““Look at the uncertainty,” said one senior Fed official. “Are we facing
deflation or inflation? Are we up or down? Growing or not?””[i]
Against a backdrop of growing policy uncertainty, the economy stalled in the second quarter with real GDP growing at a revised 1.6% annual rate. Indeed we forecast that the economy will continue to crawl at a 1.4% rate in the current quarter and then grow at a very tepid 2% growth rate for the following four quarters. (See Figure 1) Indeed we don’t visualize a return to trend growth to approach 3% or so until late 2011. In this environment the unemployment rate will remain extraordinarily high ending this year at 9.7% and 2011 at 9.5%. (See Figure 2)
Given the huge decline in output that took place in 2008-09, the economy should be growing at 5-6% annual rate, not the 2% rate that we now envision. What normally happens in a recovery is that the proverbial baton is passed from government spending and inventory restocking to housing, consumer spending and investment. In this recovery somewhere along the way the baton was dropped as housing double-dipped and consumer spending stalled. (See Figures 3 and 5) Although it is hard to visualize the double dip in the quarterly housing start data, it is very evident in the collapse of monthly existing home sales after the expiration of the homebuyer’s tax credit. (See Figure 4) To be sure, equipment and software spending has remained strong, but leading indicators of activity and corporate announcements suggest that it too, will fall from its recent heady pace. (See Figure 6)
Figure 1. Real GDP Growth, 2005Q1 -21012Q4F
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 2. Unemployment Rate, 2005Q1 – 2012Q4F
Source: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 3. Housing Starts, 2005Q1 – 2012Q4
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 4. Existing Home Sales, 2005 – July 2010
Source: National Association of Realtors
Figure 5. Real Consumption Expenditures, 2005Q1 -2012Q4F
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 6. Real Spending on Equipment and Software, 2005Q1 – 2012Q4F
Source: U.S. Department of Commerce and UCLA Anderson Forecast
What Ails the Economy?
We have two broad explanations as to what is ailing the economy. The first is the balance sheet recession hypothesis we outlined nearly two years ago which is broadly analogous, with the important exception of the U.S. not experiencing a foreign exchange crisis, to the analysis put forward by Carmen Reinhart and Kenneth Rogoff.[ii] In their historical work, “This Time is Different,” they outline the history of eight centuries of financial collapses and come to the conclusion that recoveries from the bursting of debt fueled financial bubbles are invariably slow and are associated with unusually high unemployment rates and an explosion in government debt. Sounds familiar, doesn’t it? Simply put because the imbalances engendered by the prior boom, it takes a long time for an economy to heal from a financial collapse. It certainly doesn’t have to be as bad as the 1930s or Japan’s lost two decades, but in their view a quick recovery to the semblance of the pre-boom normal is not likely.
The recovery from the balance sheet recession is being exacerbated by an extraordinary increase in policy uncertainty which is amplifying the usual economic uncertainties associated with recessions. . As early as December 2008 and almost continually thereafter in the UCLA Anderson Forecast we noted that fiscal, monetary and regulatory policy uncertainties coming out of Washington, D.C. would limit consumption, investment and hiring.[iii] In a way, policy making has become “iatrogenic” in that instead of curing the economic disease it is making it worse.
Policy makers in Washington D.C. don’t seem to understand that the decision of a firm to hire an employee is an investment decision and therefore subject to all of the budgetary criteria that goes into the buying of equipment. And remember there are no health insurance premiums associated with buying a computer. The investment/hiring decision is subject to forecasts on the future of tax, environmental, energy, financial, labor and healthcare policies.
At the present time, business firms can only make the wildest guesses as to what corporate and individual tax rates will be next year and for that matter three years from now, what the cost of healthcare will be, whether or not there will be a revived cap and trade policy with respect to carbon emissions or whether the Environmental Protection Agency will step in with regulations of their own absent a statute and whether it will be easier or more difficult to hedge risks with financial derivatives. Furthermore, it certainly does not help to have the perception, true or not, that the Administration is at best ignorant of business or at worst, hostile to business.
A Late New Deal Analogue
There is a loose historical analogy to the current environment. In the middle of the 1937-38 recession the term “capital strike” entered the political vernacular as several prominent New Dealers, in particular Secretary of the Interior Harold Ickes and Assistant Attorney General Robert Jackson, attacked the business community for “sabotaging” the New Deal.[iv] Of course left out of their theory was the impact of the full implementation of the Wagner National Labor Relations Act and the adoption of a tax on undistributed corporate profits along with a monetary tightening and the tax increases associated with the beginning of the Social Security payroll tax. In light of this history, it would be fair to say, that today's business community doesn't have a clue as to how hostile government policy can be.
Nevertheless, after two national radio speeches on the subject calling for direct controls on the economy by the previously mentioned New Dealers, the subject was dropped like a hot potato as Roosevelt adopted an all-out Keynesian deficit spending policy. With the likelihood of a European war increasing, President Roosevelt became more conciliatory towards business, the tax on undistributed corporate profits was effectively repealed and the full implications of the Social Security program became more widely understood. As a result the economy began to recover well before the advent of rearmament.
