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- Real Assets rebound led by listed infrastructure
Market index returns
Week to date since May 01, 2024 as of May 08, 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 moved higher this week following the somewhat dovish comments out of the U.S. Federal Reserve (Fed) meeting last week and weaker employment data in the U.S. It was relatively quiet on the news front this week, but the few new data points that did come out were relatively positive at the margin. Economic data out of Europe has tilted positive, and Sweden’s Riksbank cut interest rates this week, its first cut since 2016, and front-running potential cuts this year from both the European Central Bank (ECB) and the Fed. China too is showing signs of improvement on the economic front, and their major stock market gauges have been on the upswing since bottoming in early February of this year. In the U.S., following lackluster nonfarm payroll data last week, employment trends show signs of gradual deterioration, with both initial jobless claims and continuing claims coming in higher than expected and increasing sequentially, with the latter at 231k (the highest since August of last year). However, this represents exactly the sort of sign the Fed may be looking for to shift from fighting inflation to protecting full employment. Against this backdrop, Real Assets rose but underperformed broader equities. Global Infrastructure securities bested broader equities’ returns, with strength seen across Europe. Global Real Estate Securities, Natural Resource equities, Commodities, and TIPS all ended our review period higher but lagged the broader market returns.
Why it matters: While weakening employment trends in the U.S. might be a key data point for the Fed to consider, we would expect them to give a keener eye to Consumer Price Index (CPI) and Producer Price Index (PPI) data, which will be released next week and are expected to show that inflation in the U.S. remains stubbornly high. Europe and the UK are in recovery mode and are likely to see rate cuts this summer. Data out of China is incrementally positive too, but it remains to be seen when their property markets might finally start to gain traction, which could provide a major boost for commodities. Conflicts in the Middle East and Ukraine remain impactful geopolitical risks, although it’s hard to handicap how either plays out. There are also many major elections ahead this year, which could alter the course of political alliances, foreign policies, and relative sector performance. Given the divergence in central bank policies and ongoing regional conflicts, we would expect to see increased volatility in foreign currency exchange rates, which could give way to greater dispersion as some regions and asset classes outperform others.
Macro Dive: We’ll first review recent Institute for Supply Management (ISM) services data in the U.S. We’ll then look at improving economic data out of Europe, before turning to China, where recent trade data is starting to paint a better picture.
Why it matters: While weakening employment trends in the U.S. might be a key data point for the Fed to consider, we would expect them to give a keener eye to Consumer Price Index (CPI) and Producer Price Index (PPI) data, which will be released next week and are expected to show that inflation in the U.S. remains stubbornly high. Europe and the UK are in recovery mode and are likely to see rate cuts this summer. Data out of China is incrementally positive too, but it remains to be seen when their property markets might finally start to gain traction, which could provide a major boost for commodities. Conflicts in the Middle East and Ukraine remain impactful geopolitical risks, although it’s hard to handicap how either plays out. There are also many major elections ahead this year, which could alter the course of political alliances, foreign policies, and relative sector performance. Given the divergence in central bank policies and ongoing regional conflicts, we would expect to see increased volatility in foreign currency exchange rates, which could give way to greater dispersion as some regions and asset classes outperform others.
Macro Dive: We’ll first review recent Institute for Supply Management (ISM) services data in the U.S. We’ll then look at improving economic data out of Europe, before turning to China, where recent trade data is starting to paint a better picture.
- Interestingly, Services (data) Misses: ISM Services PMI Index for April, released on May 3rd, showed contraction in activity with a reading of 49.4, which surprised investors as the index was expected to be greater than March’s 51.4 but instead fell into contractionary territory for the first time since December 2022. Anthony Nieves, the chairman of the ISM, stated in the report that the decline was a result of “lower business activity, slower new orders growth, faster supplier deliveries and the continued contraction in employment.” Inflation was also a noted concern and was evidenced in the ISM Services Priced Paid metric, which rose to 59.2 in April, exceeding expectations and March’s 53.4 level. The ISM Services Employment index was also troublesome as it contracted at a faster pace, registering 45.9 in April from 48.5 in March. Overall, while a contraction in the services industry may be a welcome sign to those hoping to see rate cuts this year from the U.S. Federal Reserve (Fed), the price paid metric continues to be a worrisome sign that policy rates could stay higher for longer.
- Europe inflation falls, but retail sales healthy: New economic data out of Europe this week continues to show an improving outlook, with the Purchasing Managers’ Index (PMI), Producer Price Index (PPI), and retail sales all released. First, the PMI Composite and Services prints of 51.7 and 53.3, respectively, showed continued expansion, exceeded expectations, and climbed from the prior month. Although the Manufacturing PMI remained in contraction at 45.7, it was better than expected and improved slightly from 45.6 in March. PPI data was released the same day and showed continuing signs of easing inflation as the month-on-month print for March fell by 0.4% and the year-on-year fell by 7.8%. Falling prices appear to be giving European consumers new confidence, as retail sales for March were better than expected at 0.8% and climbed out of the negative territory seen in February. Year-on-year retail sales, which were expected to remain in decline, also climbed out of negative territory from February, registering growth of 0.7% in March. Given that inflation continues to show signs of easing, even as economic growth picks up, the ECB appears to remain on track to ease policy rates in June, with overnight index swaps estimating a greater than 90% chance of a rate cut at the June 6th meeting.
