Not surprisingly, politics dominated the start to the New Year. The optimism that permeated the investment/corporate community after the election of Donald J. Trump managed to survive (i) an ill-fated immigration ban, (ii) a half-assed attempt to “repeal and replace” the Affordable Care Act and (iii) a never-ending investigation into the potential collusion between members of the victorious Trump campaign and Russia.
Readings of economic data in the US have been steadily improving leading up to the election, which improvement continued in First Quarter. As a result, implied probabilities of an increase in the federal funds rate steadily climbed intra-quarter; when the Bureau of Labor Statistics reported an addition of 235,000 in February non-farm payroll employment compared to estimates of 200,000, the first rate hike of 2017 became all but a formality. Surprisingly, despite all the hoopla leading up to the March 14/15th meeting, the yield on the 10-Year Treasury Note actually fell from 2.446% to 2.396% during the quarter; most of the decline took place after the rate hike – buy the rumor, sell the news apparently.
The Wilshire US REIT Index (“Index”) was essentially unchanged in First Quarter, underperforming both the S&P 500 and Russell 2000 Indices which advanced 6.1% and 2.5%, respectively. The majority of the constituents in the Index produced negative returns (70 out of the 118 constituents) and there was significant dispersion in total returns with the best performing REIT, Silver Bay Realty Trust, returning 26.0% compared to -22.5% for the worst, Cedar Realty Trust.
In terms of relative performance by sectors, First Quarter saw a reversal of the reflation trade as REIT investors, at least, had some misgivings about the ability of President Trump to deliver all the prosperity that he promised during the campaign. Short duration property types gave back some of their Fourth Quarter 2016 gains while interest rate sensitive sectors like Health Care and Manufactured Housing bounced back in performance.
The one constant in relative performance by property type, recently, has been the underperformance of Retail; while the calendar may have turned, investor sentiment on malls and shopping centers has not. Holiday sales were anemic, J.C. Penney said that it would close 140 stores and Sears frightened shareholders with “going concern” language. It has gotten so bad that hedge funds are starting to buy credit default swaps on commercial mortgage backed securities secured, at least in part, by malls and shopping centers, a strategy reminiscent of bets against subprime mortgages during the financial crisis. Clearly e-commerce is a ubiquitous threat; however, unlike the rest of the world, America is extremely over-retailed and anchor tenants are having an existential crisis. Until the rationalization runs its course, the baby (internet resistant formats like grocery anchored neighborhood centers and A malls in top-flight locations) will continue to get thrown out with the bath water.