July 2023
Although there have been slowdowns in some areas of the economy, the S&P 500 is up almost 17% for the year. However, Sasan says the S&P’s growth is not as steep as it looks and is mostly due to a handful of companies that are up almost 58% for the year, like Apple, NVIDIA, Tesla, Google, Microsoft, etc. Most other S&P 500 companies are only up around 5%.
Furthermore, Chris notes that rising interest rates have created competition for stocks since investors can now get a safe, reasonable return by investing in some fixed income or U.S. Treasuries at around 5%. Sasan agrees and highlights our focus on private lending as regional and smaller banks pull back, creating more opportunities for creative/flexible financing to be handled privately.
Chris and Sasan also expect the commercial real estate sector to face challenges but see potential in multifamily apartments and opportunities for private real estate managers to capitalize on dislocations in the commercial real estate market.
Finally, Chris and Sasan discuss the importance of diversification and highlight the potential in the commodities and natural resources sector due to factors like globalization and decarbonization. They also encourage listeners to actively manage and diversify their portfolios as the financial landscape continues to evolve.
Click here to subscribe to our YouTube.
Watch previous episodes of THE FINANCIAL COMMUTE here:
Ep. 41 Food Lending with an Emphasis on Risk Management
Ep. 40 Real Estate Lending with a Focus on Building Relationships
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by managing director of Investments, Sasan Faiz. Sasan, thank you for joining us.
Thanks for having me on, Chris.
Halfway through 2023. Can you believe it?
Yeah, it's been it's been a rough ride so far.
It's like, let's rewind. Okay. It's January of 2023. Headlines are all about rate hikes and recessions and real estate crash as we've gone through the first six months of the year. A lot of those headlines, some are true and some are just headlines. Right. We haven't had a recession yet, although we've seen a slowdown in certain some areas of the economy.
The Fed did continue to raise interest rates, but we had a few banks collapse and we had this whole debt ceiling debacle. So with all that said, how interesting do you find it that the S&P 500 is up? You know, call it 16, almost 17% for the year?
Yeah, I think I probably would not have believed it if somebody told me in January that the market was going to be up that much. But the markets were down pretty good in 2022. So some of it has to do with that, with the bounce back and the expectations that the economy didn't go into a recession, which we don't know yet.
But definitely, I think it's a little bit deceiving when you look at the indices like S&P 500 up 16, 17% for a year. It's really powered by seven megacap technology companies are up almost 58% for the year. So those are that Apple, Microsoft, Amazon, Nvidia, Tesla, Google. And these are the stocks that have been driving the market higher.
If you look at the 493 stocks that are in S&P 500, only up 5%. So on the surface, it looks like the market is up a lot more than the basically the broad market. But the broad market really has not participated.
Yeah, thank you for, thank you for lifting up the hood of the car. I mean, I don't like just talking about the S&P 500, but it's one of the most popular, you know, indices to look at. So just to recap, of the 500 companies, seven of them drove the majority of the growth because 493 of them were only up 5% versus the index up almost 17.
Yeah, that's incredible.
Yeah. And I think that, you know, narrow breadth. So when you have just a few stocks driving, the index is usually a sign of trouble down the road, especially if you are going into an economic slowdown or downturn. A lot of money is just going to where the march believes it's a little bit safer, larger companies, but you need broader participation.
We had a little bit better participation from the general market late in the quarter, but still I was not that was not enough to lift all stocks. So so actually, when you look at Megacap, technology companies were up quite dramatically When you look at small stocks and commodity and natural resource stocks, those are actually down for the first half of the year.
Yeah, and you know, a lot of some of the headlines earlier in the year were around sort of AI. And so the introduction of AI and that drove a lot of the growth for companies like the Microsofts, the Googles, the Nvidias of the world. You know, again, that group is really led the way. You know, tell me a little bit about, you know, international.
What happened with international so far halfway through the year?
I think the broader developed international was doing actually better than the general U.S. market in the beginning, maybe three or four months of the year. They're a little bit lagging. But but valuations are more reasonable in the in the international markets, emerging markets. So those are China and some of the more countries that have not been developed as much, Those actually lag because the China's economy is a little bit getting started and stopped, started and stopped and the growth of the economy has disappointed quite a bit.
So we haven't had that major growth in emerging markets, even though the economies are growing better than the developed international. But developed international actually is doing relatively well. So one more point that I think I want to make on the on your point about A.I., uh, so artificial intelligence, there is no question that's going to be a huge driver from a technological point of view.