- UK is OK: The Bank of England (BOE) held a policy setting meeting on Thursday and opted to hold rates steady, although two members voted to cut rates now. Given the dovish comments from the meeting, a potential rate cut in June is on the table, but in no way guaranteed, while investors continue to price in a full cut by the August meeting (per overnight index swaps). More encouraging news came the following day as UK GDP for the first quarter was released, which exceeded expectations and showed the UK had left its recession behind as GDP grew 0.6% quarter-on-quarter and 0.2% year-on-year, after 3 consecutive quarters of declines or no growth. Digging a bit deeper for the quarter, services grew by 0.7% from 4Q 2023 while production rose by 0.8%, but construction continues to contact, falling by 0.9% and matching the same decline seen in 4Q, although it was noted extremely wet weather in February may have hampered construction activity.
- China – greens shoots of recovery, but concerns linger: April’s trade data was encouraging as exports and imports returned to growth territory in April, after a weak March. According to China’s customs agency, China's exports rose by 1.5% in April compared to a year earlier, and imports rose 8.4% year-on-year. Both data points came in ahead of economists’ expectations. Exports in April were boosted by emerging markets demand, transportation (car) products, and a lower base for comparison. Likewise, a lower base played a role in the imports surge, but volumes also edged upward. Demand spurred by the AI race helped drive import growth, as electronic and hi-tech imports saw double digit gains. After implementing a slew of policy support measures in recent months, the latest trade figures suggest the Chinese government may be making some headway in its attempts to stabilize the economy; however, the jury is still out. Weak domestic demand has led to deflationary pressure, as CPI was reported at only 0.2% on an annualized basis in April and PPI fell by 2.3%, while the property market remains a drag on confidence. Beijing has set an economic growth target for 2024 of around 5%. Sustaining the momentum in domestic demand will be critical to meeting this target.
Real Assets, Real Insights: First, we review reported earnings data and the outlook for U.S. apartments. Then we look at a potential merger in the paper & packaging space and conclude with a peek at recent natural gas price movements and where it might be headed.
- Have to admit it’s getting better (Real Estate): Fundamentals for U.S. apartments appeared to turn a corner. While the U.S. listed apartment names recently reported first quarter results, they also gave an update on what was achieved in April. Across the board, blended rent growth in April, which includes both replacement leases and renewals, was better than what was reported for the first quarter. Additionally, renewal leases in April were all positive and increases ranged from up 3% to over 5.0%. Rental growth was notably stronger in coastal names as compared to sunbelt names, where there are still some declines in replacement leases. Markets where excess new inventory has been an issue (such as Austin and Atlanta) continue to see market rents decline. New supply will remain elevated through the end of the year, such that replacement leases will continue to be impacted throughout 2024, though we are starting to see permitting activity on the decline. That said, as home ownership remains out of reach for many amidst elevated home prices and mortgage rates, apartment landlords should have a captive audience of renters, and moveouts due to home purchases should remain low.
- From pulp to paper (Natural Resources): Reuters reported this week that the Brazilian-based paper and pulp company Suzano was interested in acquiring U.S.-based International Paper (IP) in an all-cash deal. While the reported $42 per share offer represented a 14% premium to IP’s unaffected share price, some might view this as a merger of equals as both companies currently have equity capitalizations just above $13B USD. Neither would confirm the details, as negotiations are still ongoing with no formal deal in place. We are somewhat skeptical that IP shareholders would accept the relatively modest rumored premium, and it could prove challenging for Suzano’s balance sheet to fund such a deal in cash. If an agreement is reached, International Paper would likely need to abandon their acquisition of UK-based DS Smith Plc, which was announced last month in a $7.3B deal and remains one of its key priorities. Additionally, there is limited product or geographic overlap between the two companies at present, which could keep a lid on any potential synergies. If a merger between Suzano and IP does occur, it would create one of the largest paper and packaging companies in the world with a truly global reach.
- Natural gas turning a corner? (Commodities): Natural gas prices have been in the doldrums as of late, and while prices did spike precipitously following the Russian invasion of Ukraine in 2022, they fell hard in December 2022, have fallen further since, and remain below pre-invasion levels. However, prices have started to climb recently as both supply and demand issues have helped drive values upward. In the U.S., producers are curtailing production targets for the second quarter, and warmer than usual weather has started the air conditioning season early, leading to an increased burn rate for electricity generation. In Europe, natural gas has been well supplied, but Russian gas transit through Ukraine will not be renewed this year, leading to European buyers likely needing to purchase more LNG via western ports. As for actual pricing, the most active futures contract (June 2024 delivery) for Henry Hub natural gas (the primary U.S. pricing metric) has risen almost 20% over the past two weeks. Natural gas in Europe, per Title Transfer Facility (TTF) pricing in the Netherlands (also for June delivery) is up ~32% from its February 2024 low, and even in the Asia Pacific region, the Japan Korea Marker (JKM), which measures prices delivered not only to Japan and Korea but also China and Taiwan, has risen ~34% from its February 2024 low. While we’re not ready to call it a comeback, if production continues to be curtailed and the Northern hemisphere sees a hot summer, we could see prices continue to move higher.