A Tax Compromise
Thus it would certainly help if there were at least a perceived truce between the business community and the Obama Administration. Because the drafting and adopting regulations associated with the healthcare and financial reforms will go on well into 2013, a good start would be to compromise on the contentious tax issue. that can actually be accomplished this month! One example of a bipartisan compromise would include permanently setting the tax on dividends and capital gains at 15% compared to the 20% rate for both proposed by the Administration and 39.6% for dividends should the current law lapse, increasing the top rate on ordinary income to 39.6% as contemplated by the Administration and the lapsing of current law, but have the Bush tax cuts remain in force for incomes up to $400,000 for a joint return instead of $250,000 as proposed by the Administration. Add to that setting the inheritance tax exclusion for a family at $7.5 million as proposed by the Administration or $10 million as proposed by some congressional Republicans. And maybe they could throw in the taxing of carried interest capital gains for private equity and hedge funds at ordinary income tax rates.
There you have it, a reasonable compromise where both parties can declare a victory, but can they actually come together and do it? The Obama Administration would get its higher top rate and a step, albeit smaller, toward deficit reduction and the congressional Republicans would get their low taxes on capital. Above all the economy would achieve at least a vestige of certainty with respect to tax policy. One of the worst things that could happen would be a one year extension of the Bush tax cuts. The uncertainty would remain, incentives would be untouched and the economy would have the increased burden of debt. Remember policy makers are playing with fire with respect to the tax issue. A recent article co-authored by former Council of Economic Advisors Chair Christina Romer noted that exogenous increases in taxation have caused severe shocks to economic activity.[v]
Problems Confounding Policy
The Fed has tried practically everything in its policy toolkit to halt the recession and engender recovery. Short-term interest rates have been cut to zero, its balance sheet has exploded, the open market committee has purchased mortgages and long-term treasury bonds with abandon (quantitative easing) and they announced that short-term interest rates will remain low for “an extended period.” Yet unemployment remains high and the recovery is faltering. At the recent Jackson Hole conference, Chairman Bernanke promised he would do whatever it takes to keep the recovery going.[vi] Whether further quantitative easing will work remains to be seen but to the public it is beginning to look like pushing on the proverbial string. After all, record low mortgage rates are not triggering a housing boom, far from it.
Our view is that monetary policy will work with an unusually long lag. We forecast that the Fed’s zero rate policy will remain in place for at least another year and after that the Fed Funds rate will slowly increase. (See Figure 7) Concomitantly long-term interest rates will likely remain unusually low and we anticipate that the yield on 10-Year U.S. Treasury notes won’t exceed 3% until the third quarter of 2011.
Figure 7. Federal Funds vs. 10-Year U.S. Treasury Yields, 2005Q1 – 2012Q4F,
Source: Federal Reserve Board and UCLA Anderson Forecast
Despite the ongoing policy ease, we expect inflation to remain quiescent during the forecast period. (See Figure 8) Both headline and core inflation will be under control staying below 2% for all of 2011 and the risk of deflation, though nontrivial, remains small. Despite the low rate of inflation, low nominal rates will keep real returns to savers extraordinarily low.
Figure 8. Headline vs. Core Inflation, 2005Q1 – 2012Q4
Source: Bureau of Labor Statistics and UCLA Anderson Forecast
With respect to fiscal policy the Obama Administration is on track to pile up a record decade of deficits. (See Figure 9) Somewhere along the way taxes will have to increase substantially, an inevitable policy uncertainty, and entitlement spending will have to cut radically. In the meantime fiscal policy is not working the way it is supposed to be. Instead of spending with alacrity, consumers are saving and where consumption and investment are rising, a significant portion of it is coming in the form of increased imports. (See Figures 10 and 11) Stimulus in America is turning out to be great news for the exporters of China and Germany.
Figure 9. Federal Surplus/Deficit FY 2000 – FY2010F
Source: Office of Management and Budget and UCLA Anderson Forecast
Figure 10. Personal Saving Rate, 1990Q1 – 2012Q4
Source: Department of Commerce and UCLA Anderson Forecast
Figure 11. Real Imports, 2005Q1 – 2012Q4F, Quarterly Data
Source: Department of Commerce and UCLA Anderson Forecast
Conclusion
In an economy wracked by a post financial bubble environment and living in a theme park of policy uncertainty, we forecast very sluggish growth accompanied by high unemployment. As time passes the economy will naturally heal and the policy uncertainties will resolve themselves to the extent that growth will return to a 3% path and unemployment will begin on its long trajectory downward. We forecast that these more ebullient trends will become noticeable by 2012.
Higher savings and increased imports seem to be one of the key reasons why macroeconomic policy is not working the way the traditional models would have it. Thus if policy is to work it will have to restore the confidence of businesses and consumers to spend and invest in America. A real reduction in policy uncertainty would go a long way toward that end.
[i] Financial Times, August 19, 2010, p.1.
[ii] Reinhart, Carmen M. and Kenneth S. Rogoff, “This Time is Different,” Princeton; Princeton University Press, 2009.
[iii] See Shulman, David, “The Balance Sheet Recession,” UCLA Anderson Forecast, December 2008
[iv] See Brinkley, Alan, “The End of Reform,” New York: Knopf, 1995, pp. 56,57
[v] See Romer, Christina D. and David H. Romer, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” American Economic Review, 100, June 2010, pp.763-801.
