Eq: Total Market
Someone say doomsday scenario?
Or at least strongly imply it?
Democrat; Republican -- you can just shunt the ideologies aside. Both have a separate point of view with no end in sight in order to circumvent default as the government edges toward its so-called debt ceiling x-date, according to cnn.com. That, of course, is when the Treasury could find its pockets empty, meaning paying all government obligations would require extraordinary measures.
Okay, so while the odds still are relatively low that the government will default on its debt, Wall Street’s no fan of the impact the equity markets would feel in light of debates flashing no indications that the credits are anywhere near rolling.
Meantime, investors should devote rapt attention over the next few weeks and, as one expert suggests, stand poised to become “a bit more defensive,” according to cnbc.com.
At this point, at least, setting aside the fact the short term Treasurys have priced in reluctance, significant volatility isn’t necessarily in the cards as far as the markets are concerned.
“Congress was willing to play the game of chicken, but there were fewer members of Congress actually willing to crash the car,” said Betsey Stevenson, professor of public policy and economics at the University of Michigan.
In an article for MarketWatch, Jamie Chisholm discussed some reasons for why stock market volatility has remained depressed despite the ongoing crisis in regional banks which some fear could lead to a credit crunch. In contrast, the stock market seems more responsive to economic data and the Federal Reserve.
Economic data continues to signal an economy that is growing albeit decelerating but also not in a recession which would hurt corporate earnings. Q1 earnings also have come in stronger than expected.
The Federal Reserve is in the final innings of its rate hike cycle. Futures markets are already looking ahead at rate cuts by the end of the year or Q1 of next year. And, inflation data continues to moderate and move in the right direction which is also supportive of asset prices.
It’s also surprising that the market seems unconcerned about the debt ceiling deadline and a potential default, although there has been chatter about positive progress from negotiations between Republicans and Democrats. Surprisingly, the regional bank crisis is having little spillover impacts on the market or economy. In fact, the S&P 500 is 3% higher than from when the crisis began, while the Vix is nearly 10% lower.
Finsum: One mystery for market participants is that volatility remains depressed despite ongoing struggles for regional banks and a looming debt ceiling deadline.
In an article for Reuters, Mike Dolan discussed the widening gap between market volatility which has been trending lower since October of last year and headlines of various geopolitical, financial, and economic risks that are increasingly dominating headlines. The Federal Reserve is expected to hike rates despite signs that the economy continues to decelerate, considerable stress in the banking system, increasing chatter of a ‘technical default’ for the US Treasury if the debt ceiling is breached, and important data points in the coming weeks in the form of earnings from tech giants and the April jobs report.
Despite these potential threats, the VIX, which measures stock market volatility, reached its lowest levels since November 2021. The stock market is also nearing a 20% move rise from its October lows, which many market participants would define as a new bull market. Volatility is similarly depressed in the Treasury market and the currency markets despite upcoming central bank meetings, indicating that this divergence between the VIX and headline risk is not unique to equities.
Finsum: There is a widening gap between various headline risk and market measures of volatility which are at multi month lows.
In an analyst note, JPMorgan’s Chief Equity Strategist Marko Kolovanic discussed the anomaly between an increasingly shaky market and economic outlook, in contrast to the S&P 500 volatility index (VIX) which continues to trend lower.
A week ago, the VIX dropped to 16 which is its lowest level since November 2021, despite the S&P 500 being 16% lower compared to 17 months ago. Yet, economic growth continues to decelerate, inflation is meaningfully higher, and the Fed remains in a hawkish posture.
Kolovanic notes that we are not likely to see any abatement of these pressures in the coming months given the tightening of financial conditions and rising recession risk, while the Fed’s priority remains stamping out inflation even at the expense of the economy and labor market. Further, he notes stress in the banking system and drumbeat of rising tensions regarding China, Russia, and an upcoming election cycle.
He says depressed volatility is due to technical reasons, primarily the selling of short-term options which leads to dealer buying of stocks and volatility leaking lower. Adding to this is continued resilience in Q1 earnings while many were anticipating a meaningful decline.
Finsum: Volatility is at 17 month lows despite stocks being much lower. JPMorgan’s Marko Kolovanic explains some reasons behind this discrepancy.
Yo: model portfolios. You’re on a proverbial roll.
In recent years, the acceleration of third party model portfolios has been the bomb, according to wisdontree.com. Over the last five years, assets in model portfolios -- leaving out nary a one – have spiked a minimum of 18% annually, estimated Broadridge. Over the next five years, they’re expected to roll past $10.3T in AUM.
