The financial world - broker analysts in particular - have turned bullish on S-Reits as a horde. You can read about their upgrades [here], [here], [here] and [here].
What's with the sudden exuberance?
The answer: Words.
Literally.
Post the 12-13 December 2023 meeting of the U.S. Federal Reserve, Federal Open Market Committee (FOMC), a press release was made.
Here is a snippet from the official statement:
"The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective." [emphasis mine]
If you have read the above paragraph attentively, you will notice that the Fed did NOT say, "That's it, folks. We are done jacking up interest rates. On the other hand, we will start cutting interest rates in 2024. Bring out the champagne!"
And yet, the financial world chewed on the announcement, consulted the stars and reacted as if the rate cut is a sure thing.
Granted, the Fed's latest dot plot, which shows the interest rate projections of individual FOMC members, highlighted the possibility of 75 basis points easing in 2024. But we ought to remember that these are merely projections and not set in stone.
Interestingly, the Minutes of the December meeting [here] showed that the FOMC members had gone through the trouble to choose their wording carefully, so as not to cause the animal spirits to run amok:
"Members generally viewed the addition of the word 'any' to this sentence as appropriately relaying their judgment that the target range for the federal funds rate was likely now at or near its peak for this policy tightening cycle while leaving open the possibility of further increases in the target range if these were warranted by the totality of the incoming data, the evolving outlook, and the balance of risks." [italics mine]
The market heeded the front part of the message and threw away the rest. The Fed had emphasized that any rate decision will depend on incoming economic data (which is what the Fed has always done). The latest U.S. inflation print came in at 3.4% y/y on Thursday, higher than the previous month's 3.1%. If the number continues to persist around this band, while no risk to the economy emerges, there is a chance that the Fed is going to sit pat on their hands and do nothing to the federal fund rate for now.
According to CME FedWatch, four out of five traders think the first easing will happen in March. Most participants are confident it will happen by mid-year.
There are financial experts who think that the Fed may have to cut interest rates steeper than expected, such as JP Morgan Asset Management [here].
Regardless, I play the Devil's advocate, and question WHAT IF the U.S. inflation remains sticky and the rate cut does not happen until after June?
This means any relief is only likely to come in the later half of the year. Hence, it may be prudent not to throw caution to the wind for S-Reits just yet.
The impact of high cap rates has yet to be reflected in the property valuation of most S-Reits. Last month, Elite Commercial Reit reported a portfolio valuation value that was 11.5 percent lower than the previous year [here]. Meanwhile, Manulife U.S. Reit reported a 8 percent decline in property valuation [here]. Not to forget the warning by CapitaLand Investment of the significant valuation decline for the past financial year [here].
Add to the fact that most S-Reits will have to refinance their debt at a higher cost this year with no certainty that salvation is just around the corner.
In short, go into any trade with your eyes wide open. Things can get messy before they get better. But don't take my word for it.
What's with the sudden exuberance?
The answer: Words.
Literally.
Post the 12-13 December 2023 meeting of the U.S. Federal Reserve, Federal Open Market Committee (FOMC), a press release was made.
Here is a snippet from the official statement:
"The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective." [emphasis mine]
If you have read the above paragraph attentively, you will notice that the Fed did NOT say, "That's it, folks. We are done jacking up interest rates. On the other hand, we will start cutting interest rates in 2024. Bring out the champagne!"
And yet, the financial world chewed on the announcement, consulted the stars and reacted as if the rate cut is a sure thing.
Granted, the Fed's latest dot plot, which shows the interest rate projections of individual FOMC members, highlighted the possibility of 75 basis points easing in 2024. But we ought to remember that these are merely projections and not set in stone.
Interestingly, the Minutes of the December meeting [here] showed that the FOMC members had gone through the trouble to choose their wording carefully, so as not to cause the animal spirits to run amok:
"Members generally viewed the addition of the word 'any' to this sentence as appropriately relaying their judgment that the target range for the federal funds rate was likely now at or near its peak for this policy tightening cycle while leaving open the possibility of further increases in the target range if these were warranted by the totality of the incoming data, the evolving outlook, and the balance of risks." [italics mine]
The market heeded the front part of the message and threw away the rest. The Fed had emphasized that any rate decision will depend on incoming economic data (which is what the Fed has always done). The latest U.S. inflation print came in at 3.4% y/y on Thursday, higher than the previous month's 3.1%. If the number continues to persist around this band, while no risk to the economy emerges, there is a chance that the Fed is going to sit pat on their hands and do nothing to the federal fund rate for now.
According to CME FedWatch, four out of five traders think the first easing will happen in March. Most participants are confident it will happen by mid-year.
There are financial experts who think that the Fed may have to cut interest rates steeper than expected, such as JP Morgan Asset Management [here].
Regardless, I play the Devil's advocate, and question WHAT IF the U.S. inflation remains sticky and the rate cut does not happen until after June?
This means any relief is only likely to come in the later half of the year. Hence, it may be prudent not to throw caution to the wind for S-Reits just yet.
The impact of high cap rates has yet to be reflected in the property valuation of most S-Reits. Last month, Elite Commercial Reit reported a portfolio valuation value that was 11.5 percent lower than the previous year [here]. Meanwhile, Manulife U.S. Reit reported a 8 percent decline in property valuation [here]. Not to forget the warning by CapitaLand Investment of the significant valuation decline for the past financial year [here].
Add to the fact that most S-Reits will have to refinance their debt at a higher cost this year with no certainty that salvation is just around the corner.
In short, go into any trade with your eyes wide open. Things can get messy before they get better. But don't take my word for it.
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