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Victoria Place (VP):Welcome to Five questions for the Chief Investment Officer. My name is Victoria and I'm a senior analyst working with our CIO, John, in the investments team.
John, as this graph shows, the Australian share market has recently hit record highs, which is great news for investors. However, it's been a long 12 years just to get back to where we were in 2007.
Other markets seem to have recovered much faster. Would you agree that our patience has been tested?
John Pearce (JP): The graph you're referring to, Vicky, plots the ASX 200 Price Index. And yes, 12 years is a long time, particularly when you consider the US market recovered in less than half that time. I think it's useful to point out the reasons why.
Think about the difference in composition between our markets. If we go back to 2007, we have the top five stocks in the US, look at those companies. Industrial companies, an energy company, and only one technology company. Roll the clock forward to today and the top five companies in the US are all technology companies.
Look at Australia. In 2007, two big mining companies, two major banks and Telstra. Roll the clock forward, and what have we got? Two big mining companies, two large banks, and CSL has taken over Telstra. So it's clear that the Australian market has not got the companies that really benefitted from the technology revolution.
But it's not all bad news. I mentioned before, it was the ASX price index that that graph plotted. The price index does not include dividends, which is an important exclusion, because for investors, we're interested in total return (capital gains plus dividends received).
Let's have a look now at the ASX 200 accumulation index, which includes dividends. I think this is the index that the mainstream press should really be focusing on, not the other one. Look what we see. The market actually recovered in 2013, and we've pretty much been hitting record levels ever since.
VP: Once again, we see a real disconnect between a roaring share market and a soft economy. Why the market optimism?
JP: First on the economy, we presented these statistics in June. This is just after Reserve Bank cut rates, and we see unemployment slightly higher than the Reserve Bank wanted, inflation lower than Reserve Bank wanted and GDP growth lower than the Reserve Bank wanted. Roll the clock forward, and pretty much all the metrics are still below or above where the Reserve Bank wants it, so the economy is definitely in a soft patch.
Now, why the optimism? Well, up until the last couple of days, there was optimism that some sort of trade deal would be hammered out between China and the US. And that's turned to pessimism, but look, they're still underlying. The market is still very high. That's very much been driven by the interest rate picture. If we think about Australia, we just had the Reserve Bank governor, Phil Lowe, reiterate that Australian rates are going to stay low for quite some time. We've already got a record low cash rate of 0.75% and the governor said that that could potentially be dropped to 0.25%. He even countenanced the possibility of unconventional monetary policy. That's really quantitative easing, so going in and buying government bonds.
I personally hope we don't have to do that because that will signal that the economy is in pretty bad shape. I also question the effectiveness of it. If I think of what's curtailing investment at the moment, it's not the level of interest rates or the quantity of money—it's lack of confidence. That's what's required.
Now, on a positive side, the Reserve Bank governor has ruled out silly policies. Silly policies like the European Central Bank's pursuit of negative interest rates. The bank of Japan buying large swathes of the Japanese stock market. I think it's pretty safe to say that there's a snowflake's chance in hell that the Reserve Bank would countenance such a policy.
VP: While the rally in markets has benefited all of our growth options, the performance of our sustainable options has been particularly impressive. Can you elaborate?
JP: It's been stellar over the last year. We've had the Sustainable Balanced option recording close to a 20% return and the Sustainable High Growth option close to a 25% return. A few tailwinds are operating here. Firstly, the options are underweight the underperforming energy sector. Secondly, they're slightly overweight the outperforming property sector. And they've generally got a bias towards developed markets which have performed better than emerging markets.
A word of caution once again. We are seeing some switching behaviour towards these sustainable options, and these tailwinds don't last forever
The other point worth making is that we manage about $6 billion in the sustainable options. In terms of super funds, that is well in excess of the money managed by any other super fund in what we call ESG-related strategies—usually called ethical, sustainable or socially responsible. And our performance versus these peers has been stellar. If you look at the table here, this is our quartile rankings in the Sustainable Balanced option—we see very strong top quartile performances.
We do see some members leaving to join some of these other funds that tend to more heavily promote their ESG credentials. That's all well and good, but I do hope they're making those decisions for the right reasons.
VP: If we look at the history of bull markets, it almost always takes a rise in interest rates to stop them. But with inflation staying so low, all of the world's major central banks are in easing mode. So, what will it take to stop this bull in the foreseeable future?
JP: I still maintain that the biggest risk is geopolitical. In particular, the threat of a fully-fledged economic cold war between the US and China. That's not our base case. Our base case is that we'll get to some sort of uneasy truce.
I think next year, we could have a setback in terms of the US presidential elections. And US voters are going to be presented with potentially the starkest difference in economic policies they've seen for decades. If we take a look at the leading democrat, Elizabeth Warren, it's very much a social reform agenda. That includes such things as unwinding Trump's tax cuts and indeed adding tax increases, doubling the national minimum wage, breaking up large tech companies, and even such things as empowering employees with voting rights over the re-election of directors. So, very much a social reform agenda, but potentially not business friendly. I suspect that the stock market might react negatively if she indeed becomes the democrat nomination.
Now, that is not to say that Donald Trump's policies have been business friendly. Clearly, the US stock market has hit new highs, and US companies have generally benefitted from tax cuts. But if we look at the global situation, have a look at this graph.
Key trends such as global export volumes, global earnings per share of companies outside the US—they've all declined under Trump's presidency.
In my view, when it comes to politics, extreme policies—regardless of political flavour—are bad for business.
VP: Finally, John, is UniSuper likely to increase its allocation to cash if we see geopolitical tensions rise further?
JP: Well, cash is the ultimate risk-free asset so that seems like a logical move. We are holding slightly elevated levels of cash at the moment to take advantage of opportunities. But a couple of points here. Firstly, we're currently earning next to nothing on cash. So, the opportunity cost of missing out on a share market rally becomes a lot higher. History has not been kind to portfolio managers that have allocated a lot to cash based on a worst-case scenario eventuating. And history's not kind to those investors that have followed the predictions of doomsayers. And look, there have been a lot of doomsayers since GFC. And I wouldn't mind taking you through a small exercise.
Let's assume that you've got a choice between holding American equities or moving to cash. You're a bit nervous, and one of these experts has made you more nervous by predictions of doom. Let's go through some of the more popular doomsayers.
Let's start with one of the most famous hedge fund managers in the world, billionaire George Soros. In 2016, he sees the world in a crisis and he even sees shades of 2008. If you followed George Soros and moved it all to cash, you would've missed out on about 35%.
Let's go to 2012. And here, we have Marc Faber, author of the famous Gloom, Boom & Doom Report. He's actually known as Dr. Doom. In 2012, he saw the chances of a global recession at about 100%. Well, if you followed Dr. Doom, you would have missed out on about 50%.
Let's go to the most famous doomsayer of all, Mr. Roubini. He's famous for calling the GFC. In 2010, not happy enough with simply calling the GFC, he believed that things were actually going to get worse from 2010. Of course, things got a lot better, and if you listened to him and moved all your money to cash, you would have missed out on about 60%.
Now, I'm being a little bit unfair here. I'm picking on these three individuals, but there's a whole host of other doomsayers that we could have chosen.
To be fair, every now and again, they do accurately call a stock market crash. But I guess if you say the same thing over and over again, one day you're going to be right. The problem is, how many opportunities are you missing out along the way?
VP: Thanks for answering these five questions, John. If you have any questions you’d like answered, please email us at email@example.com. Thanks for watching.
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