But for example, you you mentioned Nvidia, Nvidia is selling at almost over 40 times sales, not earnings. So Nvidia is a great company, but then when you look at great companies versus good fundamental stocks, it's hard to make the argument that it's a it's a cheap stock. So so I think a lot of that hype has been priced into some of the mega-cap technology companies.
And that I think that's kind of froth is going to have to come out of the market.
Well, you can have a great company and buy it at the wrong price. Exactly. You know, so when you're investing, price determines a lot of your outcome, even though it could be a great company. So selling in that type of valuation, they need to continue to grow and expand a lot. And, you know, who knows what will happen?
A lot. A lot can change. Yeah. Yeah. I find it interesting. You know, we've had these conversations over the years with interest rates at near zero. There's really not very much competition for investing, Right. If you're not incentivized to invest in bonds or cash or other things, people are going to be forced to go other places in the stocks and real estate and what have you.
Now that the Fed has raised interest rates, I think, you know, a year and a half ago, rates were almost at zero. Now they started the year at four and a half percent. As of today, I think the Fed funds is around five and a quarter. There's now a competition for investing because you can get a very safe, reasonable return by investing in some fixed income or U.S. Treasury bills around 5%.
That affects sort of the future expected return of other types of investments, whether it be stocks or real estate. What's your take now on the overall environment now that there's a competition for dollars when it comes to investing?
Yes, I think I mean, the Fed in their last meeting, I would say they paused, but they guided still to maybe two more hikes potentially this year. So the reason for that is that inflation has come down somewhat, but it's really still sticky and above the Fed's target. So. So if you think about interest rates are still going up, valuations on the equity markets are relatively high.
So it's it's hard to imagine that the equity market is going to continue at this pace. So as you mentioned, I think on the credit side, on the fixed income side, we're seeing some good opportunities both on the public side and also on the private side. So on the public side, for example, investment grade bonds like corporate bonds and mortgage backed securities are having a decent yield.
So that's something that some of our credit managers are trying to capitalize on. But again, our focus is more on the private side. We are where we think there there are better opportunities in private lending right now where you have collateral that's going to be backing your loan and the opportunities are going to be great, especially as you mentioned, with the banking crisis.
Banks are pulling back on lending. So that's going to be better opportunities for some of these private lenders to get in there and kind of fill that vacuum that exists.
I'm glad that you brought that up because the banking collapse, you know, nobody wants to live in a world where their safe money is at risk. Right. That is not a fun environment. But with the small and medium sized regional banks either going under or being consolidated under a larger bank, what that does is it creates, you know, less flexibility for unique loans to small, medium sized businesses or even real estate.
So it creates a tremendous opportunity for private lending, a space that's going to probably grow a lot more as some of these banks tighten up their lending facilities. I hear a lot of people talking about, oh, well, rates will eventually go down, but not necessarily. All these banks are finally earning a decent yield on their loans. Even if we were to go into a little bit of a recession or a slowdown.
They're not going to be quick to lower the interest rates anytime soon.
Yeah, I agree 100%. I think the equity markets especially, I think they're really more optimistic that rates are going to come down as soon as we see some weakening in the U.S. economy that's really not priced into the market. So when you look at the Fed fund futures, we don't expect any kind of rate cuts, maybe middle of next year at best.
So I think the equity markets are a little bit too optimistic. Rates probably may may go up another maybe 50 basis points from here. But as far as being caught, I don't think that's necessarily in the cards for the next maybe 6 to 9 months, if so. So when you're looking at smaller banks, the other area, I think that's going to be a big issue is in the commercial real estate space where smaller banks have more exposure to commercial real estate than larger banks.
And and we've started to see some of the bankruptcies and potential defaults starting to materialize, but that's still going to be a little bit further further down the line. So as you mentioned, just the fact that smaller banks are more exposed to commercial real estate, that's even more reason for them to pull back on their lending. So again, more opportunities for private lenders to kind of step in there and fill the gap.
So on that, we've talked a little bit about stocks. S&P 500 up almost seven led by the technology large cap technology rally. NASDAQ 100 up almost 40. International stocks doing fairly well. Bonds are up for the year. But just real quick to stay on that topic of commercial real estate. You know, safe money or the Fed funds, that has so much to do with what you should expect from an income from a lot of different asset classes.