[vi] See Bernanke, Ben S., “The Economic Outlook and Monetary Policy,” August 27, 2010.
Wednesday, September 15, 2010
Wednesday, August 25, 2010
The Shaky Foundation Supporting Long-Term REIT Performance
Reprinted by permission from REIT WRAP Special Report dated August 16, 2010.
By David Shulman
Though the first decade of the 21st century has been characterized as “lost” for most equity investors, REITs stood out by generating a 9.75% compound annual return as measured by the total return version of the MSCI U.S. REIT Index (RMS) for the 10- year period ending in July 2010.
This performance is truly remarkable when viewed against the backdrop of a small negative total return for the S&P 500. Moreover after undergoing a near death experience in 2008/2009, REIT investors are once again looking forward to high single-digit returns for the new decade.
However, REIT performance over the last decade did not come from rising earnings and dividends; rather, it came from the tailwind of multiple expansion that is hardly sustainable. Add to that the “meltdown’s” impact (e.g. dilution resulting from massive stock issuance and significant dividend cuts, which helped right-size balance sheets) and the future appears guarded.
Where in 2000 REITs typically traded at FFO multiples in the 6-9 X range, today they trade in the 15-20+ X range. Moreover in 2000, according to data provided by Green Street Advisors, REIT forward AFFO yields were about 700 basis points above the forward earnings yield for the S&P 500; today, REIT forward AFFO yields are nearly 400 basis points below the S&P 500.
In other words, from a valuation perspective REITs are trading at the mirror image of their levels in early 2000 and it is more than likely going forward REIT performance will suffer from the headwind of multiple contraction.
TROUBLING RECORD
Beneath this stellar REIT performance is a very troubling record with respect to earnings and dividend growth. I dare say that few analysts in 2000 would have forecast the flat to down earnings that most REITs experienced over the past decade. To be sure 2000 represented a cyclical peak in REIT earnings and 2010 represents results around a cyclical trough, but the fact remains that 10 years is a long time.
Let’s get into the data. I examined the earnings and dividend performance for almost all (20) of the equity REITs that are covered by the Value Line Investment Survey. The data excluded those REITs who were bought out during the decade. Nevertheless, I believe it to be a good, though far from perfect sample, in that it leaves out a few of the major mall companies that did well.
I used Value Line because the data is readily available and it presents long term results on a consistent basis. However to be more current, I am using current IBES estimates for 2010 and Zachs Investment Research for future growth rates. The 10 year record for FFO and dividends are presented in a table at the end of this column.
Several of the “blue chip” REITs did well over the decade. The best FFO growth was reported by Public Storage (PSA) where FFO almost doubled and dividends more than doubled. Simon Property Group (SPG), Vornado (VNO), Federal Real Estate Investment Trust (FRT) and HCP (HCP) all reported credible increases in FFO and dividends. Boston Properties (BXP) reported higher FFO but a slightly lower dividend and AvalonBay (AVB) and Washington REIT (WRI) reported modest increases in FFO, but significantly higher dividends. (NOTE: In 2000 FRT, PSA, HCP and for that matter SPG weren’t as highly regarded as they are today. Moreover with respect to BXP and VNO the data ignore the impact of very substantial capital gain distributions made by those two REITs.
On the hand there were many REITs in 2000 that were perceived to be of high quality that faltered during the past decade. Apartment Investment and Management (AIV), Duke Realty’s (DRE), Prologis (PLD) and Developers Diversified (DDR) had their FFO and dividends decline by more than 50%. Such highly regarded REITs as Kimco Realty (KIM) and Equity Residential (EQR) will earn less and pay smaller dividends in 2010 than they did in 2000. The same is true for Weingarten Realty Trust (WRI), UDR (UDR), and BRE Properties (BRE). The mid-Atlantic office companies, Mack-Cali (CLI) and Liberty Property Trust (LRY) are also earning less and paying out less to their shareholders. The same holds true for Healthcare Realty Trust (HR).
In contrast to their short-run low-balling of earnings estimates, sell-side analysts are ever optimistic with respect to long term growth. Going forward analysts believe that REIT FFO growth rates will be in the range of 4-7% for most REITs, save for a few outliers. It may turn out that way, but history is on the side of the skeptics.
To be sure real estate fundamentals might drive REIT earnings higher, but where most analysts miss the mark it is with respect to capital expenditures and adverse changes in capital structure which are inherently difficult to forecast. Remember that the fastest growing REIT in the sample was PSA with a historic growth rate of 6.1%. Among the better performing REITs the growth rates ranged from 5.1% at SPG to 0.7% for AVB. Against the backdrop of the past decade, a seemingly modest 4% growth rate is stellar.
Similarly dividend growth left much to write home about. AVB, FRT, PSA, VNO and WRE reported solid dividend growth -- in the range of 32%-106%. On the other hand dividend payouts were crushed at AIV, DDR, HR, and PLD. This is hardly a record that inspires confidence for the coming decade.
Said differently, for REITs to work in the coming decade, multiples have to remain high and historically optimistic analyst forecasts have to be realized. We do not have the luxury of low multiples to protect us from untoward events.
