If there’s one piece of economic data that UniSuper’s John Pearce would like to know today, it’s what US core personal consumption expenditure (PCE) – US inflation – will be in 12 months’ time.
“Inflation is everything,” the chief investment officer of the $130 billion fund tells Investment Magazine.
“If you could know one number, with a crystal ball, one number in one year’s time, you look at American core PCE. If you’re only allowed to know one number, it would be that number, and then you could pretty much know where financial markets are going to be trading.”
But there’s one issue: “We don’t know that number,” Pearce says.
Inflation is high on, if not top of, the watchlist for all investors in 2025. Where goes inflation, so go interest rates; all key investment decisions flow from that.
“There’s still tightness in the labour market, wages still running at 4 per cent, et cetera,” Pearce says.
“So what it’s telling us is, that [inflation] number is not going down; and you’ve got government spending like crazy still. The number can stay above two and a half per cent, and we’d still be OK, I don’t see any major issue with a two and a half per cent inflation rate – which is above the 2 per cent that they’re targeting – and bond yields at four [per cent], I don’t see an issue at all with that.
“As a matter of fact, if you could be at [inflation of] three [per cent] and bond yields could be four and a half [per cent], and, actually, equities can still post double-digit, high single-digit returns. I just don’t see a problem with that. It’s when you get spikes [in] inflation, it gets above four, that’s when things will start getting pretty hairy. But it’s not our base case.”
Pearce contends that “we’re only two consecutive poor inflation numbers from having a 15 per cent sell off” in local markets.
“That’s how sensitive this market is going to be to inflation – I really think that,” he says.
“The bond market is telling you now that all is not right with inflation. It’s telling us, and the equity market is ignoring it. So, the bond market has to rally from here, or the equity market has to sell off. I don’t see that the two can hang in where they are. But I think it’s asymmetric. I don’t think a couple of inflation numbers that are OK are going to get a 15 per cent rally.”
Real challenges ahead
Added into the mix of challenges facing investors is the impact of a second Trump presidency, and whether he follows through on what he’s said he’s going to do on a number of issues central to the performance of the US economy – including, but not only, on tariffs.
And other factors are also at play which present challenges to a cohort of professional investors who have grown up experiencing a particular set of market and economic conditions. Among them is the impact of demographics, which Colonial First State chief investment officer Jonathan Armitage says is “that slow burn, or, if you want to paraphrase Hemingway, ‘Slowly, slowly, then all at once’”.
“People look at the numbers and…just assume that demographics are slow-moving, until they suddenly aren’t,” Armitage says.
“So all those elements I think are, first of all, challenges to the backdrop to which a lot of us have been investing for the last 20 years or so, 20 or 30 years. But also in various way, they’re either inflationary, or they are less deflationary than we’ve been used to. That just means that we will just see more volatility in inflation data.
“There’s nothing that I’ve seen in the last 12 months that necessarily challenges that view. And to be clear, that also means that we’ll go through periods where inflationary pressures look as if they’ve returned to the levels that we’ve seen over the last seven years or so.”
Australian Retirement Trust (ART) head of investment strategy Andrew Fisher says investors also need to watch closely to see if the economy is set for a hard or a soft landing.
“A soft landing remains the base case; is the risk more skewed to the no landing or the hard landing scenario?” Fisher says.
“We’re only two consecutive poor inflation numbers from having a 15 per cent sell off.”
John Pearce, UniSuper
“And then, even if it’s more skewed, is one of them actually realistically a risk scenario at some point? Because eventually, there will be another recession. Eventually inflation will get out of hand again, one day. I mean, maybe not be in my lifetime, but it will happen.”
Fisher notes that the longer the hard-versus-soft landing issue is discussed, the more likely it is that the issue is already settled.
“At a certain point we’ve actually had a soft landing, because we’ve talked about it long enough it’s already actually happened,” he says.
“And then the next cycle begins, whether that’s up or down.
“As time progresses, we need to be quite alert to that. I don’t think it’s a near and present threat, but things change really quickly in markets. And so that’s one big one.”
HESTA chief investment officer Sonya Sawtell-Rickson says that in 2025 she expects official interest rates to be “potentially 1 per cent lower than they are now”.
“However, there remains significant uncertainty about the future direction of interest rates,” she says.
“If inflation remains high and wages rise accordingly, there’s a risk that interest rates may not be cut at all. If this were to eventuate, we expect economic growth to remain flat, and unemployment to rise to about 5 per cent. As investors, however, we are focused on our long-term strategy and on being agile in the face of changing markets.”
Staying grounded
AMP chief executive officer Anna Shelley says “the endless gift of Trump” will have a bearing on how strategies are set and how they play out in 2025 and beyond. Whatever the actual outcomes, Shelley says investors must be able to tell whether investment decisions were successful because they were right for the right reasons, or if they were right but for the wrong reasons.
