1st Quarter, 2018
Goin Fishin: Guggenheim’s Investments’ Recession Dashboard (I didn’t make this up) is lit up like a Christmas tree, lots of red and orange, colors that, according to many, signal market stress, and stir up investors’ survival instincts, while others see nothing but a pot of gold at the end of this never-ending rainbow. The nearly decade long run of economic growth is beginning to feel like a fairy tale, unfortunately without a happy ending for many who are not paying attention. Depending on perspective, we all know how this ends; an empty punchbowl and massive hangover. There appears to be a rising chorus of those in the know who say, that “business cycles do not die of old age”: nearly 10 years of growth in the US is pretty unprecedented. The indices are in plain sight. Look at the labor market, currently at 4.1% unemployment, which has evolved from cool to overheated, monetary policy evolving from loose to tight. Historically, the Fed has hiked rates to cool the labor market and get ahead of inflation, only to inadvertently push the economy into recession. One of the most reliable and consistent predictors of recession has been the Treasury yield curve. By definition, the shape of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal, inverted and flat. A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. Fundamentally, if the yields on long-term treasuries are lower than short-term notes, investors are worried. When long-term yields drop below short-term yields, we see an inverted yield curve. Many economists use this metric to predict a recession. The past is frequently the key to the future, as recessions are always preceded by a flat or inverted yield curve. We’re getting very close to a reset. Now that I’ve mentioned “curves” three times, you’ll be tested later.
Don’t Crash the Ambulance!: Is the economy just humming along, no one too concerned over pulling the plug on the party? Overheating? Overreacting? Is California or Silicon Valley in a real estate bubble untethered to the rest of the country? The actual expansion cycle is in its 35th month, the second longest on record. Historically, full recovery takes about 6 years to close the gap between pre- and post-recession economic output. It has taken nearly 10 years for that gap to close. Based on region and sector, many home builders, commercial contractors and material suppliers have yet to achieve 100% recovery. Some economists suggests that given the severity of the 2008 crisis, it intuitively makes sense that it would take longer for the economy to reach full potential. Looking back to pre-recession of late 2007, 10 yr T-Bills were trading at 4.76% v. 2.80% today; S&P 500 at 1,378 v. 2,657 today; DJIA 12,670 v. 24,408 today! According to data from FTSE Russell and Thomson Reuters, the U.S. stock market is trading at its most expensive levels since the dot-com era. And, ten-year treasury rates are always at their historic high immediately preceding a recession. Andrew Staples, director of the Economist Intelligence Unit discussing the US economy said: “We expect the economy to slip into a technical recession in early 2020. A decade has passed since the last financial crisis and the US is currently growing at three percent or more for two consecutive decades. Unsustainable.” Are we in for a bumpy ride to the ICU, or the sanitarium, and bunkering down in hopes of surviving the imminent capital market meltdown?
Battle of the Bulls and Bears: From my perspective, I see a big potential acquisition opportunity during this period of uncertainty to invest in quality real estate similar to what is represented in our portfolio. As the sirens of the impending recession become louder, fear historically begins to direct behavior and decisions. To be clear, DJM’s internal “Acquisition Risk Matrix” dashboard is not popping out with smiley faces and blue sky! We are focused in particular on every metric that impacts our portfolio and investment strategy. Much has been written about the demise of “Bricks & Mortar” retail, along with “Yield Curve” predictors for our next recession-this is not voodoo economics.
We are paying attention and get it and are not afraid of the future. A friend recently told me that one indicator of a recession is private jet sales, sort a like the Las Vegas stripper owning 4 townhomes at the brink of the Great Recession. At the moment, demand exceeds supply for one’s favorite Gulfstream! On a recent business trip to New York, I was asked by an institutional fund manager how DJM was preparing for the “2020 Recession”, particularly its impact on retail values, cap rates and interest rates. My short answer; “Since I’ve been in commercial real estate for nearly 40 years and experienced more recessions than I can count on one hand…I think DJM will stick to its knitting, be asset specific and strategic and buy from LIFO’s-Last In First Out investors who bought into greed (height of the market) and sell into fear (“get me out of this investment” market phase) ... Some call it contrarian. I think it’s smart and a good plan for the future, which will also allow us to generate dividends, exceed our own yield curve, and continue to create wealth through real estate for our capital partners. Ok then. Let’s forget the test-pencils down. Go enjoy Spring Break.
DJM Capital Partners, Inc.
D. John Miller, Founder & CEO