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- Real Assets faltered on higher rates
Market index returns
Week to date since May 22, 2024 as of May 29, 2024
Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.
Market commentary:
Global equities declined this week as yields on longer-dated sovereign bonds increased and as U.S. consumers showed increasing signs of fatigue. Speakers from the U.S. Federal Reserve (Fed) continued to make statements that more improvement needs to be seen on the inflation front before any easing can occur and that they stand ready to increase rates further if conditions warrant it. These points, coupled with the hawkish tone in the Fed’s April meeting minutes, sent 10-year U.S. Treasury yields to 4.61%, up 19 bps during our review period. Yields in other parts of the world rose as well, with German 10-year Bund yields climbing 16 bps to 2.69% and 10-year UK Gilt yields rising 17 bps to 4.40%. Back in the U.S., personal consumption rose less than initially reported in Q1, leading to a downward revision of GDP growth, and pending home sales fell almost 8% in April from the month prior, given high home prices and elevated mortgage costs. With this backdrop, Real Assets overall also declined and underperformed broader equities. Commodities, buoyed by continued strength in industrial metals, and TIPS were the most resilient, with each falling by less than 1% and outperforming the broader markets. Natural Resources fell a bit more, underperforming broader equities, while Global Real Estate securities and Global Infrastructure securities were harder hit on weakness from U.S. self storage and office in real estate and infrastructure in the UK, which declined on a plus-sized rights offering from one of the larger names.
Why it matters: Regardless of any one individual view, it sure feels like the timing of the first rate cut from the Fed is a bit further out than what may have been anticipated a week ago (and much further out from the start of the year). The same can likely be said for the Bank of England (BOE) after recent inflation reports, but the European Central Bank (ECB) is all but certain to start reducing rates at their June 6th meeting. Meanwhile, it’s unclear when the Bank of Japan (BoJ) will raise rates again, which continues to weaken the yen. Regional disparities between central bank policies, currency movements, and localized asset performance could lead to some interesting opportunities within both Real Assets and the broader markets. Tensions between Israel and Iran appear to be simmering down or at least grabbing fewer headlines, and even Russia may be angling for a ceasefire in Ukraine. A winddown of those two conflicts would likely be seen in a bullish light, but we’re hesitant to ring the bell just yet, as either could escalate in a moment.
Macro Dive: We’ll first review the revision to the U.S.’s 1Q GDP estimate and April’s Personal Consumption Expenditures (PCE ) data. Then, we’ll cross the pond and look at the latest inflation data in the Eurozone. Continuing on our global tour, we’ll inspect the latest update from the International Monetary Fund (IMF) on expectations of China’s economic growth this year.
Why it matters: Regardless of any one individual view, it sure feels like the timing of the first rate cut from the Fed is a bit further out than what may have been anticipated a week ago (and much further out from the start of the year). The same can likely be said for the Bank of England (BOE) after recent inflation reports, but the European Central Bank (ECB) is all but certain to start reducing rates at their June 6th meeting. Meanwhile, it’s unclear when the Bank of Japan (BoJ) will raise rates again, which continues to weaken the yen. Regional disparities between central bank policies, currency movements, and localized asset performance could lead to some interesting opportunities within both Real Assets and the broader markets. Tensions between Israel and Iran appear to be simmering down or at least grabbing fewer headlines, and even Russia may be angling for a ceasefire in Ukraine. A winddown of those two conflicts would likely be seen in a bullish light, but we’re hesitant to ring the bell just yet, as either could escalate in a moment.
Macro Dive: We’ll first review the revision to the U.S.’s 1Q GDP estimate and April’s Personal Consumption Expenditures (PCE ) data. Then, we’ll cross the pond and look at the latest inflation data in the Eurozone. Continuing on our global tour, we’ll inspect the latest update from the International Monetary Fund (IMF) on expectations of China’s economic growth this year.
- PCE as expected but personal spending light: In the second estimate for Q1, U.S. GDP growth was reduced by 30 bps to 1.3%, largely driven by a revision of personal consumption, which was taken down by 50 bps to 2.0%. Further evidence of consumer fatigue was apparent in April’s PCE data, which showed personal spending grew by just 0.2% from March in nominal terms and declined by 0.1% when adjusted for inflation. While these might be signs that the Fed’s current policies are indeed restrictive, other elements in the PCE release showed that the pace of inflation was largely unchanged from March. PCE Deflators, both headline and core (excludes food & energy) all came in as expected and largely unchanged from March’s levels, with headline at 2.7% year-on-year and core at 2.8%. The one bright spot could be the core PCE deflator month-on-month, which declined by 10 bps to 0.2% in April, the lowest level this year. U.S. Treasury yields did pull back upon the release, and while odds of a November rate cut improved at the margin (per Fed Funds futures) as investors may have been expecting hotter inflation, a full rate cut from the Fed is still not priced in until December.
