Is The Bottom Almost Here?

[UK]

 

From: https://www.bloomberg.com/opinion/articles/2023-05-30/wework-s-woes-show-return-to-office-is-no-party

[changegonnacome]

7 hours ago, Parsad said:

excess capacity

 

You hit the nail on the head......and whats crazy in cities like NYC in terms of street level CRE - restaurants/bars in particular- is that city decided to retain all the COVID era extra dining capacity it created via outdoor/street dining..............very successful bars/restaurants have managed to double sometimes triple their seating capacity with these COVID era accommodations that they got to keep.....seems harmless....until you realize that doubling/tripling capacity of these establishments has kneecapped the neighbouring street level CRE & the bar or restaurant that MIGHT have opened up just down the street.

[Gregmal]

Any guesses on energy prices year over year for June? 
 

Although what’s funny is $125 barrel equates to $5 a gallon at the pump. $68 is still $3.50 my neck of the woods. Especially odd given six months ago with $75 on the barrel it was $3.15. 
 

It’s pretty clear with just about everything from energy to housing that the deflation aspect is occurring and some of it is being kept as margin. But we deny the profit gauging argument because last year margins contracted(wasn’t this obvious?). Like the Frito lay debate a quarter or two ago. Margin expansion looks likely imo if you pick your spots at well run outfits. Which could mean upside for stocks.

[TwoCitiesCapital]

13 hours ago, Sweet said:

Anecdotal and with major caveats, one of which being I don’t live in the US.  However we experienced lockdown and all the same hybrid working in the UK and commercial

occupancy has significantly improved.  Nearly everyone is regularly back in work, hybrid working still in force in some places but not nearly at the level during covid.  Could the CRE not be as bad as predicted?

 

I'm in the Midwest/rust belt. We never really had a huge boom of corporate real estate here given that the city has been shrinking for 60 years. That being said, still seeing large office towers sold prior to imminent bankruptcy from desperate landlords. 

 

My company gave employees the choice of hybrid or fully remote. Less than 1/3 chose hybrid (requires an average of 2 days in office per week). The rest are fully remote.

 

We own at least 6-7 large office buildings outright with some smaller buildings across the street from our canpus. We sold 1-2 of the small buildings and are demolishing one of the 6-7 large ones. 

 

Despite being "well insulated" from overpriced CRE, we're still here....

Edited May 31, 2023 by TwoCitiesCapital

[Sweet]

41 minutes ago, TwoCitiesCapital said:

 

I'm in the Midwest/rust belt. We never really had a huge boom of corporate real estate here given that the city has been shrinking for 60 years. That being said, still seeing large office towers sold prior to imminent bankruptcy. 

 

The company I work for gave employees the choice of hybrid or fully remote. Less than 1/3 chose hybrid (requires an average of 2 days in office per week). The rest are fully remote.

 

We own at least 6-7 large office buildings outright with some smaller buildings across the street from our canpus. We sold 1-2 of the small buildings and are demolishing one of the 6-7 large ones. 

 

Despite being "well insulated" from overpriced CRE and the only carry-costs being taxes and maintenance, we're still here....

overall what’s your feeling about CRE - long decline?

[dealraker]

The question is will it ever get such that a Bruce Flatt interview gets past the word "trophy!"  

[Viking]

Lot of quality companies hitting (or close) to new 52 week lows. Lots of commodity stocks hitting 52 week lows. Financials are hated. Most insurance stocks are selling off. Retail stocks got whacked today and many are dirt cheap. Lots of companies also trading where they were trading 5 years ago. It is like the market is in a bear market right in front of our face. Except we don't see it looking at the market averages - because of the run in AI stocks. So I started nibbling today on a bunch of different things. If stocks keep selling off this could get quite interesting... 

