US equity markets climbed for the sixth consecutive week on cooler-than-expected inflation data, hints of progress on the China/US trade dispute, and "dovish" remarks from the Fed.
Goldilocks is back? Coming off its worst week of 2019, commercial and residential real estate equities led the way this week as the 10-year yield retreated from four-month-highs.
While many analysts had expected a tariff-related uptick in inflation, the effects of Chinese currency depreciation and a general slowdown in global economic activity have kept inflationary pressures muted.
Retail sales rose faster-than-expected in October, driven primarily by higher gasoline prices, auto sales, and e-commerce. Brick and mortar categories, however, were weak as store closings continue to mount.
Ahead of a jam-packed week of housing data, the Housing Index climbed on strong earnings from D.R. Horton and gains from Restoration Hardware after Buffett's Berkshire Hathaway revealed a stake.
Real Estate Weekly Outlook
What recession? US equity markets climbed for the sixth consecutive week as a busy slate of economic data and earnings reports indicated that the 'Goldilocks' economic conditions of low inflation and solid, consumer-led economic growth may be here to stay into 2020. Cooler-than-expected inflation data, hints of progress on the China/US trade dispute, and "dovish" remarks from Fed Chair Powell was enough to push the Dow Jones Industrial Average above 28,000 for the first time as fears of certain recession, which dominated headlines in late-summer, seem to now be a distant memory.
(Co-Produced with Brad Thomas through iREIT on Alpha)
This week's gains, interestingly, were powered by last week's laggards. The S&P 500 ETF (SPY) climbed higher by 0.9% while the tech-heavy Nasdaq ETF (QQQ) gained 0.8%, led by strong gains in the more defensive, yield-sensitive equity sectors including real estate and utilities. Coming off its worst week of 2019, the broad-based Real Estate ETF (VNQ) regained its footing, climbing 2.0% on the week, led by the manufactured housing, cell tower, and data center sectors. After reaching four-month highs last week, the 10-year Treasury yield (IEF) dipped 10 basis points to end the week at 1.83%.
Ahead of a busy week of housing data, the Hoya Capital Housing Index, the benchmark that tracks the performance of the US housing industry, finished the week higher by 1.0% on strong gains from the homebuilding, residential REIT, and home improvement sectors. D.R. Horton (DHI), the largest homebuilder in the country, reported a strong quarter with net sales surging 14% year-over-year. The entry-level homebuilding segment, which is a focus of D.R. Horton and fellow homebuilder KB Home (KBH), continues to see robust demand as lower mortgage rates have rejuvenated the single-family homebuilding sector this year following a brutal 2018. Restoration Hardware (RH) got a boost on news that Berkshire Hathaway (BRK.B) (NYSE:BRK.A) took a position in the already high-flying home furnishings retailer.
The script was flipped this week as last week's outperformers, the financials (XLF), materials (XLB), and energy (XLE) sectors lagged the broader market's gains while the healthcare (XLV), utilities (XLU), and real estate sectors outperformed. With a month-and-a-half to go in 2019, the technology sector leads this year's gains, followed by the residential and commercial real estate sectors. Energy, healthcare, and utilities are among this year's laggards.
Real Estate Economic Data
Retail Sales Beat Estimates, Led by E-Commerce
Total retail sales rose faster-than-expected in October, driven primarily by higher gasoline prices, auto sales, and non-store (e-commerce retail sales). Total sales rose by 0.3% from last month and are higher by 3.1% over the last year. E-commerce sales jumped 14.3% from last year, continuing a period of reacceleration that began in early 2019. Brick and mortar categories, which exclude the three aforementioned components, were fairly weak with seven of the ten retail categories seeing negative month-over-month growth, bringing the year-over-year growth rate to just 1.8%.
As discussed in our report this week, Mall REITs: 'Do or Die' Time, softline and specialty retailers have weakened considerably in 2019 after seeing relatively robust growth last year. Store closings have unexpectedly surged in 2019 as the combination of higher minimum wages, tariff-related cost pressures, and heavy discounting have pressured margins at softline and specialty retailers. Coresight Research has tracked more than 7,500 closings so far this year, already outpacing the full-year count for 2018, and estimates that up to 12,000 could announce closings by year-end.
A theme that we’ve discussed for many years, there has been a significant and widening divergence in fundamentals and stock performance between higher-productivity mall REITs and lower-productivity mall REITs since the end of the recession. While several hundred of the roughly 1,000 malls in the US are fully occupied and thriving, the middle and lower-tier segments have seen intense pressure in recent years from a seemingly endless wave of store closings and rent pressure. Solid guidance this week from mall-based retailer J.C. Penney (JCP) helped to ease some near-term concerns, but we believe that this holiday season could be “make-or-break” time for many low productivity malls in a fight for survival. The success of several high-productivity malls leaves a glimmer of hope for a turnaround.
