This Time Is Different (Really!)
- May 01, 2013
Given March’s weak job numbers, the contraction in retail sales, and the drop in consumer sentiment, it is clear that the hopes we had for higher growth in the nation’s economy this spring are not going to pan out after all. We should not be surprised, since we know that systemic financial crises are invariably followed by very slow and protracted recoveries. In fact, according to Carmen Reinhart and Kenneth Rogoff in “This Time Is Different,” a history of the major financial catastrophes over the past 800 years, it was noted that per capita GDP after the Great Depression—the financial crisis most comparable to the recent crisis—did not return to its prior peak at for 11 years after the recovery began. Further, it took the unemployment rate (after the Great Depression) 14 years to return to its pre-crisis level.
Hope springs eternal, however, and many of us had convinced ourselves that this time it really is different. Given the safety nets that the U.S. has put in place, including federal deposit insurance, unemployment insurance, and a more active Federal Reserve, to name a few, it was hard to believe that a systemic crisis like the one we just went through could affect the economy so brutally. And indeed, such safety nets have reduced the impact of the most recent crisis. The Federal Reserve, for example, has pulled out all stops, and continues to purchase additional agency mortgage-backed securities at a pace of $40 billion per month and long-term Treasury securities at a pace of $45 billion per month in order to help fulfill their dual mandates of fostering maximum employment and price stability. They have also kept the target range for the federal funds rate at 0.0 percent to 0.25 percent, and intend to keep this rate very low until well into 2015.
Thus far, the Federal Reserve’s accommodative monetary policy has been viewed as the most valuable tool in keeping the economy afloat, in promoting further liquidity, and rallying the stock market. However, now that the Federal Reserve’s asset holdings have topped $3 trillion, increasing numbers of investors are viewing such huge purchases as increasingly risky and counterproductive to transitioning off of these support lines. Even Real Estate Research Corporation’s (RERC’s) institutional investment survey respondents, who had consistently viewed this accommodative monetary policy as a positive influence on the economy, have reversed their views and in first quarter 2013 gave monetary policy a negative rating, indicating that they believed monetary policy was now weakening the economy and leading to overall financial instability. Based on the discussions among Federal Open Market Committee members, it is likely that at some point this year, the Federal Reserve will begin to wind down, or “taper” off, their asset purchases and allow interest rates to begin to rise to more normal levels.
But for now, there aren’t too many options left for investors. Although interest rates are expected to begin rising and eventually benefit savers again, risk-averse investors and retirees who have invested in cash are currently losing ground. Those who have invested in bonds and securities are expecting the bubble to pop as rates begin to increase, and depending on the rates, could lose 50 cents on the dollar. And those who were chasing yield and had ventured back into the stock market are watching for the inevitable correction in this volatile trading environment. Not surprisingly, RERC’s first quarter 2013 institutional investment survey respondents lowered their ratings for stocks and bonds, while increasing their ratings for cash to 3.7 and their ratings for commercial real estate to 7.0 on a scale of 1 to 10, with 10 being high.
Real estate is expected to continue to fare relatively well as we continue to slowly work our way through this long recovery. It is a hard asset and something that has real value, versus the potential bubbles we are seeing with other investment alternatives. Real estate prices may be a little high in the coastal markets and values seem to be slightly ahead of the fundamentals, but new construction has been held in check and vacancy is expected to continue to slowly decline. In addition, real estate can serve as a hedge against inflation, it offers some economic stability by providing income, and we anticipate global, national, and local demand for this asset class to continue. While returns are expected to be slightly lower over the next few years than they were last year (returns are estimated to be approximately 8 percent in 2013), they are still very reasonable on a relative basis. Investors should also keep in mind that commercial real estate generates around 80 percent of its return from income (versus betting on the come in the form of appreciation), unlike most other investments.