Monday, January 23, 2012

The State of the Investment Environment

Excerpts from December 2, 2011 article by David Lynn, Contributing Columnist for National Real Estate Investor. 


Rednews.com



The U.S. economy grew in the third quarter at the fastest pace since 2010 with real GDP expanding at a 2.0 percent annual rate, up from 1.3 percent in the second quarter. Household purchases, the biggest part of the economy, increased by 2.4 percent, much stronger than forecast.
In addition, business investment remained robust. Corporate spending on equipment and software climbed 17.4 percent, the most in a year, contributing 1.2 percent to economic growth. This economic growth, along with hope for a possible resolution of the European debt crisis, has eased some concerns of a double-dip recession in the near term.
After a hiring slump in May and June, employers have since increased payrolls by an average of 132,000 workers per month, including 120,000 workers added in November. After little change in the unemployment rate since April, the jobless rate declined to 8.6 percent in November, its lowest point since March 2009, as a result of job gains and a decrease in the labor force.
Driven by both revenue growth and cost-containment, corporations reported a solid third quarter, with profit growth rising by 11.6 percent year-over-year.
Consumer spending has remained strong as households have dipped into their savings. The personal saving rate was 3.5 percent in October, up 20 basis points from September, but it remained at one of the lowest levels since December 2007.
The most recent monthly data suggest the economy is gradually improving, with incomes rising by the most in seven months during October. Retailers reported a strong start to the holiday shopping season over Thanksgiving weekend, with sales during the four-day weekend rising 8.7 percent from a year earlier, according to MasterCard Advisors’ SpendingPulse.
In November, consumer confidence rose to its highest point since July. While consumer confidence continues its monthly improvement, it remains vulnerable to outside political or economic setbacks, according to the Thomson Reuters/University of Michigan Survey of Consumers.
The cost of living in the United States has trended up throughout 2011, primarily due to rising food and gasoline costs. The Consumer Price Index (CPI) declined in October by 0.1 percent over the previous month as a result of lower energy prices.
The U.S. housing market continues to struggle, despite record low mortgage rates and historically high affordability.
Both single family starts and new and existing home sales remain at depressed levels. With an anemic job market and rising foreclosure sales, we do not expect a meaningful recovery in the housing market over the next 12 months.
The S&P downgrade of U.S. debt in August and a worsening European sovereign debt crisis in August and September initiated a drop in confidence globally. As a result, equity markets plummeted worldwide. Driven by a flight to safety, investors bought more U.S. Treasury Bills, and 10-year treasury yields plunged from 2.8 percent in early August to a record low of 1.7 percent in mid-September.
To provide additional monetary stimulus, the Federal Reserve launched “Operation Twist” – using maturing short-term treasuries ($400 billion) on its balance sheet to purchase longer-term treasuries through June 2012. Its intent is to thereby push down interest rates on everything from mortgages to business loans, giving consumers and companies an additional incentive to borrow and spend money.
In response to European debt crisis, six central banks, including the Federal Reserve, recently announced a coordinated effort to provide access to U.S. dollars for commercial banks through temporary U.S. dollar liquidity swap arrangements.
Negatively impacted by rising market volatility, investors became more risk averse, with risk spreads for non-treasury assets widening significantly during the third quarter. Spreads of AAA CMBS over swaps have increased by over 200 bps since mid-August, prompting investment banks to withdraw several large new issuances, at least temporarily, according to Commercial Mortgage Alert.
Commercial real estate fundamentals have generally continued their recovery path, although leasing activity slowed moderately during the third quarter of 2011.
National transaction volume across the five major property sectors totaled $45.4 billion in the third quarter of 2011, 15.3 percent lower than the second quarter but still 38.0 percent higher than the same period one year prior, according to Real Capital Analytics. The firm also reported the average transaction cap rate for all properties over $5.0 million remained unchanged at 7.1 percent during the third quarter of 2011, 10 basis points lower than the same period one year ago.
Looking forward, we think that U.S. economic fundamentals are improving although we are still vulnerable to exogenous shocks from overseas. GDP growth in the fourth quarter could accelerate to 2.5 percent, creating a healthy momentum into 2012.
David Lynn is a managing director, generalist portfolio manager and head of investment strategy for Clarion Partners in New York.

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