Figure 1. REIT FFO and Dividend Growth Per Share, 2000 – 2010E
REIT '00 '10 CAGR Est.CAGR '00 '10 %Ch
FFO Dividend
AIV $4.81 $1.28 -12.4% 6.3% $2.80 $ .40 -86%
AVB 3.70 3.97 0.7 6.6 2.24 3.57 59
BRE 2.38 1.87 -2.4 6.1 1.70 1.50 -12
BXP 3.46 4.23 2.0 5.2 2.04 2.00 - 2
DDR 2.19 .86 -8.6 N/A 1.44 .08 -94
DRE 2.46 1.08 -7.9 26 1.64 .68 -59
EQR 2.50 2.16 -1.5 4.9 1.58 1.35 -15
FRT 2.56 3.88 4.2 7.1 1.82 2.64 45
HCP 1.66 2.15 2.6 6.4 1.47 1.86 27
HR 2.62 1.32 -6.6 5.3 2.23 1.20 -46
KIM 1.35 1.11 -1.9 3.0 .91 .64 -30
LRY 3.17 2.65 -1.8 8.7 2.13 1.90 -11
CLI 3.79* 2.79 -3.0* 5.0 2.38 1.80 -24
PLD 2.21 .59 -12.4 34 1.35 .60 -56
PSA 2.59 4.70 6.1 19 1.48 3.05 106
SPG 3.28 5.40 5.1 7.9 2.02 2.40 19
UDR 1.47 1.11 -2.8 4.4 1.07 .73 -32
VNO 3.86 5.17 3.0 10.3 1.97 2.60 32
WRE 1.79 1.97 1.0 1.0 1.23 1.73 41
WRI 1.93 1.66 -1.5 4.6 1.33 1.04 -22
*-Corrected
David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. Heis now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted at:david.shulman@baruch.cuny.edu
By David Shulman
Though the first decade of the 21st century has been characterized as “lost” for most equity investors, REITs stood out by generating a 9.75% compound annual return as measured by the total return version of the MSCI U.S. REIT Index (RMS) for the 10- year period ending in July 2010.
This performance is truly remarkable when viewed against the backdrop of a small negative total return for the S&P 500. Moreover after undergoing a near death experience in 2008/2009, REIT investors are once again looking forward to high single-digit returns for the new decade.
However, REIT performance over the last decade did not come from rising earnings and dividends; rather, it came from the tailwind of multiple expansion that is hardly sustainable. Add to that the “meltdown’s” impact (e.g. dilution resulting from massive stock issuance and significant dividend cuts, which helped right-size balance sheets) and the future appears guarded.
Where in 2000 REITs typically traded at FFO multiples in the 6-9 X range, today they trade in the 15-20+ X range. Moreover in 2000, according to data provided by Green Street Advisors, REIT forward AFFO yields were about 700 basis points above the forward earnings yield for the S&P 500; today, REIT forward AFFO yields are nearly 400 basis points below the S&P 500.
In other words, from a valuation perspective REITs are trading at the mirror image of their levels in early 2000 and it is more than likely going forward REIT performance will suffer from the headwind of multiple contraction.
TROUBLING RECORD
Beneath this stellar REIT performance is a very troubling record with respect to earnings and dividend growth. I dare say that few analysts in 2000 would have forecast the flat to down earnings that most REITs experienced over the past decade. To be sure 2000 represented a cyclical peak in REIT earnings and 2010 represents results around a cyclical trough, but the fact remains that 10 years is a long time.
Let’s get into the data. I examined the earnings and dividend performance for almost all (20) of the equity REITs that are covered by the Value Line Investment Survey. The data excluded those REITs who were bought out during the decade. Nevertheless, I believe it to be a good, though far from perfect sample, in that it leaves out a few of the major mall companies that did well.
I used Value Line because the data is readily available and it presents long term results on a consistent basis. However to be more current, I am using current IBES estimates for 2010 and Zachs Investment Research for future growth rates. The 10 year record for FFO and dividends are presented in a table at the end of this column.
Several of the “blue chip” REITs did well over the decade. The best FFO growth was reported by Public Storage (PSA) where FFO almost doubled and dividends more than doubled. Simon Property Group (SPG), Vornado (VNO), Federal Real Estate Investment Trust (FRT) and HCP (HCP) all reported credible increases in FFO and dividends. Boston Properties (BXP) reported higher FFO but a slightly lower dividend and AvalonBay (AVB) and Washington REIT (WRI) reported modest increases in FFO, but significantly higher dividends. (NOTE: In 2000 FRT, PSA, HCP and for that matter SPG weren’t as highly regarded as they are today. Moreover with respect to BXP and VNO the data ignore the impact of very substantial capital gain distributions made by those two REITs.
On the hand there were many REITs in 2000 that were perceived to be of high quality that faltered during the past decade. Apartment Investment and Management (AIV), Duke Realty’s (DRE), Prologis (PLD) and Developers Diversified (DDR) had their FFO and dividends decline by more than 50%. Such highly regarded REITs as Kimco Realty (KIM) and Equity Residential (EQR) will earn less and pay smaller dividends in 2010 than they did in 2000. The same is true for Weingarten Realty Trust (WRI), UDR (UDR), and BRE Properties (BRE). The mid-Atlantic office companies, Mack-Cali (CLI) and Liberty Property Trust (LRY) are also earning less and paying out less to their shareholders. The same holds true for Healthcare Realty Trust (HR).
