They spent 2020 uniting to fend off a historic recession, but central banks are slowly starting to take divergent paths in 2021. In the past two weeks alone, the Federal Reserve (Fed) indicated it may begin to tighten monetary policy sooner than it previously projected, while China has also indicated it’s turning its focus back to controlling debt. Peak central bank stimulus is likely behind us, so now investors will need to refocus their attention to turns in international policy making.
Policy makers aren’t going to go crazy. JPMorgan economists still see the average global interest rate at 1.3% at the end of the year, which is largely unchanged relative to today. How central banks raise policy rates will be interesting to watch as they’ll need to find the fine line between moving too fast and too slow. If they raise rates too quickly they’ll shake investor confidence, similar to the Fed’s policy error in late 2018, but sitting on their hands for too long could increase inflation expectations further and worsen financial stability as house prices and other assets are likely to surge in such conditions.
The most notable change in market pricing since the Fed’s meeting in June has been that the market now expects the timing of the first hike to be in December 2022, rather than a year later as previously predicted. Not only is the market expecting a rate hike earlier, but it’s now the speed of rate hikes to accelerate with another two increases expected within 12 months of the first. Inflationary pressures at the moment are likely to be transitory and the result of underinvestment by supply-side producers who were less convinced of the speed of the recovery. If the Fed acts on these temporary price pressures (e.g. the increase in flight prices back to normal levels from their depressed lows), will they be able to keep increasing rates after that? It doesn’t seem so.
According to Citigroup, this year will be the first since 2006 in which advanced economies add more to global growth than emerging markets. With over 57% of all U.S. adults now fully vaccinated, the US economy is making a comeback in a big way, with annual GDP growth expected to be around 6.5%. It’s been close to 30 years since such levels of growth were reported. The $5.3T in stimulus since March 2020 has provided a significant tailwind, but not without costs, as government debt per capita now sits at $85,000.
Sadly, not all nations are sharing equally in the recovery. Globally, 1.9 million people have died from Covid-19 in the first half of this year, which is more than the 2020 total. While the U.S. rose to the top of Bloomberg’s Covid Resilience Ranking for the first time in June, the Delta variant of the virus continues to threaten societies namely in India and broader Asia. The World Health Organization has warned that the Delta variant of the coronavirus is “the most transmissible of the variants identified so far” and has spread to at least 85 countries at this point in time.
The S&P 500 closed at a fresh record at the end of June amid a rally that added $6 trillion in value to stocks so far this year. As a result, valuations are again causing debate given they are now above the past decade average. The question on the mind of many investors is whether these fresh highs mark the peak of a profit recovery following the depths of the pandemic. Conversely, with the 2Q21 earnings season approaching, JP Morgan believes that earnings will come in well above current estimates, and are forecasting an earnings surprise of 14.6% for S&P 500 companies.
Investment grade and high yield corporate bond credit spreads, measures of credit risk, have now tightened by -17 and -82 bps YTD, respectively. At 304 bps, high yield bond spreads have now traded through the post financial crisis tights of 316 bps set in October 2018. According to PGIM, the outlook for high yield defaults continues to improve and the prospect of a wave of upgrades increases. The bank is predicting that about $60B of high yield paper is on the verge of being upgraded to investment grade, and that 19% of the high yield market could be upgraded by 2022.
Asset Class Commentary
Like every other part of the supply chain these days, there’s a lot of stress on America’s trucks and their drivers thanks to a booming economy and the large supply and demand mismatch. This pressure is resulting in significant delays to shipping times for both households and companies alike. Ford has had to halt production for two weeks at the Michigan factory that just began building its Bronco sport-utility vehicle, citing a lack of unspecified parts. Many other US automobile showrooms have also been left with few vehicles to display due to the semiconductor shortage that hobbled production earlier this year.
In addition to increased demand, nonunion ports are having labor issues as nonunion workers are choosing to stay home over returning to work because unemployment benefits are currently greater than their usual wage. Lack of labor at these ports is further contributing to shipping delays, so much so that some retailers are now taking matters into their own hands and purchasing their own vessels to take control of moving their stock.
Commercial finance continues to be an attractive space for institutions to park funds. In June, Apollo Global Management announced that it has committed to invest up to $500 million in senior secured credit facilities originated by Victory Park Capital, a global investment firm with an extensive track record in asset-backed credit origination for emerging and established companies. Competition in the space is high and the bigger firms are having a difficult time originating larger deals so are looking for deal flow anywhere they can. In contrast, Yieldstreet is evaluating middle market transactions and continues to see value and high quality offerings. Stay tuned for more details.
Commercial real estate
The shift to online retail has been happening for years but the pandemic has definitely fast-tracked this change in behavior. The recent investment by retailers all around the country in e-commerce programs is one of the many reasons why we liked our recent offering, Norfolk Industrial Complex Equity – a last-mile logistics center in Virginia. As retailers’ beef-up their online operations and invest in faster delivery for customers, the hunt for warehouse space is on and it’s a highly competitive race according to a JLL report released in June. The report found that this year demand among mass merchandisers for logistics facilities to store inventory and pack and ship online orders will be the highest it has ever been. Walmart, Target, Big Lots, TJX and Costco are all vying for more warehouse space and are playing catch up with Amazon, which has been gobbling up space in the middle of the country for years.
Switching gears, the examination of demand for office space obviously tells a very different story. In saying this, the return to the office is here and is only expected to accelerate in Q3 2021. CBRE is estimating that by the end of the quarter 52% of large companies (>10,000 employees) will be back in the office and its floors will be reminiscent of a pre-pandemic era. Companies plan to achieve “return-to-work” via effective communication surrounding the benefits of receiving a Covid-19 vaccine, with 3% of medium size firms surveyed by CBRE confirming that they will be mandating vaccination. Over the second half of 2021, we will learn more about workplace policies around hybrid work and employee flexibility. One thing we do know is that employers will prioritize investments in collaborative office designs going forward. While the outlook for offices is looking up, the uncertainty that continues to exist is the main reason why we remain hawkish on the sub-sector of commercial real estate. For this reason, Yieldstreet investors can expect to see more offerings in the industrial and multifamily sectors of the market over the next few months.
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