History has shown that an election cycle is a huge determinant of market performance. Leading up to an election, policym
The Unsweet Sixteen The Top 10 Factors Impacting the Economy in 2016 Ben Miller, CEO
2007 We are here > 2008 2009 Peak Best-Performing Asset Classes
• Commodities
Recession
Bottoming
Recovery
Expansion
• Treasury notes
• Cash
• Emerging markets
• Growth stocks
• Treasury bonds • Cash
• Corporate bonds
• High-yield debt • Value stocks
• US large-cap stocks • Int’l equities
• Corporate bonds
• Real estate
• Cyclicals
• Distressed assets
Source: Princeton Asset Management, LLC
January is a time when many investors reevaluate their portfolios and, as an investor myself, I’ve been thinking a lot about what events may unfold over the next year and how they will impact the 80,000+ investors on Fundrise. I strongly believe that investors have more downside risks than upside potential in 2016. Enclosed are my Top 10 Factors to look out for in 2016, and how Fundrise has developed an investment strategy around them.
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The Presidential Cycle History has shown that an election cycle is a huge determinant of market performance. Leading up to an election, policymakers boost economic activity. Meanwhile most presidents take their economic medicine at the beginning of their election term so that things are looking up by the time they run for office again. During the majority of 2016, all eyes will focus on the November 2016 election. Federal Reserve Chair Yellen has stated that the Fed intends to raise interest rates twice in 2016, which the markets will initially shrug off. However as uncertainty around a new administration settles in and the seemingly never-ending government stimulus retracts, it’s likely that markets will pull back.
Recession Likely in 2016 Economic indicators are already flashing yellow for caution. The market has begun to price more risk into forecasts, increasing high-yield bond spreads in the last 18 months. Although primarily driven by energy and materials, spreads are nearly as high as they were in the fall of 2011 when Standard & Poor’s downgraded the United States government’s bond rating. These are early warning signs that turbulence is coming and 2016 may be the year we finally see the effects. BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread 10% 9% 8%
high-yield Increase in late 2015 s bond spread
7% 6% 5% 4% 3%
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Asset Prices at All-Time High Asset prices today are at an all-time high. Meanwhile, most investors see more downside risk in the market than upside. In other words, that means you are paying the most expensive price while also taking on more risk. This phenomenon can be seen clearly when looking at the S&P 500 PE Ratio which is above its long term average and bond yields which, on an absolute basis, are close to all-time lows. In 2016 we can expect to see many smart investors sitting on the sidelines waiting to see how this all plays out.
Interest Rates and Inflation Have Bottomed Inflation and interest rates have been low for so long that people have begun to assume that rates will remain low permanently. Although the Fed implies rate hikes up to 3.5% by 2018, the market is only pricing a Fed funds rate of 1.75%. However, based on changing global labor dynamics, we have likely reached the bottom. In other words, I believe the market has incorrectly predicted that the low-rate environment was permanent, and we will start to see a recovery driven by a structurally tighter labor market in the next 12-24 months. The Long-Run Path of the US Federal Funds Rate 20%
16%
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12%
avg. 10.0%
8%
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avg. 5.1%
avg. 3.5%
4%
0% Jan '70
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Aging Population Becomes a Drag on Growth More people are leaving the US workforce than entering 80 75 Population in millions
70
Age cohort entering the labor force (15-29)
65 60 55 50
Age cohort leaving the labor force (55-74)
45 40 35 30
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2015
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The good news about modernity is that it has allowed people to live longer. As living standards rise, people have fewer children. The unintended consequence, though, is a shrinking workforce. According to the National Bureau of Economic Research, declining workforce participation is shaving 0.7% GDP growth annually. Between 2000 and 2050, the number of US residents over 65 is projected to increase by 135%, while for residents ages 16–64, the number is projected to increase by 33% only. The US aged dependency ratio (those working relative to those retired) is projected to decline from 5.1 in 2000 to 2.9 in 2050, a 43% decline. The relative decline in the working population will mean diminished growth and fewer people to support public programs like Social Security and Medicare.
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Globalization is So Yesterday Starting in the 1990s, the world saw one of the greatest expansions in history. The fall of the Iron Curtain and China’s embrace of capitalism (albeit state managed) brought hundreds of millions of new workers into the global economy. From 1995 to 2015, according to the World Bank, more than 200 million people from rural China moved to work in cities. Unbelievably, the world has almost fully absorbed that labor force and the trend is significantly diminishing. The difference is meaningful for a host of reasons, with the two largest being that it drove down the cost of production and was also extremely deflationary on wages in developed countries like the US. The Unsweet Sixteen
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The Return of Rising Incomes Initial jobless claims in the United States are hovering near a 40-year low as the economy recovers. At a 5% unemployment rate, the American worker may actually have bargaining power for the first time in 25 years. Not only is the job market tight, but also there is less competition from workers abroad (prediction #6) and, starting in 2015, more Baby Boomers le" the US workforce than Millennials entered it (prediction #5). These combined factors will turn the table in favor of workers who will begin to demand higher salaries as companies have few alternatives for skilled labor. Civilian Unemployment Rate 10% 9%
la T i bo g h rm t ar ke
8% 7% 6% 5% 4% 3% Jan '02
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Continued Housing Recovery Although housing construction has recovered substantially from the recession, housing supply still lags behind overall demand. David Crowe, chief economist at the National Association of Housing Builders, estimates that 7.4 million home sales were lost due to the slow recovery. Many millennials have been putting off their first home purchase in favor of renting but as this generation begins having children and rental rates rise, we can expect to see a large pool of first time buyers enter the market.
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The US is the Shelter in the Storm Even with all the various headwinds facing the national economy, the US still looks downright healthy in comparison to the boiling chaos in the Middle East, the stagnation in Europe, and the ailing Emerging Markets. The dollar is arguably too strong and hurting our exports. However, corporate balance sheets are healthy at leverage rates similar to 2006 (below 25%), but with durations twice as long, at 17 years. Oil is around $35 per barrel, providing a windfall for world consumers. All things considered, while a recession is likely and arguably a healthy reset, the US economy should be able to muddle through as foreign capitals continue to depend on Uncle Sam for safety.
History Doesn’t Repeat, It Rhymes As we begin 2016 it’s hard not to recognize that things seem to look a lot like they did in early 2008. Bond markets are jittery with spreads widening. Volatility has increased significantly. Asset prices are high. Lenders have become increasingly too aggressive in their assumptions, and all this as another presidential election looms. While we can’t know for sure what 2016 holds, the one thing that is certain is that it will not be a pure repeat of 2008.
So What Should Investors Do? At Fundrise, we’ve created a strategy that takes into account the changing economy: A. Lend Short: On average no more than 2-4 year term maturities. B. Borrow Long: Lock in long term loans (10+ yrs), with Fannie, Freddie, and others. C. Stress Test: Ensure that in more conservative scenarios, where growth is slower and interest rates are higher, the asset still performs. D. Identify a Margin of Safety: Focus on senior and mezzanine loans with high coverage ratios and existing cash flow.
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This information does not constitute an offer to sell nor a solicitation of an offer to buy securities. The information contained herein is not investment advice and does not constitute a recommendation to buy or sell any security or that any transaction is suitable for any specific purposes or any specific person and is provided for information purposes only. Each investor should always carefully consider investments in any security and be comfortable with his/her understanding of the investment, including through consultation with investment and tax professionals.
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