The financial media has recently been inundated with strong economic news. Now would be a good time to step back, put everything in context, and think about what the longer-term image might tell us.
According to the economic headlines of recent months, we are and fuego straight away. March wage numbers rose by 916,000 at the first release of the data, which was a big surprise.
The production numbers of the ISM survey were equally impressive, with a strongly expansive value of 64.9 on April 1. That’s the highest reading since March 1983, in case you were wondering.
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Why is the economy doing so well?
We have vaccines rolling out on an impressive schedule, more and more states are relaxing COVID-19 restrictions and a general optimism that people will come out and spend as the year goes on.
We are also seeing inflation numbers picking up, which some say is a sign that consumer spending and demand is gaining momentum.
All this has been confirmed by stones, which everyone knows will always rise forever, probably without even retreating and certainly not crashing no matter what. (Please don’t let me add a disclaimer to this statement. If you think I meant it, I have a bridge to sell you).
If we are to believe the stock market, our friendly officials at the Federal Reserve and Congress have erased the financial troubles associated with COVID-19. It was all a bad dream, nothing to worry about. The S&P 500 has blown past its pre-pandemic highs and is right back at the top of the trend line set in 2019.
Real estate also behaves in the same way. Maximum rates for everything we look at are lower than ever before. The Boulder Group recently released a survey showing that retail and industrial ceiling rates were the lowest ever in the first quarter.
The problem is that COVID-19 happened. Lots of people lost their jobs and the economy was saddled with a tremendous amount of debt to try to mitigate its effects. We can argue whether that fiscal and monetary spending really helped anything (it didn’t, at least not to the extent that some would argue), but for the moment let’s acknowledge that it happened and there will be consequences.
However, let’s dig a little deeper and see if we can’t generate actionable insights by thinking critically about what we see.
I certainly do not want to take away from the improving figures that we are seeing, that is not my intention. Like everyone else, I want the economy to be robust, that people find work and create prosperity for themselves and their families.
But my job is to analyze, interpret and contextualize the data so that I can make the smartest investment decisions. Some problems emerge through that lens.
The right question to ask is not, “Is the economy better?” That answer is clearly yes. The better question is, “Do investment valuations and the associated expected returns on a relative basis make sense given the current state of the economy, and where can we invest to give ourselves the best available risk-return profile?”
What about employment data?
Yes, the sequential increase in employment in March has increased by 777,000 people, which is fantastic. However, the newly released figures for April show a major disappointment: 266,000 jobs created versus the expectation of a million. Let’s zoom out and become equally sophisticated data analysts. We’re still about 8.4 million jobs, or 5.5%, below the peak.
Now let’s take it a step further and project where the employment would have been if it had continued to grow at the rate it had since 2000. Then we can calculate the gap and project when we might get back to the trend.
The average growth in employment, including the expansion months only, has been 0.18% per month since 2000. Average employment growth since the COVID-19 bottom in April 2020 was 0.94%. The growth rate in March was 0.64%.
To give us a good idea of how employment could evolve, I give the economy the benefit of the doubt – despite the setback in April – starting growth at 1.25% and then slowing down the growth rate by 20 basis points until we reach the long term. forward trend of 0.18%. That would mean that 1.8 million, 1.5 million, 1.25 million and 967,000 jobs will be added from May to July, respectively. For context, months of a million jobs are absolutely unheard of, occurring only a few times last year during the PPP-driven new hires. I recognize that this is just an estimate to get us thinking, but it would mean a huge job growth. That gives us something like the following table.
I am not claiming that my projection is airtight. This is simply an exercise to better understand the scale of the challenge facing the economy. Assuming there are no setbacks (remember we were only using extension months), we would catch up to the pre-recession peak sometime around May or June of 2022, and it would take several more years to hit the trendline.
The job growth has the potential to be really strong all year round, but at the end of the day, there’s still a good chance we won’t be back all the way when we close 2021.
What obligations does the economy create?
Probably the single most important factor to emerge from this crisis will be the sheer amount of liabilities being created throughout the economy. Most obvious and obvious is the run-up in federal government debt. But there are also some ‘shadow’ liabilities to consider, including state and local government budget deficits and their future pension liabilities, as well as individual liabilities in the form of unpaid rents, mortgages, or other debts to be paid. refunded at some point when forbearance programs expire.
As for federal debt, avert your eyes!
You can see above that we never really got ourselves together after the great financial crisis, when we hit the danger zone. Research shows that debt to GDP becomes quite problematic at around 90%. We’ve been blown past that and we’re at 129%.
High public debt is associated with lower economic growth. The government is sucking up resources that would otherwise remain in private, more productive hands. It results in less investment in capital goods and subsequently poor labor productivity growth.
While many more issues come into play here – including demographics, which create additional economic headwinds – we need to consider the long-term negative consequences associated with debt. Real estate is usually an investment for several years.
Looking ahead to the future economy
The next few months come with really exciting economic statistics. We have to celebrate and take it into account, but also keep it in context. Long after stimulus controls have faded and the exuberance of unlocking parts of the economy wears off, we’ll still have a mountain of jobs to recover and a big, steaming pile of debt to pay back.
This is where it gets interesting, and where the main battle will be in the financial markets.
In a traditional economy, the demographic and debt dynamics associated with the US would lead to very slow economic growth over time, and any stimulus would quickly fade and create more debt.
If you think this will remain the case, the outlook is for continued low inflation, low interest rates and low labor productivity. In this scenario, if we experience a shock, real estate prices in certain sectors and regions could fall as deflation or disinflation increases, borrowing becomes less attractive and the reality of a slow economy affects rental growth in commercial real estate.
In my opinion, that is what we will get if we maintain the status quo. Today, however, there is more potential than ever for a different scenario.
I think real estate investors should be well aware of the potential of inflation in this market. With debt spiraling out of control and with both the Federal Reserve and the federal government indicating their willingness to borrow, issue and monetize debt for as long as it takes, we can see inflation build up as a result of a psychological aversion to owning dollars and bonds. as they pile up at the Fed.
Fortunately, I think there are ways to invest in real estate that will allow you to perform well in both scenarios. You can do this by capitalizing on the long-term themes that will transcend cycles with less sensitivity to economic activity.
Think of product types and real estate regions where you have strong rental pricing power while being flexible and able to manage expenses. Think about the long-term demographic trends and the types of products that will thrive in a recession, but great when inflation is severe.
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