Both the Vanguard Australian Shares Index ETF (ASX: VAS) unit price and BHP Group Ltd (ASX: BHP) share price look well-placed to end 2022 with a bang.
Since the end of September 2022, the Vanguard Australia shares Index ETF has lifted around 10%. Over the same time period, BHP shares have surged more than 20%.
It has been a strong period of time for Australia's biggest business, which has a commodity portfolio across iron ore, copper, nickel, coal and potash.
It's an interesting question to consider whether the exchange-traded fund (ETF) or the resources giant will do better. Keep in mind that BHP holds the biggest position in the Vanguard Australian Shares Index ETF portfolio – at the end of October 2022, it comprised 9% of the portfolio.
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The case for the BHP share price
It's important to note that 2022 hasn't finished yet, so if BHP shares keep rising from here, it could be harder for the company to outperform the ASX share market in 2023.
The company's success is heavily linked to commodity prices. Whether the price of iron ore is US$50 per tonne or US$150 per tonne, BHP still needs to pay for the people, machinery, trucks, trains and boats needed to get the resources out of the ground and to its industrial customers.
When the iron ore price goes up, it largely adds straight onto the company's cash flow and net profit after tax (NPAT), after paying more to the government. Of course, a lower resource price can wipe off the profit.
According to reporting by the Australian Financial Review, the broker Citi has suggested that the iron ore price could go as high as US$150 per tonne by June 2023 as China relaxes its COVID-19 restrictions.
This means people in Shanghai, for example, no longer need a negative COVID test to enter "most public places". And a negative test is no longer required for people to enter a Beijing-based supermarket or commercial building.
There is also work being done by Chinese officials to help Chinese property developers that are in financial trouble, according to the AFR.
The broker Morgans thinks that the BHP share price has already priced in much of the China recovery potential, which is why it only rates it as a hold, with a price target of $44.80. That implies a drop of around 5%.
On Morgans numbers, the BHP share price is valued at under 10x FY23's estimated earnings with a potential grossed-up dividend yield of 8.8%.
The case for the Vanguard Australian Shares Index ETF
There are some major iron ore miners within the S&P/ASX 300 Index (ASX: XKO) – the index that the ETF tracks – like BHP, Fortescue Metals Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO).
The big question for the non-iron ore miners is how the Australian economy performs in 2023.
A big part of the weighting of the ASX 300 is to banks like Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB), Australia and New Zealand Banking Group Ltd (ASX: ANZ), Westpac Banking Corp (ASX: WBC), Bank of Queensland Limited (ASX: BOQ) and Bendigo and Adelaide Bank Ltd (ASX: BEN).
Interest rates have jumped. In some ways, this can help banking profitability because loan rates are rising quickly, faster than savings rates. But there's also the problem of potentially higher arrears if borrowers can't handle the higher repayments.
Some banks are now saying that a big improvement in lending margins has already occurred. Higher interest rates may not lead to much of an improvement in lending margins from here.
There's also the question of how retailers like Wesfarmers Ltd (ASX: WES) will perform if consumers have less money to spend because of inflation and higher interest rates.
My verdict
From here, I think the capital growth performance could be quite similar between the two by the end of 2023. If the interest rate is only increased by 25 basis points in 2023, I think the Vanguard Australian Shares Index ETF will outperform because the underlying businesses may see fewer negative headwinds, such as higher borrower arrears.
But, in terms of total returns, I think BHP could produce stronger returns because of the large dividend yield that it pays. This could provide a useful boost for shareholders.
