Welcome to Five questions for the CIO.
My name is Victoria Place and I'm an analyst
in UniSuper's Investment team.
I'm joined here by John Pearce, our Chief
Investment Officer.
John, let's jump straight into politics and
get your views on the impact the chaos in
Canberra is likely to have on the economy
and financial markets.
We've gone 27 years without a recession.
I don't think there'll be many people putting
that down to political stability and great
leadership.
Generally speaking, I think the impact of
politics on the economy and financial markets
is exaggerated.
If you look at the Australian share market,
we're currently trading around 10-year highs,
so the market is taking the current changes
in its stride.
I am generalising there.
There are some clear exceptions.
For example, the energy sector—I'd imagine
it would be pretty difficult contemplating
large investments in a sector where you don't
have a nationally coordinated policy.
It looks like one of our largest investments,
gas pipeline operator APA, is getting caught
in the crosshairs of politics.
Can you elaborate?
It's an intriguing and rather complicated
story, so let me try.
APA—we've got about $1.8 billion invested
in this company, so it is a very large investment.
APA is the owner and operator of about 15,000
kilometres of gas pipelines all around Australia.
So you can understand why we believe it's
a classic ‘fortress asset’ and it's very
suitable for many of our investment options.
What are the big developments?
CKI, which is a Hong Kong company, has made
a takeover offer of $11 per share for APA
and that represented about a 30% premium to
where the shares were trading at the time,
so very healthy.
The APA Board has recommended to shareholders
that they accept the offer and we are happy
with the Board's recommendation.
We actually accumulated our shares at prices
well below $11, so if this deal does get pulled
off, we're making a lot of profit for our
members.
That's the good news.
There's always a twist to these sorts of deals—the
twist here is that it is subject to regulatory
approval.
The competition regulator, the ACCC, has to
approve it and also the Foreign Investment
Review Board—so ultimately, Canberra.
The share price is currently trading at around
$9.70, which is well below $11, so the share
market is basically saying, "Look, we’ve
got real doubts that this deal is going to
get pulled off."
Why the doubts?
CKI is a Hong Kong-based company.
Politicians are saying, "A Hong Kong company
is effectively influenced by the Chinese government
and it’s against our national interest to
hand over control of such critical infrastructure
to such a company."
I don't know how this is going to play out.
There's speculation that there could be another
bid, but as I said, it's speculation.
Regardless of whether a deal gets done or
not, APA is a fortress asset.
We've accumulated the shares at attractive
prices, so we're happy either way.
Switching from Australian to global politics,
it seems that Trump is intent on escalating
the trade war with China.
Is there a resolution in sight?
Unfortunately not.
What's the status so far?
America has levied 25% tariffs on $50 billion
of Chinese imports and the Chinese have retaliated
in kind.
Trump said he's prepared to keep going and
he's fairly confident this is a battle that
he can win.
Why?
Because the mathematics are on his side.
America actually imports over $500 billion
of Chinese goods and only exports about $130
billion.
Trump's rationale is that, eventually, the
Chinese will have to run out of firepower.
Trump has actually said he's prepared to go
the whole $500 billion.
Let's hope that doesn't happen because it
won't just be bad for China and America, it
will be bad for the global economy.
In fact, economists are already revising down
estimates for global growth if indeed this
war escalates.
The reason why it's bad for the global economy
is because trade is fundamentally interconnected.
Let's take the example of mobile phones.
It turns out that mobiles phones are actually
the largest export from China to the US, and
obviously iPhones will be a significant component
of that.
If I asked you how many countries get involved
in the manufacture of an iPhone, I bet you
wouldn't guess it's actually 31 countries.
If you look at that table, China actually
has the most suppliers to an iPhone, so you
think, ‘Well, this is actually hitting China’.
But if you look at the value contribution
of China, and where the money is actually
made, China is only a small part of this because
it's in the low-end manufacturing.