In contrast to their short-run low-balling of earnings estimates, sell-side analysts are ever optimistic with respect to long term growth. Going forward analysts believe that REIT FFO growth rates will be in the range of 4-7% for most REITs, save for a few outliers. It may turn out that way, but history is on the side of the skeptics.
To be sure real estate fundamentals might drive REIT earnings higher, but where most analysts miss the mark it is with respect to capital expenditures and adverse changes in capital structure which are inherently difficult to forecast. Remember that the fastest growing REIT in the sample was PSA with a historic growth rate of 6.1%. Among the better performing REITs the growth rates ranged from 5.1% at SPG to 0.7% for AVB. Against the backdrop of the past decade, a seemingly modest 4% growth rate is stellar.
Similarly dividend growth left much to write home about. AVB, FRT, PSA, VNO and WRE reported solid dividend growth -- in the range of 32%-106%. On the other hand dividend payouts were crushed at AIV, DDR, HR, and PLD. This is hardly a record that inspires confidence for the coming decade.
Said differently, for REITs to work in the coming decade, multiples have to remain high and historically optimistic analyst forecasts have to be realized. We do not have the luxury of low multiples to protect us from untoward events.
Figure 1. REIT FFO and Dividend Growth Per Share, 2000 – 2010E
REIT '00 '10 CAGR Est.CAGR '00 '10 %Ch
FFO Dividend
AIV $4.81 $1.28 -12.4% 6.3% $2.80 $ .40 -86%
AVB 3.70 3.97 0.7 6.6 2.24 3.57 59
BRE 2.38 1.87 -2.4 6.1 1.70 1.50 -12
BXP 3.46 4.23 2.0 5.2 2.04 2.00 - 2
DDR 2.19 .86 -8.6 N/A 1.44 .08 -94
DRE 2.46 1.08 -7.9 26 1.64 .68 -59
EQR 2.50 2.16 -1.5 4.9 1.58 1.35 -15
FRT 2.56 3.88 4.2 7.1 1.82 2.64 45
HCP 1.66 2.15 2.6 6.4 1.47 1.86 27
HR 2.62 1.32 -6.6 5.3 2.23 1.20 -46
KIM 1.35 1.11 -1.9 3.0 .91 .64 -30
LRY 3.17 2.65 -1.8 8.7 2.13 1.90 -11
CLI 3.79* 2.79 -3.0* 5.0 2.38 1.80 -24
PLD 2.21 .59 -12.4 34 1.35 .60 -56
PSA 2.59 4.70 6.1 19 1.48 3.05 106
SPG 3.28 5.40 5.1 7.9 2.02 2.40 19
UDR 1.47 1.11 -2.8 4.4 1.07 .73 -32
VNO 3.86 5.17 3.0 10.3 1.97 2.60 32
WRE 1.79 1.97 1.0 1.0 1.23 1.73 41
WRI 1.93 1.66 -1.5 4.6 1.33 1.04 -22
*-Corrected
David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. Heis now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted at:david.shulman@baruch.cuny.edu
Saturday, August 14, 2010
Dividend Yields, Bond Yields and Macroeconomic Policy
Last week Aaa rated Johnson & Johnson (JNJ) sold 10 year bonds at a 3.15% yield, well below the 3.71% dividend yield on its common stock. Old codgers like myself remember that stocks in general, with the exception of 1929, invariably yielded more than bonds until mid-1958. After that bonds always yielded more than stocks. As I wrote in my "Paradigm Shift" paper for Salomon Brothers in 1995 the reason for the revaluation of share prices then, in the view of Benjamin Graham, was that macroeconomic policy had the ability to prevent depressions. That view was logically based on policy successes that worked to end the recessions of 1948-9, 1953-4 and 1957-8 with the last one being particularly deep.
What the capital markets are now signalling is that stocks are especially cheap in the light of the past 50 or so years of history or perhaps, more ominously, the markets no longer believe that macroeconomic policy can work in preventing either a depression or a long period of Japanese-like stagnation. In a nutshell, at least for now, it is a vote of no confidence in the Obama Administration and the Fed.
In my own view its a little of both. Stocks are cheap, but the macro environment is extremely troubling. By way of disclosure, my family owns shares in JNJ.
What the capital markets are now signalling is that stocks are especially cheap in the light of the past 50 or so years of history or perhaps, more ominously, the markets no longer believe that macroeconomic policy can work in preventing either a depression or a long period of Japanese-like stagnation. In a nutshell, at least for now, it is a vote of no confidence in the Obama Administration and the Fed.
In my own view its a little of both. Stocks are cheap, but the macro environment is extremely troubling. By way of disclosure, my family owns shares in JNJ.
Saturday, July 31, 2010
In the Washington Post, "GDP report: Economic growth slows with 2.4 percent rate in second quarter", p. a1
"The problem is it looks like the consumer was really weakening in June, so you're starting the third quarter in a position of weakness," said David Shulman, senior economist at the UCLA Anderson Forecast. "The components of this report are ugly."
Full URL: http://www.washingtonpost.com/wp-dyn/content/article/2010/07/30/AR2010073000806_pf.html
Full URL: http://www.washingtonpost.com/wp-dyn/content/article/2010/07/30/AR2010073000806_pf.html
Wednesday, July 28, 2010
Is the U.S. Headed for a Double-Dip Recession?