That said, even in light of this growth, advisors are questioning their ability to leverage third party models in the practice, dwelling on, for instance, “which of my clients are a good fit for third-party models?”
To abet their ability to manage client investments, advisors can cherry pick from a burgeoning cocktail of model portfolios, according to thinkadvisor.com.
As of March of last year, there was nearly $350 billion in model portfolios, Morningstar reported in June. That’s a leap of 22% over the nine months before. As of November of last year, more than 2,500 models were covered in the firm’s database – more than doubling the amount the prior two years.
At Ares Wealth Management Solutions, we continue to receive inquiries from financial advisors regarding the forward prospects for private real estate given the recent decline in public real estate. We believe the most useful way to help advisors grapple with these questions is to point to historical data. Thankfully, we have data on both private and public real estate returns going back to March of 1978, and while no one can predict the markets, we believe the powerful benefits that private real estate can bring to a portfolio should persist through this cycle.
First, the basics—
Since 1978, public real estate has delivered approximately thirty percent higher annualized returns than private real estate. However, this can be largely attributed to public real estate using three times more leverage than private real estate, and as result, public real estate has experienced three times the volatility. Private real estate by comparison has provided much better risk-adjusted returns.1
Source: Bloomberg. All data from March 31, 1978, through September 30, 2022. Public real estate measured by the FTSE NAREIT All Equity real estate Index, which is a free-float adjusted, market capitalization-weighted index of publicly traded US real estate equity. Private real estate measured by the NFI-ODCE Value Weighted Index. The NFI-ODCE index is a capitalization- weighted, net of fees, time-weighted return index with an inception date of December 31, 1977 which represents various private real estate funds. Sharpe ratio is a measure of risk-adjusted returns and has been calculated using a risk-free rate of 2%.
The low correlation of private real estate to public real estate, we believe, is particularly notable.The low correlation of private real estate to public real estate, we believe, is particularly notable.
Seeing the low 0.11 correlation figure, one of the natural questions that our financial advisor clients follow with is, "But is private real estate just public real estate on a lag?"To investigate whether the 0.11 correlation with public real estate is just a trick of lagged time, we run the correlation of private and public real estate after applying varying lag lengths.We find that the correlation ticks up mildly over time while remaining low. So, historically, any lagged effect of public real estate onto private real estate has been tempered.
Source: Bloomberg. All data from March 31, 1978, through September 30, 2022. Public real estate measured by the FTSE NAREIT All Equity real estate Index, which is a free-float adjusted, market capitalization-weighted index of publicly traded US real estate equity. Private real estate measured by the NFI-ODCE Value Weighted Index.
During historical periods of drawdowns in public real estate since 1978, investors in private real estate had a noticeably different experience:
• Two-thirds of the time private real estate had no drawdown at all when public real estate was in drawdown.
• In the three occasions where private real estate did experience a drawdown, they came at a nine- to twelve- month lag on average.
• Over the past 40-plus years, private real estate drawdowns were meaningfully shallower and shorter-lived than public real estate drawdowns.
It turns out that private real estate has rarely followed public real estate into its frequent drawdowns—drawing down only three times since 1978 versus twenty-five times for public real estate over the same period. On those occasions when private real estate did draw down, it only moderately followed public real estate, and did so by a lag of nine months on average.It turns out that private real estate has rarely followed public real estate into its frequent drawdowns—drawing down only three times since 1978 versus twenty-five times for public real estate over the same period. On those occasions when private real estate did draw down, it only moderately followed public real estate, and did so by a lag of nine months on average.
In fact, historically, there have only ever been two meaningful (i.e., greater than two percent) private real estate drawdowns: one during the early 1990s recession following the Savings and Loan Crisis and the other during the Global Financial Crisis. These extreme real estate sell-offs were driven by over-building and over- leverage. These forces caused lending to dry up, at which point the private real estate market eventually capitulated (though less than the public real estate market).