[TwoCitiesCapital]

48 minutes ago, Viking said:

Lot of quality companies hitting (or close) to new 52 week lows. Lots of commodity stocks hitting 52 week lows. Financials are hated. Most insurance stocks are selling off. Retail stocks got whacked today and many are dirt cheap. Lots of companies also trading where they were trading 5 years ago. It is like the market is in a bear market right in front of our face. Except we don't see it looking at the market averages - because of the run in AI stocks. So I started nibbling today on a bunch of different things. If stocks keep selling off this could get quite interesting... 

 

Agreed. S&P equal weight telling a very different story from the S&P cap weight. 

 

I've been buying a few commodity companies now that they've sold off significantly and I can reinvest profits from prior trims, but still waiting for the last shoe to drop - corporate profits. In a recession, I expect most things will get cheaper and most stuff outside of oil and small regional banks andaybe 1-2 other sectors don't seem to be pricing in any recession. Still prefer to own quality spread and duration. 

 

2 hours ago, Sweet said:

overall what’s your feeling about CRE - long decline?

 

I expect it'll be city dependent. I doubt the Midwest gets hit as hard as population centers on the coasts. But yes - we've clearly overbuilt CRE. 

 

If even 10% of workers are remote on average, you have a very large abundance of office real estate at the margin. And my guess is the figures are quite a bit higher than 10%. 

 

Sure it can be converted - but that takes time. And it takes capital, and capital requires a return, and that return is largely going to come from lower valuations and not increases in cash flows. 

 

Maybe its not true of every building or even every city - but I expect CRE to be plagued with issues for the next 5-10 years as leases come due and aren't renewed and redevelopments are slow to happen because people can't afford to write down the value of the property against the debt carried on it. 

 

It could also be true that elevated inflation bails them out and cash flows CAN make up a decent portion of it - but in a real basis, and compared to other asset classes, I expect it'll still be a poor comparable. 

 

Edited June 1, 2023 by TwoCitiesCapital

[Spekulatius]

On 5/31/2023 at 5:06 AM, Sweet said:

Anecdotal and with major caveats, one of which being I don’t live in the US.  However we experienced lockdown and all the same hybrid working in the UK and commercial

occupancy has significantly improved.  Nearly everyone is regularly back in work, hybrid working still in force in some places but not nearly at the level during covid.  Could the CRE not be as bad as predicted?

The UK and the rest of Europe has returned to the office, the US hasn’t.

[changegonnacome]

5 hours ago, Spekulatius said:

The UK and the rest of Europe has returned to the office, the US hasn’t.

 

Yep agree from numerous anecdotal conversations with folks there.......the lag in US office return is really a function of an exceptionally tight labor market dare I say 'overheating' economy vs. UK/Europe....put simply middle managers and/or employers in US don't sense they have the leverage (yet) to impose fully their end state post-COVID WFH policies without spiking attrition to undesirable levels............I'd imagine moving forward that if SuperCore inflation starts failing, and it isnt right now, that it will be inversely correlated with office attendance........which is to say as office attendance rises SuperCore will be failing.......likewise office attendance will be positively correlated with productivity gains which will be dis-inflationary (P -WFH.....'Pretending to Work from Home' is real)...you can pretend to work from the office but its much easier to do so at home!....at least in the office there is some monkey see monkey do social proof going on that others are working and so should you! I'd imagine increasing office attendance will also be inversely correlated with wage growth.

 

I watch the Kastle systems site - it will be a nice coincident indicator of some of the above:

https://www.kastle.com/safety-wellness/getting-america-back-to-work-occupancy-by-day-of-week/

Friday is the real canary in the coalmine day IMO......YoY Friday attendance has barely budged...you see this spike up meaningfully MoM and the Fed is getting what it wants/needs & the labor market is cooling.

 

I've completely got wrong the time its taken for the Fed to effect a slow down.....the resilience of the US economy has been impressive.....I for sure underestimated how rate insensitive large swathes of the American consumer is........Europe is making genuine progress on underlying inflation for the opposite reason......but ultimately the Fed will succeed.......it's amazing how the conversation has pivoted from rate cuts in H2 to conversations around 6% Fed Funds. Just given the level of rate insensitivity it might be very surprising how high the Fed needs to get to drive unemployment up to 5%....which at the end of the day if you read between the lines is what they are aiming at.....NAIRU is ~4.5%.....and to achieve the supercore disinflation they want they probably need to hit ~5%......I think written in JP's notebook is a dream scenario where he gets unemployment to the late 4%'s.....and supercore into the mid 2's.....and THEN he starts cutting knowing that momentum + lags will finish the job.

