Make no mistake; the US economy is doing well. The third estimate of Second Quarter GDP growth came in at 4.2% compared to 3.0% for Second Quarter 2017 and the latest estimate for Third Quarter GDP growth from the Federal Reserve Bank of Atlanta is 4.2%. According to the Bureau of Labor Statistics, changes in total nonfarm payroll in the past three months were 134,000, 270,000 and 165,000, respectively, an average of 189,667 in-line with the average of 199,417 for the 12 months prior. With the Index of Small Business Optimism from the National Federation of Independent Business hitting an all-time high of 108.8 in August, is it any wonder that risk assets, at least in the US, are setting records?
Coming off the best quarter for the S&P 500 Index since 2013, it’s hard to pinpoint storm clouds in the horizon. The third hike in the federal funds rate by the FOMC did very little to deter risk appetite. Ditto for prospects for a trade war. Funny enough, all that the rate hike (with the concomitant rise in the Dollar Index) and the President’s America First policy did was to create a moat around US risk assets at the expense of emerging markets and China. The long end of the yield curve did increase a bit as the yield on the 10-Year Treasury Note rose from 2.849% on June 30 to 3.056% on September 30 but the yield curve flattened with the spread between the yields on the 2-Year and 10-Year Treasury Notes going from 33 bps in Second Quarter to end the Third at 24 bps.
The Wilshire US REIT Index (“Index”) was up 0.7% in Third Quarter, trailing both the S&P 500 and Russell 2000 Indices which advanced 7.7% and 3.6%, respectively; 58 out of the 114 constituents of the Index produced positive returns; NexPoint Residential Trust Inc, was the best performing name, advancing 17.6%, compared to the worst, Government Properties Income Trust, which fell 26.7%.
With the 21 bps increase in the long end of the curve, it is not surprising that property types with short lease durations like Manufactured Housing and Apartments outperformed during the quarter and, for the most part, the retail landlords continue to bask in the afterglow of a positive annual convention of the International Council of Shopping Centers which took place in May. Secular growth stories like Industrial and Data Centers (particularly those catering to hyper-scale demand from cloud providers) clambered back on the leaderboard after reporting solid Second Quarter earnings. The only real outlier in performance was Storage to the downside but that was more the case of reversion to the mean (under the guise of renewed concern about supply) after a particularly strong bout of outperformance in the first half of year.
Looking at the trailing 1-Year performance by property type, short duration property types like Hotels and Manufactured Housing performed well and Apartments and Storage REITs have delivered in-line performance despite heightened supply. In contrast, property types with longer duration leases like Health Care and Office have underperformed. Taking a step away from short-term relative performance, the trailing 1-Year performance by sectors make a whole lot of sense in a period where there has been a upward bias to interest rates (2.326% to 3.056%, year over year).