Market index returns

Week to date since July 12, 2023 as of July 19, 2023

Global equity markets headed higher this week as the potential “soft landing” narrative in the U.S. gained further traction. Even as regional tensions flared in Eastern Europe, volatility in equity markets remained docile, and the U.S. dollar continued to weaken, falling briefly below 100 (as measured by the DXY) for the first time since April 2022. Against this backdrop, Real Assets also ended the week higher – Commodities were the standouts, outperforming broader markets. Global Infrastructure securities were the only real assets class to sustain a mild loss, as weakness from towers weighed.

Why it matters: Sentiment seems to have shifted from fear to greed, with investors overlooking the expected decline in aggregate earnings this season and focusing instead on future earnings, with great expectations for productivity gains from artificial intelligence (AI). Geopolitical risks could also quickly shift capital markets as the war in Ukraine rages on, China’s economy appears stuck in second gear, and the U.S. approaches a consequential presidential election. Given these unknowns, we continue to advocate for portfolio diversification with an allocation to real assets, which can offer inflation protection, competitive real yields, and low correlation to other asset classes. Additionally, listed real assets provide transparency and liquidity benefits vis-à-vis their private market counterparts, and can be used in lieu of or as complements to private real assets allocations. Read more about some of these strategic benefits in our recently authored article here.

Digging deeper: This week, we mourn the expiration of the Black Sea grain deal before reviewing recent inflation prints, which could have global implications for central bank policies. Then we dive into China’s latest economic data and consider what additional steps they might take to stimulate growth. Finally, we remark on the returns divergence between private real estate funds and public markets.

• Paint it black: One day before it was set to expire, Russia withdrew from the Black Sea grain deal following an attack on a key bridge to the Crimean peninsula. Russia also declared that any ship entering Ukrainian ports could be considered a military target and has already launched multiple attacks on Ukrainian ports and grain storage infrastructure. Ukraine responded in-kind – any Russian ships entering the ports will be considered as carrying military cargo. As the region is a major global export hub for grains (Russia, Ukraine, and Belarus accounted for ~17% of corn and ~40% of wheat globally prior to the invasion), wheat and corn prices jumped considerably on the news, leading all commodities’ returns this week.
• Can the UK shop ‘til inflation drops?: This week saw new inflation data from several developed countries. First, in the UK, inflation was lower than expected and down from the month prior but remains at one of the highest levels amongst developed markets with a headline print of 7.9% year-on-year and 6.9% core (ex food, energy, alcohol, & tobacco). This led to a weakening of the pound and lower rates on UK gilts. Despite this pressure, UK consumers have been remarkably unfazed as evidenced by June retail sales growth of +0.7% versus expectations of just +0.2%. In the Eurozone, headline inflation of 5.5% was in line with expectations and fell from the prior month, but core inflation of 5.5% exceeded expectations and accelerated by 10 bps from May. Elsewhere, inflation in New Zealand (5.9%) and Canada (2.8% headline vs. a slightly more worrisome 3.9% core) continued to fall. New Zealand and Canada are likely to experience only one more rate hike this cycle, if any.
• China’s GDP disappoints: China’s 2nd quarter GDP grew 6.3% year-on-year from 4.5% in Q1, but missed expectations of 7.3%. Further, the jobless rate for 16-24 year-olds hit a new high of 21.3% in June and retail sales disappointed, growing just 3.1% from a year ago when much of the country was in COVID-related lockdowns and significantly down from 12.7% in May. Central planners have announced that new policies supporting non-state-owned businesses will be launched, but have shared few details on timing and scope. The new policies would come in addition to the planned easing of home buying restrictions, which are being considered to support a flailing residential property market.
• Property markets part ways (for now): Historically, listed real estate returns have tended to lead private real estate returns by about a year – second quarter data affirmed this trend. Preliminary 2Q data for the NFI-ODCE (a common proxy for direct real estate funds) showed a -2.7% total return which compares to a +1.2% gain for listed REITs (measured by the FTSE Nareit All Equity REITs Index) over the same time frame. Recall that listed REITs fell for the first three quarters of 2022 before reversing course and have now gained ground for three consecutive quarters. By contrast, direct real estate gained for the first three quarters of 2022, but have now fallen for three consecutive quarters (if the preliminary data holds). If this relationship between listed and private real estate stands, we would expect private real estate funds’ valuations to stabilize in the near future.

What we are watching: Central bank rate decisions will be in focus next week with the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) holding policy meetings, while the Bank of England (BOE) meets the following week – we preview all three below. We then turn to employment trends in the U.S. which could help avert a recession this year. Next, as part of our continuous monitoring of credit conditions, we highlight a new debt issuance that has us concerned about capital raising in the office sector (and ponder what are credit rating agencies thinking). Finally, we look at some of the largest telecom names and discuss what implications their potential new liabilities could have for the U.S. tower names.

• Central bank triple play on deck: Next week, the Fed will almost certainly raise its benchmark rate by 25 bps following its 2-day meeting, but are future hikes in store? Currently, the futures markets ascribe a 20-30% chance that one more hike will occur this fall. The following day will bring a decision from the ECB, which is widely expected to deliver a 25 bps hike. The odds for additional hikes beyond that point in the Eurozone are even greater, but appear limited to just one more 25 bps hike by the end of the year before a pause. A week later, the BOE will be on tap, where market participants are evenly split between expecting a 25 or 50 bps hike; similarly, one or two additional 25 bps hikes are expected before an anticipated pause in 2024.
• Labor offers an economic lifeline: Employment trends in the U.S. remain robust. Initial jobless claims fell to 228k this week from 237k the week prior and below expectations of 240k. While continuing claims did creep up to 1,754k from 1,729k a week ago, the print remains well below the 10-year trailing average of ~3M. We won’t see July’s non-farm payroll data released for another two weeks, but do not expect a material pickup in the unemployment rate from June’s 3.6%. Should inflation continue to trend lower, giving the Fed reason to end the current rate hiking cycle, it could be the resilient strength of employment in the U.S. that ultimately prevents a recession.
• Borrowing issues?: This week brought us the first unsecured debt issuance from a U.S. office REIT in some time. Piedmont Office Realty Trust issued $400M of 5-yr senior unsecured debt with a 9.25% coupon at a slight discount, equating to a 9.5% yield-to-maturity. While this high rate may have been a bit surprising (Piedmont debt is currently investment grade with a long-term issuer rating of BBB from S&P), it’s even more shocking that a number of junk-rated bonds with similar maturities from hotel REITs are trading at lower yields. This could be an isolated issuer incident…or it represent the tip of an iceberg of much wider credit spreads forthcoming for office names. Given that MSCI recently released a report estimating that $24.8B of U.S. office buildings were in distress at the end of the second quarter, we believe that higher coupon rates for office issuers could be in store.
• A lead weight drags down telecom (and towers): Following reports that some of the largest telecom providers could be on the hook for environmental remediation from decades-old, lead-sheathed buried cables and amidst multiple sell-side downgrades, AT&T fell to its lowest price in 30 years while Verizon fell to its lowest in a decade. While not directly exposed, this could have ramifications for the tower owners (which also fell on the news): AT&T and Verizon are amongst their largest tenants, and any slowdown in capital expenditures by these major carriers could translate to lower future revenue for tower companies. AT&T regained some ground following a statement that less than 10% of its copper-wire network has lead-clad cables; however, we expect this issue will take time to unravel fully and will be watching carefully for any spillover effects to the tower names.