“And it can just be luck,” Shelley says.
“You’ve always got to be a bit wary of your successes and not necessarily attribute them to your own team’s brilliance always [and] even after they’re successful, still questioning, if we did get that right, could it have been better? If we did get that right, was there another way to do it? Was there a more risk-reducing way that we could have done that? And if we did get that right, was there something else we missed? Was there an adjacent investment decision that we could have made at the same time, and we missed that one, but we got this one?
“There’s always learnings, and I think you still got to do almost like a post decision analysis, and we do this quarterly, where we look at what went right, what went wrong, what would we do differently, and I think that sort of a discipline is really healthy to have.”
Shelley says it’s also possible to be right, but to experience an unexpected outcome.
“The first time Trump got elected, was a good example of that. A lot of people thought they knew if that happened what would happen to markets and, actually, they got the outcome right, but then the market aspect wrong,” she says.
“There’s always that possibility. So I think as much as possible, you’ve got to try and dissect what was good, even if we made a bad decision. What did we get right about it? What did we get wrong? Were there any gaps in the process? What would we do differently next time?”
UniSuper’s Pearce says that right now the fund is accumulating cash, “but we’re not selling; we’re in inflow at the moment, so we’re building up cash”, Pearce says.
“We don’t like giving the exact detail, but all I’m saying is that in terms of what we are doing – and cash also becomes interchangeable with whether we’re holding bonds, et cetera – we’re building our more defensive assets, let’s put it that way.”
Pearce says part of the reason for this is that “our gut feeling in our asset allocation committee [is] that the Trump trade is likely to fizzle”.
“The markets now are just looking at the good stuff: obviously deregulation; lower taxes and all that; the sugar shot; friendly to business; but he’s got to do something on tariffs,” Pearce says.
“He can’t sit there and do nothing. So the question is, how much, how soon, on whom? But he’s got to do something.
“You say, look, that’s all factored-in. I don’t think it is. So, the Trump trade will fizzle.”
ART’s Fisher says a critical question is “does Trump do everything Trump says he’s going to do?”
“Full control of three houses, the works, he can do whatever he wants,” Fisher says.
“But the reality is, he probably doesn’t need to do everything he wants, or he says he will do, because he has all of that power. What is he saying he’s going to do as a bargaining tactic, and what is he saying he wants to do because that’s structural reform he wants to make to global markets?
“How that plays out over the 12 months I think will have some impact on the risk around inflation breaking out again. If it breaks out in the US, it’ll break out everywhere.”
Armitage says people associate the introduction of tariffs with a Trump presidency but in reality “tariffs have been rising before Trump first came to occupy the White House”.
“I mean, there’s data that suggests that actually tariffs have been rising since about 2010 [or] 2012 across the OECD, but actually the number of instruments that governments have been putting in place, which they may not have called tariffs but they certainly looked like it, or protectionist policies, was already on the rise,” he says.
“That is the backdrop that we are we’re going to have to get used to investing in, and that is obviously quite different from the backdrop that I’ve spent most of my career investing in.”
Private assets’ time to shine
Fisher says that in addition, “the other big thematic I’m thinking about is around the public-private dynamic”.
“In a lot of facets, but most meaningfully for us, the public-private dynamic at the moment is leaning more into private real assets and away from public market equivalent,” he says.
“We’ve been doing the opposite for a couple of years. So in the inflationary breakout post-COVID, you saw some really strong outperformance in infrastructure and real estate versus public markets; then you’ve had two years where the reverse has happened, and so we’ve been less inclined to go into real assets for the past couple of years, [but] much more inclined to do so for the next couple of years. So we’ve put out some fairly sizable targets in terms of deployment to the teams over the next two years. So that’d be a big thematic that plays through the portfolios.”
For her part, Shelley says she’ll watching the advancement and impact of technology “and how that comes to bear in different sectors”.
“That will be something that will also be putting the pressure on our managers on,” she says.
“The prospect for significant advancements in medicine, for example, are really exciting, and, I think, very real,” she says.
“But then you’ve got to think through how it might impact other sectors within the economy, and then even how we operate ourselves. Is it going to impact how we operate, how we trade, how the counterparties that we deal with, how they operate, how they trade. So that’s a big one.”
Sawtell Rickson says ongoing challenges, such as geopolitics and climate change, are creating opportunities in the development of solutions, “including reshoring manufacturing and the energy transition”.
“We are of course also monitoring the return of Trump to the US presidency and the effect policy changes may have on these thematics, and markets more broadly,” she says.
“In addition, AI may deliver productivity benefits, that have the potential to enhance company profit margins and deliver long-term economic growth.”
