Before we begin this Bennelong Funds Management podcast, we would like to acknowledge the traditional custodians of the land on which we are recording and pay our respects to Elders past, present, and emerging. We celebrate the stories, culture and traditions of Aboriginal and Torres Strait Islander communities who work and live on this land, and we commit to an ongoing journey of reconciliation and respect.
Holly Old:
Hello and welcome to the final Quay Global Investors podcast for 2022. My name is Holly Old and I'm an account director with Bennelong Funds Management. Joining me today is Chris Bedingfield, co-principal and portfolio manager with Quay Global Investors. Chris, welcome.
Chris Bedingfield:
Good morning, Holly.
Holly Old:
Chris, your latest Investment Perspectives article discusses the yield curve and your views on whether we are heading for a recession as some commentators are speculating. Can you summarise that article for us and your views on what the current inverted yield curve may indicate?
Chris Bedingfield:
Yeah, so there's been a lot of action in the bond market all year, I guess is the best way to start it. And what we’re seeing now is we're seeing the long end in the United States and elsewhere, but we're seeing long end bonds now yielding less than the short end. And the best way to describe that, people call that the yield curve, it's the difference between the 10 year rate and the two year rate. And right now the fact that the 10 year rate is lower than the two year rate in the US and elsewhere, I should add, particularly in Europe, but particularly in the US the fact that that's inverted has historically signaled a recession in the United States. And that's why I think you're getting a lot of commentary out of the US at the moment that the Fed is going to create a recession, I think people are looking at the yield curve.
And it's quite rational for people to think about it that way, because if you look at the history of whenever that yield curve goes inverted, and again, I'm defining that as the difference between the 10 year rate and the two year rate. Whenever that's gone inverted, there's been a recession within the next six to nine months and that goes all the way back to the 1980s. So its track record is remarkable and so it's very natural for people to sort of say, well, we can bake this in. And I think that's kind of affecting equity markets a little bit and a lot of market sentiment.
So this month we kind of question that a little bit. We pushed back on that a little bit and where we started was to say, well yes, the inverted yield curve has always predicted a recession. One of the recessions that it predicted was the 2020 recession. The yield curve went inverted in 2018 and 2019 and then there was a recession in 2020. But I think it's a long bow to suggest the yield curve predicted the pandemic, which is what caused the 2020 recession. And thinking about 2019, what really happened then was the yield curve inverted and the Fed started cutting rates but there was no real sign of recession.
And that's what the inverted yield curve is saying. It's not necessarily saying it's going to be a recession, it's just saying the Fed will cut interest rates. And the Fed can cut interest rates without a recession like they did in 2019. And I think there is a non-zero chance, a reasonable chance that the Fed will cut again into next year and the year after without a recession. And that scenario is really playing on the idea that this inflation, it really is transitory. If inflation is transitory and we can get through all the supply bottlenecks now that China's opening up, we'll see if that plays out, you could get a scenario where the yield curve is inverted, the Fed starts cutting rates in the next year or two, and we don't have a recession. And in fact, when you look at GDP growth in the United States, it's accelerating. It's not decelerating, it's accelerating. So there's no sign of any slowdown in GDP growth. There is signs that supply bottlenecks are freeing up and the yield curve might not be saying recession. It just might be saying, dare I say it, soft landing.
Holly Old:
Perfect. Excellent. Thank you, Chris. You and your business partner Justin have had a busy few months with various trips overseas for company visits and the like. You also recently returned from the US where you completed the New York Marathon for the first time. Congratulations.
Chris Bedingfield:
Thanks. I made it.
Holly Old:
Well done. But in addition to that, you also attended the recent NAREIT Conference. What were your top three takeouts from the conference?
Chris Bedingfield:
I think there was a couple of very strong themes that came out. Firstly, cost to finance is on top of everyone's mind. Funding rates have gone up, but that's no news to anyone. I guess you can differentiate between the companies that have staggered their maturity profiles versus the companies that haven't. A staggered maturity profile, they're not so worried about the cost of debt because they're just refinancing debt that they put in place 10 years ago. And 10 years ago, the 10 year bond rate was 3% and today it's three and a half. So there's not much of a headwind for those companies. But for others that couldn't help themselves, refinanced everything at 2% during the pandemic, are now facing headwinds. So it really depends on who you're talking to, but certainly cost of funding is a topic. But what's pleasing is availability of funding is not a problem. So companies are accessing the debt markets. Yes, the cost is higher, but whether it's the mortgage market or whether it's the unsecured debt market or whether it's bank appetite lending directly, there doesn't seem to be any problem. And that's a great source of comfort for us, because the two things we worry about in real estate, it's not interest rates, as we say from time to time, it's supply and it's access to capital. And right now access to capital is pretty good.
