HFF Research Update for November 14, 2016: The Contract of Suspense

Monday, November 14, 2016

Weekly insights on current research in the commercial real estate industry from HFF Managing Director of Research Jimmy Hinton. View Daily Rates on the HFF website.

In 1936, Alfred Hitchcock released the espionage thriller Sabotage. In the film, a young boy named Stevie carries a canister of film reels across London. Unbeknownst to Stevie, his canister actually contains a time bomb meant for a theater. The audience is painfully aware of Stevie’s plight of ignorance with the clock winding toward its last second. Suspense mounts in signature Hitchcock fashion as Stevie encounters pesky distractions and minor obstacles to complete his delivery and escape the imminent blast. The suspense is particularly disturbing as Stevie has been affectionately sympathized to the audience earlier in the film under the director’s deft care. The fretting audience assumes Stevie’s survival; that Hitchcock will uphold the “contract of suspense.” Instead, Hitchcock allows Stevie to die alongside a busload of innocents when the bomb explodes before he can successfully deliver the package.

Given Hitchcock’s surprising narrative, many viewers consider the scene a double entendre within the film’s title; their expectations were sabotaged.

As of this writing, the Dow Jones Index has hit an all-time high, and the 10-year UST has seen its yield rise as high as 2.26 percent, and now 2.21 percent – levels not experienced since January.

The rush in bond yields has been driven largely by expectations (bets, rather) relating to fiscal spending, inflation of asset prices and the strength of the USD. As we very well know, yet seem to quickly forget, expectations can disappoint. Disappointment’s cousin is self-sabotage – when our own expectations are so bold they unsettle the very proposed outcome they anticipate.

Wall Street is warning such an outcome could transpire. According to Bloomberg, “some of the bond market’s biggest dealers and investors say the economic optimism [associated with the new Trump administration and the Republican-controlled Congress] may be short lived.” HSBC, Goldman Sachs and Wells Fargo are each warning the fixed-income market is possibly overreacting. Why? Because the sharpest rise in the 10-year UST’s yield in three years may tighten financial conditions before President-Elect Trump is even sworn into office, to the extent anticipated growth is choked before his policies are enacted.

Meanwhile, the Financial Times is onto an investor behavior that starkly defies the upward movement in equity values.

According to the periodical’s analysis of Morningstar data, $200 billion of funds have been drained from the world’s equity markets since January – the highest rate of exodus since 2011 when a $148 billion sought greater security. Moreover, $100 billion was liquidated from equities markets in the third quarter alone. I will grant the timing proceeded the Brexit vote and preceded the final months leading up to the presidential election – behavior demonstrative of an investing public deeply uneasy with political instability, lofty corporate valuations, declining earnings per share and cycle length.

In stark contrast to their developed economy counterparts, the lack of lift in emerging market bourses cannot be explained by these fund outflows. In fact, the significant majority of the capital is being withdrawn from U.S. and European equity mutual funds focused on large and mid-sized companies. To be sure, the departure of capital from stock markets globally (now -6 percent in capital contributed) flies in the face of the expansive values they have enjoyed year-to-date (+4 percent in value).

Bond and money market funds have attracted $276 billion and $150 billion of capital, respectively, since the start of the year; more than doubling the amount of capital _leaving_ equity markets. Yet, the global bond market has experienced a trillion-dollar-plus loss of value and money market borrowing rates have risen dramatically in a short period of time.

With a political referendum in Italy in December, elections in Germany and France next year and a Trump administration that is still forming not only its participants but also its policies, expectations are a dubious exertion.

As I write from Bahrain this evening, Washington, D.C. politics continue to dominate print and television media headlines. While the Middle East and its investors “continue walking the same path,” they vigilantly scour news for indications of political and investment trajectories. The next four days promise feedback from more than 10 investors from Manama, Abu Dhabi and Dubai representing ultra-wealthy family offices, professional investment corporations, investment banks and sovereign wealth funds. It will be interesting to gauge expectations from such a broad audience.

Alfred Hitchcock deliberately sabotaged his viewers’ expectations, in a reminder we shouldn’t take outcomes for granted.

Will the market sabotage its own expectations? Will capital flows eventually shine through to market valuations?

The contract of suspense hangs in the balance.

About Jimmy Hinton

Jimmy Hinton serves as Managing Director of HFF, responsible for the firm’s national research efforts. Mr. Hinton works with the executive management team to assist in investor relations and to inform both HFF staff and firm clients with in-depth analysis of economic, property and capital market trends. He is also responsible for providing extensive market reports, client presentations and deal-specific analysis for debt placement and investment sales assignments. Mr. Hinton’s responsibilities include substantial interaction with pension funds, life insurance companies, regional and CMBS lenders, REITs, foreign investors and private equity funds.

During his tenure at HFF, Mr. Hinton has supported the execution of more than 150 commercial real estate transactions totaling more than $4.5 billion in 20 states. Mr. Hinton has experience in fixed- and adjustable-rate debt, mezzanine debt, construction loans and joint venture executions on behalf of clients engaged in the acquisition, development and recapitalization of property types including multi-housing, industrial, office, retail, medical office and storage properties.

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