 

 

Edited June 1, 2023 by changegonnacome

[mattee2264]

With the debt ceiling deal done Democrats will be able to continue trillions of annual deficit spending which will put them at odds with a Fed that wants to reduce inflation. 

Obviously Republicans are toothless and just looking to score points with trivial spending cuts. And for some reason global markets aren't willing to impose any discipline.

 

I remember the utter outrage at the fiscal plans of Liz Truss in the UK and the market reaction with the pound plummeting and interest rates spiking across the board.

But somehow it is OK for the USA to run trillion dollar deficits and no one blinks an eye.

 

But with that kind of ongoing fiscal stimulus it is difficult to imagine a deep recession and inflation is more likely to be an issue going forward 

 

[TwoCitiesCapital]

28 minutes ago, mattee2264 said:

With the debt ceiling deal done Democrats will be able to continue trillions of annual deficit spending which will put them at odds with a Fed that wants to reduce inflation. 

Obviously Republicans are toothless and just looking to score points with trivial spending cuts. And for some reason global markets aren't willing to impose any discipline.

 

I remember the utter outrage at the fiscal plans of Liz Truss in the UK and the market reaction with the pound plummeting and interest rates spiking across the board.

But somehow it is OK for the USA to run trillion dollar deficits and no one blinks an eye.

 

But with that kind of ongoing fiscal stimulus it is difficult to imagine a deep recession and inflation is more likely to be an issue going forward 

 

 The exorbitant privilege of being the world's reserve currency....until we're not. 

 

With the way the current monetary system is set up, the US HAS to run trade deficits to provide a constant supply of dollars to the rest of the world so they can have enough dollars to settle trade in. We import their goods and export dollars they need to settle their imports of raw materials. 

 

What do they do with those dollars? Hold them as reserves in the form of US treasuries until needed. How do they get treasuries? Well the Treasury has to issue them. 

 

WE basically have to run twin deficits to provide enough treasuries to supply the world with dollars and a constant flow of attractive, liquid reserve assets (~6.5 trillion in global reserve assets currently denominated in USD). 

 

Now the size of the deficit is probably larger than what is required by this process, but then you have the dollar claims of the euro-$ banking system providing a steady bid too, but that is too complex and beyond me to know the impact. 

 

As long as we're the reserve assets, we probably get a pass until a better alternative reserve comes along. Everyone else? Not so much. 

Edited June 1, 2023 by TwoCitiesCapital

[changegonnacome]

16 minutes ago, mattee2264 said:

But somehow it is OK for the USA to run trillion dollar deficits and no one blinks an eye.

 

Its the “exorbitant privilege” that comes with being the worlds reserve currency - its both a privilege and curse...a privilege cause it gives an economy that has it so much economic latitude....a curse cause the politicians and the electorate get into a death spiral of exploiting the privilege to an absurd degree. The short version of the global monetary system is that it fundamentally requires the USA to run a budget deficit and trade deficit. The world, as it continues to grow, is perennially 'short' dollars....the US supplies dollars via its budget and trade deficit. I've no problem with this necessary deficit estimated at ~3-4% but the absurd levels right now are not helpful.

 

The reserve currency status can also function a lot like the so called "resource curse" that bedevils many commodity rich economies.....large wealth in the ground but no enguiniety and dynamism to create goods & services outside of pulling stuff out of the ground.......look at Israel in the middle east....its amazing.....all these oil rich arab states surrounding them and Israel sitting over nada, dust......and they've grown to be the real economic powerhouse in the region (sure with lots of help from the USA) but make no mistake the system, their lack of resources as a forcing function for ingenuity of the Israeli people built that economy......while their Arab neighbors still have only dwindling oil reserves. The danger of the reserve currency curse....is your country can do a reverse Israel......rely more and more on deficits over time versus the dynamism of the past.