And then on the supply front, the other big theme that's coming through is developments aren't working, they're not penciling. A combination of rising construction prices and rising labour rates is making new developments very hard to work. Combine that with an uncertain transaction market. No one knows where the direct market pricing is for a lot of asset classes, and so supply is being taken out of the market. Now that's a long-term effect. That'll affect 2024 and 2025, but positioning for that now is where the opportunity is. That's what we're trying to do.
And then just on the transaction market, nice little tidbit for us, which gives us some comfort I guess, is there's not many transactions occurring at the moment, but there was a very large manufactured housing transaction that occurred while we were over there. It was in Florida. It was a billion dollar plus transaction and it was done on a three point something yield. So notwithstanding the fact with seeing bond rates go up, this is a good example. If you own a good asset or a good asset class, cap rates don't move with bond rates. The tightness of the manufactured housing market, the attractiveness of the industry, means that when opportunities come up, there is capital there and they'll pay a big price to get set. So good transaction evidence, and remember over 10% of our portfolio is in this space. So the appetite is very strong for that asset class, so we saw that as an interesting takeaway.
And then the last thing is every company is on recession watch, as you would expect, as I was just mentioning a moment ago. But no one sees it. No one sees it. The leasing market stays very strong across residential, industrial, self storage is holding up very, very well. It's coming off a very great year last year. It's still holding up very well. So the leasing market's very good. And then the real estate companies that are more consumer facing, so retail – we had good meetings with Brixmor, and Simon and a number of other retail landlords – they are seeing no change in consumer behavior. Consumers are still shopping. I think I saw some data since I've come back. That Black Friday weekend, footfall was 10% higher this year than last year. So that's store level footfall. So we feel really good about retail, that notwithstanding that everyone's waiting for this recession, the data's not there and that was some of the key takeaways. And we came away feeling cautious, but still feeling pretty good about how we're positioned.
Holly Old:
So Chris, just before we wrap up today, I wanted to have a quick chat to you about the US tech wreck. Where do you see the risks and opportunities?
Chris Bedingfield:
Yeah, it's a good question. And funnily enough, the conference that I was just talking about was in San Francisco, so it's kind of like ground zero for technology, and the headlines have been pretty clear. Companies like Facebook are now letting people go, and Twitter's letting people go, and Apple is not hiring anymore. Amazon is actually letting people go as well. So where the risks really lie is those tech related industries or tech related locations. So East coast apartments are certainly one area that is affected. One of the other areas is office. Over 60% of gross leasing that's occurred in the last 10 years has been tech related. And that's not West coast, that's everywhere. So that's Boston, New York, Atlanta, Austin in particular, and then as well as the West coast as well. So those are the two areas of risk is really the West coast apartment markets, particularly younger people rent. So it's more apartments than single family homes. And then also to a lesser extent, well to the same extent I would say as office, but then to a lesser extent also, life science as well, 'cause life science is really at that tech end of the market.
So they're the three areas. And then how we positioned that. We did have West coast apartments earlier this year in Essex. We've cycled out of that and actually moved more into single family homes. So that company is exposed and we've reduced our exposure there. We've reduced our exposure to multifamily generally. And on the office side, we have a very, very small office exposure, which is more of a Manhattan exposure than an office exposure, through Empire State Realty Trust. It's more of an observatory deck, some apartments and a few office buildings.
So we're not really exposed to it. I guess the feedback we're getting from the companies is they're not seeing any negative demand yet, but I would expect these tech layoffs will lag. The impact will lag into next year and we are concerned about it, and right now we don't have much exposure to it. But it's definitely a bit of an issue. On the other side of the equation, if you’re long mall REITs, which we are, it's not bad news to see Amazon shedding staff. It's saying a lot about what our theme is there, which is the online retailers run its course in a large way. It's very hard to make money to being a pure online retailer. Amazon is an exception of course, but there's not many other exceptions to that. Bricks and mortar, the leasing market's great, footfall's great, the consumers coming back to the store, the retailers are coming back to the store. And that big theme of the last 10 years looks like it's starting to break.
Holly Old:
Looks like we're in for an interesting 2023.
Chris Bedingfield:
Looking forward to it. I think there's some unbelievably good opportunities out there right now. We're kind of spoilt for choice so the challenge for us is to remain patient with what we've got and keep scouring for good opportunities.
Holly Old:
Excellent. All right. Well thank you for today, Chris. Really appreciated your time. Some really great information that we’ve shared for investors. Well done on doing the marathon. Great effort. Just to wrap up, Quay’s most recent Investment Perspectives, titled The yield curve, recessions and soft landings, that we talked about at the beginning of today's recording, is going to be the last article for this year. The Investment Perspectives are going to continue again in February 2023. If you don't already receive the team’s thought pieces and would like to, just click the subscription link at the bottom of the podcast webpage and subscribe to the Quay insights.
Chris Bedingfield:
Have a good Christmas, Holly, good New Year, and we'll talk again soon.
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