November Market Update & CRE Executive Survey Readout

Whether you subscribe to the definition of a recession being back-to-back quarters of GDP contraction OR the National Bureau of Economic Research’s (NBER) more interpretive approach stating a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”, it no longer matters.  We’re practically here. 

While we saw the two-quarters of compression in GDP earlier this year, the labor market was still robust.  But now we’re seeing the labor market’s lagged effect when measured against GDP with the most recent layoff rounds at Big-Tech firms reflecting that.  The one glimmer of hope for the avoidance of a recession was a Q3 uptick in GDP; however, that was largely driven by net exports and is a much less substantive measure than consumer spending and business investment.  

AN INVERSION ALWAYS LEADS TO A RECESSION

With all of this in consideration, if we are to forecast whether a bumpy road is ahead, using the tried-and-true measure of the yield-curve inversion provides us the best crystal ball.   For over the past 40-years, every time the yield-curve has inverted, the U.S. Economy has entered a recession.  With the only exception of the 2020 COVID Recession where the 10-2 year spread was almost zero… but still close enough to inversion in the eyes of the free market’s invisible hand.  

If we are predicting with more than a 50% probability of entering recession based on the aforementioned observations, how severe will the recession be?  Notwithstanding any unpredictable escalations in the Russo-Ukrainian War, we’re probably in for a minor one.  The road will get a bit bumpy but will not have any Pennsylvania-backroad sized potholes that would destroy the U.S. Economy’s proverbial suspension….. and speaking of Pennsylvania…. Another metric which signals the recession will not be severe is Philadelphia’s loss to Houston in the World Series last week.  Every time a Philadelphia professional baseball team has won a world series, we’ve entered a major financial crisis or a severe recessionary period.  1928….1980….2008…… Thank you Astros for saving us all. 

LONG-TERM RATES CATCH UP TO CORE INFLATION

As we enter this mild recession, we are likely through a lot of the worst of it.  Long-term rates are pretty close to core inflation, which will hopefully bring about some downward pressure on consumer good and commodity prices.  The Fed will keep increasing rates, but at a more tapered pace. Asset prices have normalized and hopefully the bludgeoning stops; however, broad-based, weak corporate earnings could keep the trend going. 

CRE LOAN BALANCE GROWTH MOST STABLE

On the lending side, despite all the turmoil we’ve experienced since 2020, CRE loan balances have been resilient. We will likely experience volatility in Office Space and New Construction, but stability in Multi-Family, Senior Housing, and Industrial lending should keep CRE as the most stable loan type in recent trend when measured against C&I and consumer. However, the biggest downside risk is interest rates continue to rise without any near-to-medium term compression, in conjunction with continuously decreasing NOI, most likely in office.  Re-financing needs combined with DSCR covenants could create default events which would disrupt CRE loan balances.

EQUITY PRICES BACK TO REALITY

Stock prices swelled during the pandemic as investors sought yield in a continuous low-rate environment. As the price-to-earnings ratio swiftly outpaced corporate earnings growth, the Bull market came down with both horns. Things that seem too good to be true, usually are.  Horn one was the drastic increase in the P:E ratio had to eventually equilibrize against the more tapered growth of corporate earnings, a market correction.  Horn two was the bold and substantial rate hikes by the Fed to control inflation. Both dampening expectations on business investment while also offering higher yield from a broader variety of asset classes.  Something to look forward to is that the proverbial red cape has already been waved and taken away from the matador.  If corporate earnings can maintain healthy growth, even as unemployment may rise to a more normal 4.5 – 5%, the angry Bull likely won’t get riled up again.

CRE MARKET SURVEY RESULTS

Talking about the economy in an abstract way helps us to make sense of what’s going on in the world, but it’s difficult to make that information actionable without context. To get a better understanding of how current market conditions will impact the commercial real estate (CRE) industry, we surveyed 25 banking and finance executives from across the industry.

The sentiment survey covered everything from their predictions for the economy in the coming year, how market forces would affect different asset classes, as well as their plans for investment, hiring and technology spend.