Right. So you've got small and medium sized regional banks sort of going under or getting consolidated or being stressed back when interest rates were zero. Somebody could buy a property at a four cap, which is their unlevered yield. So, you know, a $10 million property will generate $400,000 of income. Right. That was attractive when rates were at zero.
Now that the Fed funds or U.S. Treasury bills are at call it five, that that's not that attractive. Now to buy that real estate, that illiquid investment, you need to be getting a premium on that. So that should be trading at and call it an eight cap, so to speak. Just I don't know for sure. I'm just using round numbers.
Right. So where a $10 million property should generate around $800,000 because you can go get a risk free return of 5%, which is $500,000 by buying Treasury bills. Right. What we're seeing right now is I read something about deal volumes in commercial real estate being down close to 70% year over year, meaning there's a there's a mismatch between what people are willing to pay and what people are willing to sell and all.
There's a lot of loans out there that are coming due in the next couple of years that are going to have to refinance from a low interest rate, call it 3% to a higher interest rate at six or seven. And that extra cost for borrowing money is going to affect the value of that real estate significantly. We have some of our real estate managers that think that this could create one of the best buying opportunities in the next decade, depending on what could happen.
Obviously, time will tell. What are some thoughts that you would you would share on that?
Yeah, I think, you know, commercial real estate in general, I think there are different segments to it, office that I think what you're referring to, that's the more stressed sector of commercial real estate. But we have managers that are more active on their multifamily apartments because the demographics, because of lack of supply since the great financial crisis is really that's been a tailwind.
So that part of the market is doing well. The office space, you're right. I think that's that's still a big question mark that's going to have to get resolved over the next maybe few months. So that part is definitely going to present some opportunities. We have talked to both private real estate managers and also on the public side at commercial mortgage backed securities, CMBS, where managers feel that they're going, there are going to be some opportunities to capitalize on those dislocations are going to occur in the commercial real estate.
So with we'll stay tuned but we’re in touch with our managers. And I think you're right, there's going to be some great opportunities in that space.
I'm glad that you brought that up because supply has a lot to do with price and the resiliency of it. And so single family homes and multifamily have weathered this storm a lot better than some of the other asset classes. Yeah, so Sasan, any thoughts around opportunities out there for investing, whether it be in stocks, bonds, real estate, commodities?
What are you seeing out there?
So I think one area where we have the high degree of conviction that hasn't really participated in the equity market rally year to date is space associated commodities and natural resources. So it's something we've talked about in the past, kind of the two big macro factors of deglobalization and decarbonization. So the shift toward renewable energy and the fact that we're going to be on shoring a lot of the manufacturing to the U.S. from across the world.
So those are two factors that are going to be beneficial for natural resource companies. And again, they have not participated in a rally, I think mainly because China's economy has been weak. The dollar has been a little bit stronger. So I think going forward, the valuations are very reasonable and these are really multi-year trends, kind of higher inflation and the kind of move toward renewable energy that's going to be beneficial for resource stocks.
So when you look at the equity markets, it's best not to paint everything with a broad brush. There are pockets of opportunities. That's why we have manager active managers that are going to be able to capitalize on those opportunities.
I think the natural resources actually had a pretty good month. They might be lower for the year, but I think the month of June it was up almost, almost close to 6%.
Come back pretty nicely. Yes.
Anything else you'd like to share before we recap?
No. I mean, I think our focus has been on private lending. Again, we like the asset based lending. So that's loans that have collateral that backs those loans. I think we are finding some great opportunities. A lot of these loans are floating rate. So as interest rates go up, they participate in the higher rate as well. And there's collateral backing these loans.
So we are getting some we're getting compensated very nicely in some of these strategies. And we are finding a lot of good managers that are going to be capitalizing on these opportunities that are going to, I think, present themselves over the next few months.
I agree. I mean, look, there's going to continue to be a lot of headline risks out there. Fears of recession, the Fed continuing to raise interest rates if there if they're still concerned with their ability to tackle inflation, there's going to be the whole student loan repayment, so less money in the system. There's going to be a lot of headwinds that the economy is likely to face.
And it's important to stay diversified. If you're only using traditional stocks and bonds to stay diversified, you're not doing enough to best protect you. There's a whole area and universe out there to invest in that's becoming larger and more popular now that those smaller, medium sized regional banks have been challenged. And that is one of those with private lending or private diversified credit.
So thank you for sharing that.
Absolutely. Thank you.
Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.