Surprisingly, the home improvement-related retail categories also remained weak in October's report despite the reacceleration in the single-family home construction industry. Earnings next week from Home Depot (HD) and Lowe's (LOW) will be critical indications of the health of the home improvement spending market. We continue to forecast a solid acceleration into 2020 given past correlations with housing market activity.
Inflation Remains Cool Despite Tariffs
This week, the BLS released the Consumer Price Index and Producer Price Index data for October, each showing similar trends of cooling core inflation. While the "headline" CPI and PPI inflation index each rose faster-than-expected, the more economically-important Core figure, which remove the effects of food and energy, came in cooler-than-estimates. Core CPI is higher by 2.3% on a year-over-year basis, while Core PPI cooled to just 1.6%, the lowest since early 2017. While some analysts had expected a tariff-related uptick in inflation, the effects of Chinese currency depreciation and a general slowdown in global economic activity have overwhelmed the forecasted upward pressure on prices.
Housing costs continue to be the primary driver of what little overall inflation that there is. Housing (CPI: Shelter) accounts for more than a third of the total CPI weight, and since 2013, housing inflation has been significantly above the overall inflation rate. From 2015 through late 2016, housing inflation was one of the only components keeping Core CPI out of deflationary territory, and since 2013, core inflation excluding housing has averaged roughly than 1%. Consistent with earnings results from the apartment REITs and private-market data showing solid rent growth since late 2018, CPI: Shelter remains well above the broader rate of inflation at 3.3%. Primary rents rose 3.4% on a year-over-year basis while Owner Equivalent Rents rose 3.3%.
Interestingly, as we discussed in our report on the Apartment REIT sector, persistent housing inflation is a relatively recent phenomenon. Over time, markets seeing well-above-trend rental growth experience a subsequent period of elevated new development, and vice-versa, but the market-based supply response can be interrupted and skewed by price ceilings or other regulatory actions. Since 2000, shelter inflation has outpaced the broader rate of inflation by more than 1% per year, fueled by a persistent supply shortage in the most in-demand US housing markets. By comparison, in the forty-year period between 1960 and 2000, housing inflation averaged -0.6% per year.
Rising housing inflation has reignited the rent control debate on the 2020 campaign trail. The dirtiest words in real estate became a focus during the apartment REIT's 3Q19 earnings as well after Oregon and California became the first states to enact state-wide rent control laws this year despite overwhelming economic evidence, including the consensus of 95% of economists, that rent control laws do more harm than good for renters. While some campaigns blame "corrupt real estate developers," ultimately it's been the over-regulation of housing development and density at the local, state, and national levels that have been at the root of the housing shortage.
2019 Performance Recap
While gains have been harder-to-come-by for the real estate sector over the last quarter following a red-hot first half of 2019, the broad-based real estate indexes remain higher by 24% YTD on a price-basis, slightly lagging the 25% gains on the S&P 500. The Housing Index has climbed 29% this year with all eight US housing industry sectors higher by at least 14% this year, led by the 52% gain from the single-family homebuilders. At 1.83%, the 10-year Treasury yield has retreated by 85 basis points since the start of the year and is roughly 140 basis points below peak levels of 2018 of 3.25%.
This week, in addition to our Mall REIT report, we also published Cell Tower REITs: Dealers to the 5G Arms Race. After a hot start to 2019, the high-flying cell tower REIT sector has cooled over the last quarter as investors seek certainty regarding the timing of network deployment post-merger. After a hot start to 2019, the high-flying cell tower REIT sector has cooled over the last quarter as investors seek certainty regarding the timing of network deployment post-merger. Fundamentally, cell tower REITs delivered another strong quarter in 3Q19 and continue to deliver sector-leading AFFO growth at nearly 10%. We believe that macro cell towers will continue to be the "hub" of wireless networks for the foreseeable future.
Next Week's Economic Calendar
It'll be a jam-packed week of housing data in the week ahead with Homebuilder Sentiment released on Monday, Housing Starts and Building Permits released on Tuesday, and Existing Home Sales on Thursday. Also relevant to the residential real estate sector, it'll be another busy week of retail earnings as well with home improvement giants Home Depot reporting results on Tuesday while Lowe's reports on Wednesday.
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Disclosure: I am/we are long RH, AWI, HOME, KBH, BBBY, BECN, TMHC, DHI, Z, TGT, VNQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: It is not possible to invest directly in an index. Index performance cited in this commentary does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. All commentary published by Hoya Capital Real Estate is available free of charge and is for informational purposes only and is not intended as investment advice. Data quoted represents past performance, which is no guarantee of future results. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy.
Hoya Capital Real Estate advises an ETF. In addition to the long positions listed above, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Real Estate and Housing Index definitions and holdings are available at HoyaCapital.com.