cash flow yield (%)
Facebook 23.5 3.1
Amazon 13.2 2.5
Alphabet 31.5 3.8
Apple 58.4 3.8
Microsoft 44.3 3.2
Netflix 2.7 −0.5

To put that into some sort of perspective, CSL—which is Australia’s largest company by market value—makes about USD $2 billion per year. These are profitable companies.

In terms of cash flow, are these profits generating cash? Cash is really important, and I want to introduce you to a concept of ‘free cash flow’. Very simply, a company gets cash from its operation. It then has to use some of that cash to invest, to sustain the company. Free cash flow is the cash that’s left over, and the company can use that to buy back its shares, it can use it to increase dividends, it can use that to invest in further growth opportunities. The free cash flow generated by these companies is enormous. If we look at the free cash flow and divide it by the value of these companies, we can get to what we call a ‘free cash flow yield’.

And we see these numbers, they’re in excess of 3%—once again, Netflix being the anomaly. Netflix is not generating free cash flow, it’s more like the sort of companies we saw during the dot-com where they needed the cash just to sustain their business. With a yield of around 3% free cash flow, compared to bond yields around 1%, that is telling me that we are certainly not in bubble territory. In fact, the more this correction goes, the more attractive this sector starts looking to us.

AB: The one asset that seems to be hitting new highs is gold. Why is that? And does UniSuper invest in gold?

JP: With the price of gold just hitting $2,000 an ounce, the gold bugs are out in absolute full force.

A graph showing the price of Gold in 20101 at approx. 1,000+ (USD) per ounce to just under 2,000 (USD) per ounce in 2020.
Source: Bloomberg.

Why the recent attraction? The theory is that with the central banks around the world engaged in quantitative easing (QE) and money printing, ultimately, they will debase their currencies; that has to lead to inflation and therefore the demand for real assets, such as gold, has to increase. Is UniSuper buying this? Not really. If you look at recent history, that theory hasn’t really borne out. We’ve seen the US and European central banks at QE and money printing for the best part of the last decade. The Japanese have been at it for over two decades, and no signs of inflation. So that nexus seems to have been broken.

If we look at gold in terms of as an asset, gold does not produce any income per se, it is really just like another currency. So therefore, we don’t believe that’s a sort of asset that we want to have in superannuation, because we believe superannuation is someone’s life savings—we like to see income generation, or the prospect of income generation. And, finally, if you look at the long-term performance of gold, it’s not that flash. Here’s a bar chart. Over the last five years, indeed, gold has outperformed US bonds and US shares. Over the last 10 years, gold hasn’t even outperformed US bonds. Over 100 years, it’s all about US shares. It’s about a 6% difference there.

A bar graph compares the nominal returns of US Equites, US 10 year Treasury and Gold over the last 5, 10 and 100 years. Gold shows relative underperformance over the long term.
Source: Deutsche Bank, Nominal returns.

And if you don’t think that’s big, consider this: if you had invested $100 in gold 100 years ago, that would now be worth about $9,500. If you had $100 in bonds, that would be about double, about $19,000. If you had $100 in US shares over the last 100 years, that would now be worth $2.1 million. So, it’s not just gold that glitters.

AB: John, you mentioned taking more risks to achieve returns, but given markets have rallied so hard, where do you see the opportunities?

JP: Just because the market’s staged a pretty good recovery, it’s certainly far from bubble territory. The markets have actually been quite discriminating in terms of which sectors have risen, and which haven’t. If you look in Australia, the tech sector over the last 12 months is up about 40%. The property sector is down about 20%. If you had a bubble situation, you wouldn’t have any sector going down by 20%. It’s the companies and sectors that were hardest hit during the crisis that still remain well below their pre-crisis highs, and that’s where the opportunities lie.

The question of course remains: what does the post-crisis world look like? Is everything going to get back to normal? We do have a few clues. Let’s have a look at a few of them. Shopping centres. If you look at Scentre, the owner of Westfield shopping centres—outside of Melbourne, nearly 100% of stores are now open and we’re seeing foot traffic around 85% of pre-crisis levels.

Graph shows the % of stores outside of Victoria at Westfield Shopping Centres. 100% in January and February before dropping to 46% in March and April and back to 93% in July.
Source: Scentre Group

If you look at Scentre stores in New Zealand, foot traffic is actually more than it was one year ago.

What about toll roads? Once again outside Melbourne, look at Sydney toll roads. It’s about 10% below pre-crisis levels in terms of the traffic. And that’s pretty important because Sydney is not back to normal. There’s still a lot of Sydneysiders that have not gone back to the office to work.

A graph showing the Sydney toll road traffic just falling to -50% in April and as at July just -10% pre-crisis levels.
Source: Transurban

What about domestic air travel? Of course, the fear is that nobody’s going to get back onto a plane. Consider domestic air travel in countries like Taiwan, South Korea, Vietnam—these are countries that have handled the crisis pretty well. It turns out that domestic air travel today is actually higher than it was 12 months ago.

A graph shows domestic air travel returning to above 100% in July 2020 compared to 12 months ago. Vietnam at 123%, Taiwan 117% and 110% South Korea. Australia well below at 19%.
Source:SRS Analyser

So maybe the new normal, in many respects, is going to look a bit more like the old normal than we currently anticipate. If that’s the case, you’ve got companies like Scentre, Sydney Airport and Transurban that are trading well below their highs, that could represent excellent long-term value. And of course, if we end up getting a vaccine within six or nine months, we might not even have to wait too long.

AB: With the US presidential election coming up, the general consensus seems to be that a Biden victory would be good for social reforms, but negative for the market. Do you agree? 

JP: Not really. If you think over the long term, the concept of social reform and rising equity markets are not really mutually exclusive. But even the short to medium term, the theory is that Biden will unwind Trump’s tax cuts, that will be bad for corporate profitability and therefore the markets will take a hit. That’s probably going to be the case, and it’s probably going to be in the vicinity of 5% to 8%. But we shouldn’t look at that in isolation. What the market is not paying enough credit to, is the very positive impact of Biden’s stimulus programs. On top of that, Biden will go a long way to hopefully repairing relationships with allies, and will also re-commit the US to global institutions. So I believe, net net, it’s not going to make much of a difference.

Interestingly, for those who believe that Republicans have to be better for the market because it’s corporate-friendly, history is not on your side there. Let’s have a look. Over the last 100 years it turns out, on average, a Democrat presidency has been better for markets than a Republican.

Bar graph shows performance of S&P500 under Democrat versus Republican presidency. Democrats returning ~14 – 16% p.a and Repbulicans returning ~9-10% p.a
Source: Bloomberg, AMP Capital

The best combination is when the Democrats rule the White House and Congress is divided. But, overall, we have nothing to fear from a Democrat presidency.

Who will win is, of course another question, but that’s for another day. Thank you very much.

AB: Thanks, John. If you have any questions for John, or feedback for us, please email Thanks for watching.

Information on this web channel, including accessible video content, is provided by UniSuper Management Pty Ltd. Trustee: UniSuper Limited (ABN 54 006 027 121, AFSL No. 492806). Fund: UniSuper (ABN 91 385 943 850) Administrator: UniSuper Management Pty Ltd (ABN 91 006 961 799, AFSL No. 235907).

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