Reprinted by permission from Reitwrap special report dated July 19, 2010.
By David Shulman
Double-dip recessions are rare. The last one occurred from 1979-82 when a renewed round of Fed tightening triggered back-to-back declines in output. That hasn’t (isn’t) impacted discussions of whether the U.S. is headed (imminently, some argue) for a double-dip recession, however.
And last Friday’s nearly 3% drop in the broad market won’t do anything to diminish fears of a dreaded double-dip is looming. Reinforcing that concern was a decline in 10-year U.S Treasury bonds to nearly 2.9%.
Remember, of late, the bond market has been a much better forecaster of future economic activity than the stock market. Nevertheless, my own view is that the economy will not experience a double-dip recession. Instead I believe we are in for a sustained period of very slow growth. Over the next four quarters I would not be surprised to at least one quarter with real GDP growth less than 2% and no quarter with growth above 3%.
What accounts for my skepticism that the U.S. will experience a double-dip recession? Because, in the words of my UCLA colleague Ed Leamer, it usually takes a coordinating mechanism, to trigger a recession and absent an even worse crisis emanating from a collapse in the Euro, I don’t see it. Absent that trigger, there seems to be just enough impetus in capital spending, exports, inventory accumulation and modest increases in consumer spending to offset the weakness coming from deleveraging, policy uncertainty, state and local government spending and higher income taxes next year.
REITs were only beginning to reflect the coming sluggish growth reality with the late June to early July decline in share prices. How so? If my view about the future course of the economy is close to the mark, investors were beginning to realize that FFO estimates for later this year and all of 2011 are way too high. My guess is that the already optimistic analysts got sucked into much of the happy talk that was present at NAREIT’s recent REIT/WORLD confab in Chicago. If I am correct on that score -- they will likely be disappointed.
To be sure much of the optimism was grounded in a very real improvement in the real estate operating environment that took place over much of the first half. And second quarter results should be fine. However, my interpretation of what happened earlier this year is consistent with the inventory cycle the broader economy experienced. From the point of view of the tenant, leased real estate is much akin to business inventory that expands and contracts over the business cycle.
What happened earlier in the year is that enough tenants realized that they had excessively cut back on their space needs and either ceased cutting back or made modest additions to space. That showed up as improved, or, at least, less negative, absorption. Let’s make this concept a bit more specific by using apartment demand, which analysts and companies alike are most bullish about, as an example.
Just like most businesses apartment renters were shocked by the speed of the economic decline in late 2008 and early 2009. It seemed that we were headed for The Great Depression 2.0. Renters responded by staying put or moving in with friends and/or parents. As a consequence vacancy rates rose and apartment rents dropped. No surprise here. Then in late 2009 and in early 2010 without any meaningful employment growth, apartment demand picked up as tenants realized that the world wasn’t as bad as previously thought. With demand rising without employment growth, company managements and analysts began to mark-up their future outlooks, figuring logically that if things are getting better without employment growth, demand would really explode once jobs were being created in any meaningful amount.
It can certainly turn out that way, but if the increase in apartment demand was just a temporary inventory adjustment by tenants who recognized that a depression was off the table, then the future outlook for apartment rents and occupancies would be far more tepid. Obviously if the economy double-dips we would be in a whole new ball game, but the sluggish outlook I envision would mean that there would very little follow through to the demand increases experienced earlier in the year.
Similarly the demand for retail space will continue to remain depressed. Witness the very sluggish growth in June same-store sales reported last week. For whatever reason it seems that the economy really down-shifted in June. Furthermore the consumer continues to retrench from the leverage bubble of a few years ago. For example total consumer credit outstanding has been declining almost continuously since July 2008. As of May 2010 it was down $167 billion, or 6.5%. This decline is unprecedented since the start of the series in the early 1940s. More forward looking, the recent strength in high-end retailing waned in June, perhaps in response to a transitory fall stock prices. Note: There will be substantial and permanent tax increases for high-end consumers taking place next January with further rounds to come in 2012 and 2013. Analysts who expect high-end retailing to save them are whistling passed the graveyard.
In the case of the office sector, the weakest of the major real estate food groups -- with the notable exceptions of Manhattan and Washington D.C., the recovery in demand will have wait until the second half of 2012. Although private sector employment has been growing modestly, the all important financial sector continues to exhibit monthly declines. The recent blip up in Manhattan investment banking employment is the exception, not the rule.
Warehouse demand has reflected the swing in inventories from huge declines to modest accumulation. This recovery process still some legs in it, but it will likely wane by the end of the year as the inventory adjustment is completed.
All told my main point is that although I don’t think the economy will experience a double-dip, a sustained period of tepid growth will not bring with it any meaningful recovery in REIT earnings. Tepid growth when starting from a fully or near fully employed (occupied) economy can and does generate significant earnings growth, but that is not the case when vacancy rates are high.
Simply put, there is too much downward pressure on rents. This is especially true in a very low inflation environment. Going back to the sub- 3% yield on the 10-year Treasury bond, a yield that low implies there will be an insufficient dollar flow in the economy to ratify rent increases.
