Much of the conversation over the past month has been dominated by headlines coming out of China, and the news has not been positive. The huge amounts of debt used to fuel business expansion is catching up with many, including one of the country’s largest property developers, China Evergrande Group. As of the end of last year, the property developer had more than 700 projects under construction, covering 132 million square meters of total floor area. The huge pipeline is supported by huge amounts of debt, and $7.4B is due to mature and be repaid next year but the company has already started to miss interest payments sending markets into a panic as the situation is reminiscent of 2008/2009.
While most think that the banking system’s exposure to the developer is manageable and that a systemic crisis is unlikely, the uncertainty that exists in the market at the moment is driving valuations of Chinese equities down. Developed markets, however, only experienced a moderate decline in September which did erase much of the previous quarters gains but overall they continue to sit on strong gains for the year to date.
In September the Fed announced it planned to slow the pace of asset purchases and it also released its projections surrounding interest rates. It is expected that rates will increase to 1.75% by the end of 2024 and markets were caught a little off guard by this news, with treasury yields increasing in the days following the Fed’s September meeting. The hawkish shift from the Fed in conjunction with hopes that we may be at a point where most people have either been vaccinated or already infected with Covid, also caused government bonds to sell off, after their rally earlier in the quarter.
The last week of September was also a pivotal week for congressional Democrats. The party needed to keep the government funded, stave off a default, push a $1 trillion infrastructure bill to President Biden and secure the votes for a defining climate change and social policy bill. Not an easy task to say the least.
Switching to fixed income, high yield bond prices have remained flat in Q3 as momentum from fundamental credit improvement and strong corporate earnings has been offset by lingering virus concerns. Food & beverage and food & drug retail outperformed with energy remaining the best performing industry so far in 2021. Expectations are that spreads could tighten by up to an additional 40 bps by mid-2022 before some moderate widening thereafter. This view does depend on how the Fed decides to tackle rising inflation, the level of uncertainty in China and the risk of a new Covid mutation.
Asset class commentary
Commercial real estate
Amid an improving economy, the demand for commercial real estate continues to recover, but the recovery is uneven across property types and geographic markets. In line with our commentary from previous months, the demand for commercial real estate continues to recover but unevenness does exist across property types and geographic markets.
According to the National Association of Realtors, Q3 saw absorption in the multifamily market reach a decade high level, with asking rents up nearly 11% year-over-year. In the industrial market, asking rents are up nearly 7%. In the retail market, rents are up by 2% year-overyear.
The unevenness in the recovery becomes apparent when you analyse the declining occupancy rates within the office market. More than 144 million square feet of office space has been given up by tenants across the United States since the start of the COVID-19 pandemic. It is expected that office vacancy rates will likely remain above 10% in the next two years.
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