- ECB likely unfazed by inflation pickup: Flash estimates of Eurozone inflation for May were higher than economists’ predictions and accelerated from April on a year-on-year basis. The annualized headline CPI estimate of 2.6% was 10 bps above expectations and 20 bps higher than April. The increase was at least partially driven by an increase in energy costs of 0.3%, which was the first positive read in just over a year. Meanwhile, core CPI (excludes energy, food, alcohol, & tobacco) climbed to 2.9%, 20 bps ahead of estimates and April’s level. As the largest economy in the Eurozone, Germany’s harmonized year-on-year CPI of 2.8% was notable given its increase from 2.4% in April, but it was Belgium at 4.9% that recorded the largest price increases for the month. In some of the other sizeable economies, France’s CPI grew by 2.7%, Italy’s was one of the lowest at 0.8%, and Spain recorded a 3.8% jump. Still, the ECB appears to be on track to cut rates at their June 6th meeting, given recent comments from voting members and with overnight swap indexes indicating a greater than 95% chance that they do so.
- Journey to the East: The IMF completed its 2024 mission to the People’s Republic of China and lifted its growth forecast but warned on trade wars and the need for consumer-friendly reforms to sustain strong, high-quality growth. The IMF’s report, issued on Tuesday, noted that China’s economy is projected to grow by 5% in 2024, and 4.5% in 2025, reflecting upward revisions of 0.4% in both years compared to April’s world economic outlook (WEO) projections. Over the medium term, growth is expected to decelerate to 3.3% by 2029 due to aging, slower productivity growth, and the property sector correction. Furthermore, risks are likely tilted to the downside. The IMF noted that near-term macroeconomic policies should be supportive of domestic demand and mitigate downside risks while also warning that they should scale back subsidies and other “distortive” policies that support manufacturing at the expense of other industries, such as services. In a timely reminder of the task at hand, China's May manufacturing PMI fell to 49.5, a three-month low and notably lower than market expectations. This could be a warning sign for growth and likely underscores the need for Beijing to expedite its policy rollout.
Real Assets, Real Insights: First we look at the waning transaction volumes in real estate and then review some of the ways that trash can be turned into treasure, namely energy. We conclude with a review of two proposed merger transactions in natural resources, one that is likely to close and one that isn’t.
- Is this the bottom? (Real Estate): A recent MSCI report on capital trends in Real Assets showed that total U.S. commercial real estate (CRE) sales volume was just $17.1 billion in April, a 24% decrease from the same month a year ago. Global CRE data, not yet available for April, declined 17% in the first quarter to just over $140B from a year ago. In April, the U.S. downdraft was led by apartments, where volume declined by almost 50%, although hotel transaction volume almost doubled from the year ago period. The cap rate average for all transactions in April was 6.81%, up 2 bps from March. Industrial assets saw the largest cap rate expansion, 24 bps to 6.73%, while retail cap rates decreased by 6 bps to 7.15%. Additionally, the Fed’s most recent Beige Book noted CRE conditions were softer given tight credit conditions, higher borrowing costs, and excess supply concerns. However, Blackstone’s chief operating officer, speaking at an industry conference, noted a bottoming in the CRE sector and indicated now was the time to deploy capital. This was further illustrated by his firm’s recent investment in a $1 billion loan portfolio, purchased from Deutsche Pfandbriefbank and backed by multifamily, hospitality, and office assets spread across the U.S. and UK.
- When life hands you garbage (Infrastructure & Natural Resources): While reading about the demise of Fulcrum BioEnergy, we pondered if there might be other ways to turn trash into energy. Fulcrum BioEnergy was a pioneer in the clean-fuels space, with ambitions to turn municipal waste into clean-burning aviation fuel. However, after technical problems, low yields, and the unexpected creation of nitric acid, they laid off most employees and halted operations at their only operating facility in Nevada. What might be more viable in the near-term are waste-to-energy (WTE) plants. Per the U.S. Energy Information Administration (EIA), WTE plants are electricity-generating facilities that burn solid waste, or garbage, in boilers to produce steam that is sent through turbines. WTE plants are more prevalent in Europe than the U.S., as the International Solid Waste Association (ISWA) estimates there were over 520 WTE plants operating in Europe compared to just 75 in the U.S. at this time last year. Sweden, with 34 plants, may be the poster child for WTE, as it is estimated that only 1% of their trash is sent to landfills, with 52% converted to energy and 47% recycled. Still, despite the low cost to build and cheap fuel expenses, WTE plants are not without environmental concerns, as they are generally considered cleaner than coal but less clean than burning natural gas.
- Deal or no deal (Natural Resources): In a newly announced deal, ConocoPhillips is set to acquire Marathon Oil Corp. in an all-stock deal. Inclusive of outstanding debt, the definitive agreement values Marathon Oil at $22.5B and represents an almost 15% equity premium to Marathon’s unaffected share price. ConocoPhillips claims the deal will be immediately accretive to earnings and that $500M of synergistic savings can be achieved in the first year following closing of the transaction. The acquisition would add ~2 billion barrels of oil to Conoco’s known reserves at an average cost of less than $30 per barrel and would push Conoco’s equity capitalization over $150B. Simultaneously with the announcement, but independent of the transaction, Conoco announced an increase of their ordinary dividend by 34% starting in the fourth quarter, and contingent on the closing of the acquisition, a $2B increase in expected share repurchases in the first year to $7B annually, or ~$20B in the first three years. Falling into the no deal category, BHP Group is abandoning their $49B offer for Anglo American plc, which we previously reported on. Anglo American repeatedly rebuffed the overtures from BHP, and there was no mutual agreement to extend the deadline for a firm offer as required by UK security laws. It is unclear if Anglo will still look to shed De Beers (diamonds) and other mining operations involving platinum, coal, and nickel to focus more on copper and iron ore.
