August 10 2023
Market Commentary
July was one of the better months of the year for the GPR 250 REIT World Index (USD). It produced a net total return of 3.24% and broke through its ~1,310 resistance line. The index continued to sit on this level for the succeeding 21 days after breaking through.
For now, it only seems to be enjoying the view, yet to have found the moxie to go higher. Breaking it down to a sector level, self-storage performed the worst among REIT peers—producing a return of -2.87%, while office was the best performing sector, delivering 9.28%.
Of the continents in the GPR 250 World Index, Europe performed the best, producing 9.7%. Asia was the worst performing continent, producing 1.8%. The chief driver of European outperformance was German residential.
Being heavily levered, uncrowded, and high beta, the sector got a potent shot of adrenaline from some ECB members hinting at an interest rate pause. Other developments, such as hedge fund de-grossing before summer trips, eventually translating into a short squeeze, is also believed to have played a part.
Earnings season went into full swing with about half of the US names reporting in July. On a sector basis, the most negative commentary came from industrial, with occupancies and market rent growth easing faster than expected in the world’s fourth largest industrial market: Southern California.
Towers was the second most disappointing. A slowdown in macro activity from mobile carriers impacted the towers companies’ services segment. Despite a deceleration in spending, the 5G cycle is still on strong legs. The slowdown is only an elongation of the cycle rather than the start of the end.
Of the companies we own, the biggest positive was brought by Digital Realty—completing its capital recycling plan for the year by bagging $3.2 billion in proceeds at attractive cap rates. Sun Communities was our little black sheep, adjusting 2023 earnings guidance down by 2.2%.
The main drivers of the adjustment were lower than expected UK home sales and the variable rate sterling-denominated debt that funded their UK business acquisition. The UK homes sales business is a small part of Sun’s operating income, and the company plans to pay off the floating rate debt. We continue to like Sun for its chief businesses and attractive valuation.
Our newest addition to the portfolio, Cellnex (a European tower company), had its first earnings call with its new CEO, Marco Patuano, who sent a clear message to the market by reiterating the company’s new business plan to de-lever and grow organically. The message was received favourably by the market with Cellnex ending the day up 4.4%.
In the US, that seemingly unattainable pie in the sky called a Soft Landing has started its descent, gently pulled on by a thread woven from the best-case scenario of economic data. Consumer confidence climbed, unemployment held firm at 3.6%, the employment cost index q/q continued ticking down, and the advance GDP q/q reading came in at 2.4%.
The Fed’s most preferred inflation indicator, the m/m Core PCE Price Index, dropped in at 0.2%—its lowest reading since December last year. A bit of a dimmer to this party was the Fed hiking the federal funds rate by 0.25% and reiterating key points inflation still too high and it will take time to bring price increases down. The Fed did not commit to being done hiking for the year.
Europe continues to see itself in a de facto stagflation environment. GDP q/q growth was 0.3% and y/y core inflation (in at 5.5%) has shown little signs of starting any meaningful downward trend, still hovering around its post-pandemic high of 5.7%. At their monetary policy meeting, the ECB changed their tune from upcoming rate hikes to more of a wait-and-see, data dependent mode.
The BOJ once again made a tweak to their yield curve control policy, changing the 0.5% ceiling on the 10-year government bond to what they now consider a point of reference.
In response to this, markets jolted in all the directions one would expect: the yen appreciated against all major currencies and foreign securities where clusters of Japanese investors reside depreciated. The reason behind the tweak was maintaining flexibility. Governor Ueda reiterated the BOJ’s commitment to its ultra-lax monetary policy for the time being. Most of the movements saw in financial markets had reversed by the end of the trading day.
In a transitioning environment, which brings uncertainty, we reiterate our preference for hybrid companies that possess both offensive and defensive characteristics, which naturally possess elements that will benefit from a soft landing. That said, we still have a mild recession as our base case.
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