 

The huge difference with the world reserve currency moniker vs. the resource curse is that it is in its initial stages - the reserve currency status is hard earned & deservedly won. he danger of the reserve currency curse....is your country can do a reverse Israel......coming to rely more and more on deficits over time versus the dynamism of the past. That hasn't happened to the USA.....this last wave of innovation from Apple, Google, Microsoft and now in AI shows a US still striving for greatness - the GOP are attuned to the risks of the reseve currency curse.......while AOC & Sanders.....would given everybody in the country a six month vacation twice a year and fund it all with debt if left to their own devices....they have no idea where prosperity comes from.....they think its just printed on pieces of green paper called dollar bills.

[changegonnacome]

Oops @TwoCitiesCapital you nailed it while i was typing similar - spot on......its something that works, until it doesnt work....you dont want to be around when it stops working!

[TwoCitiesCapital]

Would also add M2 is cratering faster than velocity is accelerating. 

 

If M2 is going down faster than velocity is rising, typically that foretells of GDP contractions. 

 

I expect additional draws of liquidity as the Treasury has been spending down its account and will need to rebuild the balance sucking additional liquidity out of the market. 

 

We had plenty of deficit spending in 2008 and were running trillion dollar deficits going into the economic weakness in 2019 that preceded covid (were already in a manufacturing recession long before the pandemic hit). I doubt trillion dollar deficits change much in the near to intermediate term outlook and still expect a recession - potentially a deep one. 

Edited June 1, 2023 by TwoCitiesCapital

[Gregmal]

If I was looking for a real reason to be bearish...IE not the same gargled bear points that just always seem to exist in perpetuity...why isnt the student loan payments getting turned back on a larger talking point? Its the last real return to normal event (IE 2019 pre covid life) thats left. And considering how many people have them and how big they typically are...that money has to get pulled from somewhere. This was and has been a stealth stimulus check as well which unlike the previous that just stopped, this one forces money to go out the door. I'd probably guess auto purchases will be the most impacted by this. But theres probably a lot of everything that sees pullback directly bc of this. 

[changegonnacome]

Robbed from Twitter......but it vibes with this thread:

[mattee2264]

OK so there won't be any internal or external discipline to prevent the US Government from continuing to run annual deficits of over $1TR. 

 

That being said surely this means the balance of risks is skewed way more towards inflation than recession given we already saw during COVID how government spending can counter the economic cycle. 

 

Of course this time round it will be partly offset by the impact of higher interest rates but so far they've seemed to be pretty impotent having little impact on jobs or the stock market for that matter. 

 

Yes there were fiscal deficits before COVID and during the GFC but during the GFC the fiscal stimulus was much smaller and post COVID with the Democrats taking over the fiscal stimuluses are more socialist in nature whereas the Republican stimulus was more targeted to the rich eg tax cuts. 

 

 

[gfp]

The high interest rates increase the deficit spending stimulus to the economy, skewing that stimulus heavily towards those who have lots of money already.

 

The problem with the Warren Mosler type of lens on deficit spending and the economy / inflation is that it misses a much larger portion of the monetary system that isn't even measured by the US Government.  The monetary system outside of the US dwarfs the measured stuff like M2.  If the US monetary system was just what the Federal Government had "control" of, we would be roaring higher.  Instead we are just putting along because all of this stimulus is being offset by tightening money, flight to safety, hoarding and risk-off behavior globally.  The market is telling you inflation is dead for now and deflationary risks are rising.  We'll see how far it goes but the risks are higher that things get much worse because there isn't anything the Fed can do.  The Federal Reserve is basically powerless and more of a "placebo effect" or hoping that a projection of confidence sends the correct messaging that might effect behavior in the economy and get what they want.  The level of the deficit, higher or lower, is much more effective as a policy tool but it won't be used that way except in the depths of a crisis.