Guess who makes the lion's share of profit
from an iPhone?
No prizes here—it's Apple, of course.
And here is the irony.
The irony is that the biggest beneficiaries
of free global trade are the American multinationals,
so it's no surprise it’s the American multinationals
who are pleading with Trump to back off.
Trump says this is all about bringing jobs
back to America but the US is at full employment.
Lifting tariffs is only going to lift prices,
so the American consumer will ultimately be
worse off.
So this, to me, is as much about politics
as it is about economics.
Trump has to fight mid-term elections and
getting tough with the Chinese seems to be
a popular sort of strategy.
I think that the only resolution here is when
political expediency, rather than economic
rationalism, demands that it gets solved.
John, you mentioned that the Australian share
market is trading around 10-year highs.
What are the main drivers of this performance?
We know what it's not.
It's not our banking sector—which is our
largest sector—which remains in the doldrums
because of the Royal Commission.
It's basically all of our companies that are
leveraging solid global growth, and in particular,
our resources industry.
A couple of interviews back, I gave the examples
of BHP and Rio, how their profits are increasing
because they managed to lower their costs
and increase their revenues with stronger
commodity prices.
Another big influence is a lower Australian
dollar.
A lower currency is actually supportive of
companies and share prices in two main ways.
I think it's worth exploring this a bit further.
Let's look at this from an American investor's
perspective and bear in mind that about 40%
of our market is actually owned by foreigners.
Think of an American investor looking at BHP
shares, which are currently trading around
AUD$33.
That equates to about USD$26.40 at an exchange
rate of 80 cents.
It was only in February of this year when
our currency was trading at around 80 cents,
so we're using that as an example.
Roll the clock forward—let's assume that
the currency then drops down to 72 cents and
there's been no change to BHP as a company.
Look what the shares are now costing that
American investor: $23.76.
No changes to the company, yet the share price
is now cheaper by about 10% for an American
investor.
So you can see why it's now looking more attractive.
Let's look at it from a company profitability
perspective.
BHP last year earned revenue of about USD$15.9
billion for exporting its iron ore.
Once again, at an exchange rate of 80 cents,
that equates to about AUD$19.9 billion.
Roll the clock forward, at 72 cents—look
at the increase in revenue.
It goes up to $22.1 billion.
So no change to volume of iron ore sold, no
change to the price that they're getting—purely
because the currency has fallen, we're getting
an uplift of around 11% in revenues.
So while a lower currency obviously makes
overseas trips more expensive, our members
should take some comfort from the fact that
their super funds are probably benefitting.
So can we look forward to the share market
breaking more records?
Frankly, I'm a bit surprised that we're at
record levels at the moment around the world.
When the US Central Bank is tightening rates
and taking US dollars out of the market, it's
usually bad for share markets.
We have seen some impacts of this, particularly
on countries like Turkey and Argentina which
are really in crisis mode because they are
heavy borrowers of US dollars.
That hasn't impacted the rest of the world
yet, but I don't know how long that's going
to last.
I'm expecting, while the Central Bank continues
to tighten rates, we're going to see some
more short-term volatility.
But that shouldn't come as a surprise.
This is a feature of financial markets throughout
history.
Let me look at one of my favourite graphs.
Here is a graph showing 12-month rolling returns
of the Australian market over the last century.
It's a pretty scary picture, right?
There’s a lot of volatility there, and indeed,
you have to empathise with members who need
to sell shares for their living expenses,
etc.
That would be a concern and that's why we
do suggest to our members to seek advice.
However, let's look at that graph another
way—rolling 20-year returns.
Look how smooth that line becomes.
So in answer to your question, over the long
term, yes, I do expect markets to grind higher
and I do expect them to reach new records.
But that's over the long term.
That's what superannuation is all about, it's
staying the course.
Thanks for your time, John.
If you have any questions for John, or feedback
for us, please email superinformed@unisuper.com.au.
Thanks for watching.