History suggests that most public real estate sell-offs have been driven by macroeconomic worries and investor sentiment rather than by real estate fundamentals. This is supported by the fact that public real estate net asset values (NAVs) have tended to hold steady (like private real estate NAVs), even while the equity trades off due to market moves.2
As it turns out, conflicting public and private real estate returns, as seen in the present environment, have always been the normal situation, and it is not a matter of one being "right" and the other "wrong."As it turns out, conflicting public and private real estate returns, as seen in the present environment, have always been the normal situation, and it is not a matter of one being "right" and the other "wrong."At Ares Wealth Management Solutions, we believe both public and private real estate can play important, albeit very different, roles in individual investors' portfolios, and advisors should consider utilizing these tools to help achieve their clients’ overall financial objectives. That said, historical data indicates that these two investment asset classes should not be conflated, nor should public real estate be viewed as a leading indicator for private real estate.We find that historically only during the drawdowns of the Global Financial Crisis and the early 1990s real estate correction (resulting from recession and the Savings and Loan Crisis) did private real estate get deeply pulled into the malaise of public real estate.
What each of those events had in common is that they followed a crisis in lending, leverage and over-building. We find none of these forces present in the current cycle.In 2022, private real estate was not pulled into the drawdown experienced by public real estate, nor was it during the steep drawdown of COVID-19 or the long (four-year) public real estate drawdown of the early 2000s when the Dotcom Bubble burst.3The question then for an investor to ask is: Looking forward, do you believe that the world is about to head into one of those over-built-and over-levered real estate sell-offs?At this time, we do not believe underweighting would be a prudent action. Because private real estate has historically delivered positive returns in nine of ten quarters, through many market cycles, we believe the investment thesis for a full, long-term (typically dollar- cost-averaged) allocation remains intact.3
The material presented in this article is intended for informational purposes only. It does notThe material presented in this article is intended for informational purposes only. It does notconstitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector.Investing in shares of common stock of AREIT or AIREIT involves a high degree of risk, including the risk that payment of distributions is uncertain and cannot be guaranteed, the risk that an investment in AREIT and/or AIREIT is not liquid, and the risk that investors may lose the entire amount of their investment.AREIT and AIREIT may pay distributions from sources other than cash flow from operations, including without limitation from the sale of assets, borrowings, return of capital or offering proceeds, and advances or the deferral of fees and expense reimbursements, and AREIT and AIREIT may be required to fund their monthly distributions from a combination of their operations and financing activities, which include net proceeds of these offerings and borrowings (including borrowings secured by their assets), or to reduce the level of their monthly distributions. AREIT and AIREIT have not established caps on the amount of the distributions that may be paid from any of these sources.See AREIT Summary Risk Factors and prospectus and/or AIREIT Summary Risk Factors and prospectus for descriptions of other potential risks of investing in AREIT and/or AIREIT. Investors should carefully read and consider AREIT prospectus and/or AIREIT prospectus before investing. An investment in AREIT and/or AIREIT is not a direct investment in commercial real estate, but rather an investment in a real estate investment trust that owns commercial real estate.
This communication includes certain statements that are intended to be deemed “forward- looking statements” within the meaning of, and to be covered by the safe harbor provisions contained in, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are generally identifiable using the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” “project,” “continue,” or other similar words or terms. These statements are based on certain assumptions and analyses made in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate. Such statements are subject to a number of assumptions, risks and uncertainties that may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. Among the factors that may cause results to vary are the negative impact of increased inflation, rising interest rates, COVID-19, and/or the conflict between Russia and Ukraine on our financial condition and results of operations being more significant than expected, general economic and business (particularly real estate and capital market) conditions being less favorable than expected, the business opportunities that may be presented to and pursued by us, changes in laws or regulations (including changes to laws governing the taxation of real estate investment trusts (“REITs”)), risk of acquisitions, availability and creditworthiness of prospective customers, availability of capital (debt and equity), interest rate fluctuations, competition, supply and demand for properties in current and any proposed market areas in which we invest, our customers’ ability and willingness to pay rent at current or increased levels, accounting principles, policies and guidelines applicable to REITs, environmental, regulatory and/or safety requirements, customer bankruptcies and defaults, the availability and cost of comprehensive insurance, including coverage for terrorist acts, and other factors, many of which are beyond our control. For a further discussion of these factors and other risk factors that could lead to actual results materially different from those described in the forward-looking statements, see “Risk Factors” under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2021, and subsequent periodic and current reports filed with the SEC. In addition:• Interest rates for long-term U.S. treasuries have risen sharply in 2022, after declining for approximately 30 years; if interest rates for long-term U.S. treasuries stay elevated or continue to rise, real estate prices and returns may not perform as well as they did in the prior period of declining interest rates;• It is possible that private real estate prices will suffer a drawdown similar to that of public real estate in 2022; if private real estate prices suffer such a drawdown, new investors in AREIT or AIREIT may be subject to substantial