2019 End of Summer Review
2H 2019 Review
Eight months into 2019 and 10 years into the longest economic expansion in US history, financial markets and valuations continue to trend higher despite rising risks. Most pressing among these risks are continued China trade tensions and a recently inverted treasury yield curve. That said, timing the duration and depth of economic downturns and recoveries has proven to be challenging and historically is a losing strategy. Furthermore, there are powerful factors at play that are driving market strength and investor inflow. These include:
Foreign capital inflows on the back of stronger economic activity verses most developed markets and economies around the world, which continues to drive superior returns across most US asset classes.
US government yields that remain near multi-decade lows yet importantly still present a significant spread over similar rates in the rest of the developed world.
Consensus economic forecasts calling for another 25-50bps cut in the Fed Funds Rate through year-end.
Healthy job creation and strong consumer confidence, which sits at 10-yr highs. August represented the 107th consecutive month of job growth, the longest in U.S. history.
Subdued market risk metrics, as measured by tighter investment and high yield bond spreads, with lower volatility based on the VIX Index.
Near 40 Year Bull Market in rates Continues to Support Valuations:
Cap rates continue to compress following other yields lower in other asset classes:
Increasing portfolio exposure to defensive sectors and non-traded alternatives such as real estate seems prudent in the current environment. Real estate historically outperforms equities across a full business cycle and in particular during late cycle and recessionary periods.
Whilst real estate was challenged in the 2008/2009 recession when bank funding shut down, due to tight lending standards it is unlikely to fair as poorly in the next recession. Bank capital requirements are stronger, loan-to-value ratios remain contained, and most importantly in our view the supply of new capacity has significantly lagged demand growth in the current expansion, particularly in the workforce housing sector.
Supply and Demand: Out of Sync:
Home purchase prices and housing inventory have diverged since 2010, and the gap widens at the more affordable end of the market.
Although a systemic event could call an abrupt end to the current expansion, it’s more likely the economy simply runs out of steam over time as the effects of fiscal stimulus fade, the global backdrop weakens, and election uncertainty builds. That said, current data points to a relatively stable environment over the short to medium term leaving investors faced with the challenge of finding attractive returns while limiting downside risk in the event of a more bearish outcome.
At Tidegate Capital we seek to minimize risk by focusing on attractively valued assets with significant upside potential located in economically diverse and stable markets. The workforce housing sector has not experienced the overbuilding that the Class A space in the top 10 metropolitan markets has; it is also less sensitive to hot money inflow and outflows. Further, high building costs, lack of available land, and tight lending standards continues to suppress and in fact reduce capacity in the workforce housing space.
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