David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. Heis now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted at:david.shulman@baruch.cuny.edu
By David Shulman
Double-dip recessions are rare. The last one occurred from 1979-82 when a renewed round of Fed tightening triggered back-to-back declines in output. That hasn’t (isn’t) impacted discussions of whether the U.S. is headed (imminently, some argue) for a double-dip recession, however.
And last Friday’s nearly 3% drop in the broad market won’t do anything to diminish fears of a dreaded double-dip is looming. Reinforcing that concern was a decline in 10-year U.S Treasury bonds to nearly 2.9%.
Remember, of late, the bond market has been a much better forecaster of future economic activity than the stock market. Nevertheless, my own view is that the economy will not experience a double-dip recession. Instead I believe we are in for a sustained period of very slow growth. Over the next four quarters I would not be surprised to at least one quarter with real GDP growth less than 2% and no quarter with growth above 3%.
What accounts for my skepticism that the U.S. will experience a double-dip recession? Because, in the words of my UCLA colleague Ed Leamer, it usually takes a coordinating mechanism, to trigger a recession and absent an even worse crisis emanating from a collapse in the Euro, I don’t see it. Absent that trigger, there seems to be just enough impetus in capital spending, exports, inventory accumulation and modest increases in consumer spending to offset the weakness coming from deleveraging, policy uncertainty, state and local government spending and higher income taxes next year.
REITs were only beginning to reflect the coming sluggish growth reality with the late June to early July decline in share prices. How so? If my view about the future course of the economy is close to the mark, investors were beginning to realize that FFO estimates for later this year and all of 2011 are way too high. My guess is that the already optimistic analysts got sucked into much of the happy talk that was present at NAREIT’s recent REIT/WORLD confab in Chicago. If I am correct on that score -- they will likely be disappointed.
To be sure much of the optimism was grounded in a very real improvement in the real estate operating environment that took place over much of the first half. And second quarter results should be fine. However, my interpretation of what happened earlier this year is consistent with the inventory cycle the broader economy experienced. From the point of view of the tenant, leased real estate is much akin to business inventory that expands and contracts over the business cycle.
What happened earlier in the year is that enough tenants realized that they had excessively cut back on their space needs and either ceased cutting back or made modest additions to space. That showed up as improved, or, at least, less negative, absorption. Let’s make this concept a bit more specific by using apartment demand, which analysts and companies alike are most bullish about, as an example.
Just like most businesses apartment renters were shocked by the speed of the economic decline in late 2008 and early 2009. It seemed that we were headed for The Great Depression 2.0. Renters responded by staying put or moving in with friends and/or parents. As a consequence vacancy rates rose and apartment rents dropped. No surprise here. Then in late 2009 and in early 2010 without any meaningful employment growth, apartment demand picked up as tenants realized that the world wasn’t as bad as previously thought. With demand rising without employment growth, company managements and analysts began to mark-up their future outlooks, figuring logically that if things are getting better without employment growth, demand would really explode once jobs were being created in any meaningful amount.
It can certainly turn out that way, but if the increase in apartment demand was just a temporary inventory adjustment by tenants who recognized that a depression was off the table, then the future outlook for apartment rents and occupancies would be far more tepid. Obviously if the economy double-dips we would be in a whole new ball game, but the sluggish outlook I envision would mean that there would very little follow through to the demand increases experienced earlier in the year.
Similarly the demand for retail space will continue to remain depressed. Witness the very sluggish growth in June same-store sales reported last week. For whatever reason it seems that the economy really down-shifted in June. Furthermore the consumer continues to retrench from the leverage bubble of a few years ago. For example total consumer credit outstanding has been declining almost continuously since July 2008. As of May 2010 it was down $167 billion, or 6.5%. This decline is unprecedented since the start of the series in the early 1940s. More forward looking, the recent strength in high-end retailing waned in June, perhaps in response to a transitory fall stock prices. Note: There will be substantial and permanent tax increases for high-end consumers taking place next January with further rounds to come in 2012 and 2013. Analysts who expect high-end retailing to save them are whistling passed the graveyard.
In the case of the office sector, the weakest of the major real estate food groups -- with the notable exceptions of Manhattan and Washington D.C., the recovery in demand will have wait until the second half of 2012. Although private sector employment has been growing modestly, the all important financial sector continues to exhibit monthly declines. The recent blip up in Manhattan investment banking employment is the exception, not the rule.
Warehouse demand has reflected the swing in inventories from huge declines to modest accumulation. This recovery process still some legs in it, but it will likely wane by the end of the year as the inventory adjustment is completed.
All told my main point is that although I don’t think the economy will experience a double-dip, a sustained period of tepid growth will not bring with it any meaningful recovery in REIT earnings. Tepid growth when starting from a fully or near fully employed (occupied) economy can and does generate significant earnings growth, but that is not the case when vacancy rates are high.
Simply put, there is too much downward pressure on rents. This is especially true in a very low inflation environment. Going back to the sub- 3% yield on the 10-year Treasury bond, a yield that low implies there will be an insufficient dollar flow in the economy to ratify rent increases.
David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. Heis now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted at:david.shulman@baruch.cuny.edu
Tuesday, July 6, 2010
"Spending controls are key," Letter to the Star Ledger, July 6
I wish Paul Mulshine would get off his Proposition 13 fixation. (“California dreaming on property taxes,” July 4). To be sure, New Jersey’s property taxes are way too high, but a Proposition 13-like solution is not the answer. I lived in California in 1978, the year Proposition 13 passed, and authored two academic articles (National Tax Journal and Southern California Law Review) on the subject.