 

The amount of money out there doesn't matter nearly as much as the amount of money that is freely circulating / recirculating.  When market participants start with the "risk-off" stuff, the recirculation of money in the economy slows down and that effect dwarfs the small effects of slight changes in the level of deficit spending.

[tede02]

The last 18 months have really been fascinating and humbling. It's been a great reminder that no one ever consistently knows where things are going. The recession that everyone has been predicting keeps getting pushed out. I distinctly remember one prominent fixed income manager boldly predicting the Fed would never make it to 5% (and yet here we are). And then of-course there is the huge rally in equities this year despite the Fed continuing to hike and inflation staying stubbornly persistent. I reduced exposure to tech and shortened duration in fixed income in the early months of 2022. Those turned out to be good moves. But the bottom presently appears to be Oct/Nov 2022 and I definitely wasn't smart enough to reallocate in the opposite direction at that point. Maybe the Fed is forced to go to 6%+ as Jamie Dimon pondered and the economy does hit a wall at some point. I wouldn't be surprised if the lows in equities are re-tested and long-rates drift up. But who knows. I certainly don't. 

[gfp]

There hasn't really been a "huge rally in equities this year."  There has been a very narrow rally in a few very large companies.  RSP and IWM are basically flat.  Look at 5 year TIPS breakevens.  2%.  Exactly what the Fed is targeting.  The Fed didn't slay inflation.  If anything they made it worse.  But it went down on it's own anyway and they can claim it was them and move on with the high-fives.

[rkbabang]

34 minutes ago, tede02 said:

The last 18 months have really been fascinating and humbling. It's been a great reminder that no one ever consistently knows where things are going. The recession that everyone has been predicting keeps getting pushed out. I distinctly remember one prominent fixed income manager boldly predicting the Fed would never make it to 5% (and yet here we are). And then of-course there is the huge rally in equities this year despite the Fed continuing to hike and inflation staying stubbornly persistent. I reduced exposure to tech and shortened duration in fixed income in the early months of 2022. Those turned out to be good moves. But the bottom presently appears to be Oct/Nov 2022 and I definitely wasn't smart enough to reallocate in the opposite direction at that point. Maybe the Fed is forced to go to 6%+ as Jamie Dimon pondered and the economy does hit a wall at some point. I wouldn't be surprised if the lows in equities are re-tested and long-rates drift up. But who knows. I certainly don't. 

 

As I said much earlier in this thread.  I've never seen a coming recession so widely and confidently predicted by just about everyone.  Which made me skeptical that it was imminent. 

[Gregmal]

Well the answer was and is pretty simple...just stay the course. But everyone feels better being prepared for "something bad might happen tomorrow".....

[Spooky]

Things have unfolded pretty closely to how I predicted so far. Hard to say where things go from here but I'm being more cautious again now that sentiment has picked up.

[TwoCitiesCapital]

I still lean in the recession/bottom isn't in camp. 

 

The longer it takes for us to get there, the higher the level of the overall bottom can be due to retained earnings/repurchases/etc. Perhaps if it happens in late 2024 then we can end at similar lows to to what we saw in October and just let out the pressure in real returns and time instead of nominal ones. It's possible (though I'm skeptical). 

 

That being said, even with the drawn out nature of this slowdown (longest stretch of leading indicator contraction in history), I'm more comfortable owning bonds.

 

6-7% YTMs in short and intermediate duration core bonds funds that are predominantly treasuries/mortgages? And a potential double-digit kicker if rates are cut substantially? Versus a 20+ multiple on contracting earnings from stocks that have spent two years absolutely failing to be inflation hedges?  All while most economic indicators outside of employment (which lags) are screaming slowdown or already well within recessionary ranges?

 

I think I'll take the 6-7% with little risk than trying to sell to the next greater fool and bag a 15% return. Still have substantial equity exposing I'm trading around, but every month that goes by that we remain in "bull" mode, I'm trimming net exposure and adding bond funds. 

 

Maybe I'm wrong about the recession - but at least there are reasonable alternatives this time around to hide out in