Public real estate could be due a turnaround

In the weeks following the end of the third quarter, U.S. equities experienced a welcome relief rally, fueled by hopes that a deceleration in U.S. Federal Reserve rate hikes may be near. Most broad-based indexes notched notable monthly gains in October, especially the Dow Jones Industrial Average, which added 14%, its best monthly return in over 40 years. The improvement in non-U.S. equities was less robust. The MSCI ACWI ex-USA added 3%, driven by developed markets (+5% for the MSCI EAFE Index), while the MSCI Emerging Markets Index fell 3%, dragged down by China (-16%).

Key takeaways

• Economic resilience is a proverbial picnic basket for bear markets. The “abnormal normalization” of economic activity in the post-Covid era has created a unique scenario in which the U.S. economy has experienced a growth recession — a period marked by a moderate contraction of GDP growth, while other economic metrics such as employment remain relatively strong. Under normal circumstances, this would be a welcome course of events. But given the Fed’s resolute stance on beating inflation, the longer the economy remains resilient, the longer interest rates will remain at current, and likely higher, levels. This is a challenging environment for equity markets.
• Earnings resilience? Not so much. On the surface, the S&P 500’s earnings season has once again appeared largely benign, with a blended earnings growth rate of just over 2% as of 8 November. Under the surface, however, the S&P 500 has once again experienced negative earnings growth (-5%) when excluding the top-performing energy sector. With earnings expectations continuing to come down and weaker comps on the horizon, an earnings recession may be the next driver of volatility for stocks, in the absence of a meaningful catalyst such as a measurable curtailing of inflation in the coming months
• Portfolio impacts. We remain of confident that equity markets will continue to offer opportunities for investors focused on companies with pricing power that can help overcome inflation and defend or expand margins — in particular, higherquality stocks with steady earnings and strong cash flows. More specifically, in the midst of what has been a challenging year for public real estate, we are identifying opportunities in this sector due to the relative strength of fundamentals among specific property types, as well as attractive valuations. We also favor companies with quality characteristics that have delivered consistently strong returns both in the current market environment and over longer periods of time.