Mulshine neglects two fatal flaws in Proposition 13. First, two identical houses standing side-by-side can and are taxed at substantially different levels. For example, it is not unusual to have one house taxed at $3,000 and another at $10,000 depending on the initial purchase price. Second, with property taxes cut back, California over-relies on volatile income taxes to fund public services. That is why the state is subject to periodic budget crises as flush times bring with them runaway spending that has to be cut back when an economic downturn causes a collapse in income tax receipts. Sounds familiar, doesn’t it?
The real solution is spending control at all levels of government. The compromise agreement announced over the weekend is a good start, but no real reform is possible without significant reductions in pension and health care benefits for public employees.
Full URL:http://blog.nj.com/ledgerletters/2010/07/new_jersey_property_tax_cap_wo.html
Mulshine neglects two fatal flaws in Proposition 13. First, two identical houses standing side-by-side can and are taxed at substantially different levels. For example, it is not unusual to have one house taxed at $3,000 and another at $10,000 depending on the initial purchase price. Second, with property taxes cut back, California over-relies on volatile income taxes to fund public services. That is why the state is subject to periodic budget crises as flush times bring with them runaway spending that has to be cut back when an economic downturn causes a collapse in income tax receipts. Sounds familiar, doesn’t it?
The real solution is spending control at all levels of government. The compromise agreement announced over the weekend is a good start, but no real reform is possible without significant reductions in pension and health care benefits for public employees.
Full URL:http://blog.nj.com/ledgerletters/2010/07/new_jersey_property_tax_cap_wo.html
Sunday, July 4, 2010
Democrats Adjourn, while Unemployed Suffer
The Democrats control the White House and both Houses of Congress. They certainly have the power and, yet they don’t really seem to care about our nation’s most pressing problem, mass unemployment. On this July 4th nearly 15 million Americans are counted as unemployed and another 9 million are too discouraged to look for work or are under-employed. Indeed nearly one million workers dropped out of the workforce over the past two months. Given this crisis, what does the Congress do? It adjourns for the holiday. Meantime an extension of unemployment benefits and Pentagon funding await action.
Where is the concern for job creation as the officially unemployed and new entrants to the labor force wait and wait and wait? Although I have few ideas on the subject (see below), it is not all that clear what Congress can really do. Nevertheless it is hardly helpful to pass and propose new legislation that increases business uncertainty and feeds into the reluctance to hire. It seems that the Obama Administration has a giant checklist, stimulus-passed, healthcare-passed, financial reform-almost passed, cap and trade –in deep trouble, immigration reform-going nowhere. The checklist is the priority meanwhile the plight of the American worker falls by the wayside. If the Administration were serious about the economy creating jobs it would put a time-out on new regulations and cut business and payroll taxes. The deficit hawks would respond, how do you pay for it? Answer: redirect unspent stimulus money and cut out year spending on entitlements. And if Congress really had the nerve it would borrow $500 billion at 4%(current 30 year rate) to fund infrastucture projects with limited, meaning fast track, environmental review and without the prevailing wage provisions of the Davis-Bacon Act.
The Administration would not as it did a week ago hold up a loan guarantee from the Export-Import Bank for coal mining machinery to an Indian utility on global warming grounds. Only because of an outcry from the Wisconsin delegation where the machinery is made and the potential for embarrassment at an Obama event there did the Administration relent. It is chicken-shit stuff like this that drives businesses crazy.
Of course the Republicans are offering no solutions either, but they do not have the burden of being in control. The Democrats have the burden and they are royally blowing it. So much so that they may soon give the Republicans the opportunity to show that they are serious.
Where is the concern for job creation as the officially unemployed and new entrants to the labor force wait and wait and wait? Although I have few ideas on the subject (see below), it is not all that clear what Congress can really do. Nevertheless it is hardly helpful to pass and propose new legislation that increases business uncertainty and feeds into the reluctance to hire. It seems that the Obama Administration has a giant checklist, stimulus-passed, healthcare-passed, financial reform-almost passed, cap and trade –in deep trouble, immigration reform-going nowhere. The checklist is the priority meanwhile the plight of the American worker falls by the wayside. If the Administration were serious about the economy creating jobs it would put a time-out on new regulations and cut business and payroll taxes. The deficit hawks would respond, how do you pay for it? Answer: redirect unspent stimulus money and cut out year spending on entitlements. And if Congress really had the nerve it would borrow $500 billion at 4%(current 30 year rate) to fund infrastucture projects with limited, meaning fast track, environmental review and without the prevailing wage provisions of the Davis-Bacon Act.
The Administration would not as it did a week ago hold up a loan guarantee from the Export-Import Bank for coal mining machinery to an Indian utility on global warming grounds. Only because of an outcry from the Wisconsin delegation where the machinery is made and the potential for embarrassment at an Obama event there did the Administration relent. It is chicken-shit stuff like this that drives businesses crazy.
Of course the Republicans are offering no solutions either, but they do not have the burden of being in control. The Democrats have the burden and they are royally blowing it. So much so that they may soon give the Republicans the opportunity to show that they are serious.
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