Is sentiment calming?
What does this CRE cycle look like compared to others and how will fundamentals fare as economic growth slows?
The data looks somewhat brighter and confirms our view that growth in the U.S. is slowing, not plummeting.
Is sentiment calming?
In recent months recession fears increased as economic data came in below expectations, policy uncertainty (particularly trade) weighed on sentiment, and the earnings outlook turned negative. But seemingly positive developments over the last couple of weeks appeared to calm some of the more dire feelings and presented some renewed optimism. We see sentiment turning toward our long-held view that the economy is slowing, but not imploding.
Data surprises to the upside
In recent weeks, economic data outperformed expectations, including several noteworthy facets of the economy such as GDP growth and net employment change. That trend continued with last week’s data releases. The ISM nonmanufacturing index increased during October, exceeding expectations, indicating that thus far the services sector of the economy is withstanding the slowdown in the manufacturing sector. The consumer sentiment index’s preliminary reading for November showed a slight increase, demonstrating the continued optimism among consumers. And labor market data continues to look robust. The number of open yet unfilled jobs declined slightly in September, but still totals above 7 million. That figure exceeds the number of gross hires and the number of people who are technically unemployed. Weekly jobless claims also demonstrate ongoing tightness in the labor market. Combined with a few rate cuts from the Fed, the data looks somewhat brighter and confirms our view that growth in the U.S. is slowing, not plummeting. And the risk of a recession remains just that at this juncture – a risk.
The equity markets have clearly cheered the upside surprises while discounting the earnings declines.
Trade policy uncertainty easing?
In addition to data points, recent progress (or at least the appearance of progress) on the trade front has also buoyed optimism. It appears as if the U.S and China are negotiating in phases, with phase 1 still in progress. Key issues -- including the rollback of tariffs -- remain undecided and are not currently under negotiation. We have not changed our view that progress on this front will occur gradually and on a limited basis. That appears enough to prop up sentiment, at least among publicly traded markets, if not businesses themselves that still see much uncertainty and risk in trade policy.
Earnings also helping
Earnings for the third quarter of 2019 have largely surprised. Admittedly, many companies lowered guidance throughout the year as the business environment became more challenging. Yet positive outperformance demonstrated further that things are slowing, not imploding. With roughly 90% of S&P 500 companies reporting earnings at the time of this writing, roughly 75% reporting a positive earnings surprise and roughly 60% reported a positive revenue surprise. Earnings declined year over year and the third quarter marked the third consecutive quarter of year-over-year earnings declines. That had not occurred since the second quarter of 2016. The equity markets have clearly cheered the upside surprises while discounting the earnings declines. Publicly traded markets continued to hit all-time highs in recent weeks while bond yields have continued to tick up, both signs of optimism among investors. For the fourth quarter, negative earnings guidance (essentially signaling that earnings will underperform what was previously anticipated) has outpaced positive earnings guidance. But we do not expect that markets will behave very differently as long as earnings do not severely disappoint.
What we are watching this week
Inflationary readings highlight some key releases this week. The consumer price index (CPI) for October should show an increase in both core and headline prices. On a year-over-year basis, both core and headline inflation should hold fairly steady, with core CPI quietly hovering near 2.4%. The producer price index (PPI) for October should rebound following a somewhat unexpected decline in September. Year-over-year should continue showing a slowdown, potentially reaching the lowest level in years. Retail sales for October should show a minor increase, following an unsettling decline in September. We still expect a healthy consumer heading into the important holiday shopping season.
What it means for CRE
At the risk of sounds like a broken record (or streaming service for the younger readers), commercial real estate (CRE) continues to fare well. The sector has ridden the ups and downs in economic data and sentiment well. We see no signs of meaningful deterioration across major property types or markets. While demand has moderated, along with the overall economy, new supply growth remains relatively limited across property types. This CRE cycle increasingly looks like the last cycle with relatively limited supply growth. That compares favorably to previous cycles which endured either widespread overbuilding in the case of the S&L Crisis from the early 1990s or localized overbuilding in the dot-com bubble in the early 2000s. That limited supply should keep fundamentals in a relatively strong position, even as economic growth continues to slow in coming quarters.
Thought of the week
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