Why We’re Optimistic About 2021
As this uncommonly turbulent year winds to a close, investors are taking stock and preparing for a strong entrance into the recovery promised in 2021. COVID vaccines are finalizing trials and preparing for distribution, a new White House administration is transitioning into power, and hopeful analysts predict a summertime return to some measure of economic normalcy. There are legitimate reasons for optimism entering 2021. Tim Duy from the University of Oregon puts it this way:
“There is nothing fundamentally ‘broken’ in the economy that needs to heal…there was no obvious financial bubble driving excessive activity in any one economic sector when the pandemic hit… With Covid-19 cases surging again, it is understandably hard to look optimistically to the other side of this winter… Don’t let the near-term challenges distract from the economic stage being set for next four years.”
Vaccines Are a Game-Changer
Pandemics have a way of upsetting the status quo. In the 14th century, the Bubonic Plague decimated half of Europe’s population, and a third of the world’s. When it ended, there was jubilation and dancing in the streets. A labor shortage caused by so many deaths led to the end of feudalism and centuries of unchanging drudgery for the masses. Inventions such as the printing press spurred the spread of knowledge and ideas across distances. This in turn spawned the scientific revolution, the industrial revolution and the birth of a then-radical notion of democracy — the elections of leaders. In short, things got better.
We recently received the light at the end of the tunnel news that we pretty much waited all year for. Pfizer and Moderna are showing ~90% success rate with their vaccines at this stage of development. Distribution will be key, but there is less uncertainty in the vaccination timeline now, and this represents the beginning of the end. “The United States will most likely reach an epidemiological end to the pandemic in Q3 or Q4 of 2021,” McKinsey forecasts. (Maybe even sooner.)
Effective vaccines will be the key to getting the global economy back to pre-corona levels, according to Danske Bank chief strategist Henrik Drusebjerg. As long as restrictions and lockdowns persist, there is a limit to how far economic activity can be ramped up.
“In light of recent increases in equity prices, investors seem to have already cashed in some of the promise held by upcoming vaccines, but we expect to see further increases in 2021. Moreover, the economy and the financial markets will continue to be supported by the extremely accommodative monetary policies of the central banks, plus low or negative yields on many bonds limit alternatives to equities if investors require an opportunity for return – though we do see attractive return opportunities in emerging market bonds,” he says.
Interest Rates and Inflation Will Be Kept in Check
Central banks will maintain highly accommodative monetary policies for most, if not all, of 2021. Partly, this is because inflation remains significantly below their objectives, with few signs that it will suddenly accelerate. But expansive monetary policies will also reflect the receding chances for meaningful second-round fiscal expansion in the U.S., the United Kingdom, the European Union or Japan.
The onus for nurturing the recovery is, once again, reverting back to its customary source—central banks. Accordingly, while yield curves may steepen modestly in expectation of improved economic conditions, interest rates at all maturities and spreads between different classes of credit are likely to be dominated by steadfast monetary adherence to low policy rates supported by quantitative easing. One consequence is that the U.S. dollar, which has recently softened on the world’s foreign exchange markets, is likely to decline further.
Looking to 2021, there is the potential for inflation to break through 2% around mid-year should vaccine deployment reach critical mass and business and consumer confidence improve. Projections for 2021 suggest that inflation will run at 2% for the year overall, which is slightly below the upper end of the Fed target.
The interest rate climate also remains benign with both 3-month T-Bills and 10-year Treasury notes at around 0.1%, roughly half the level of one year ago. Although there may be some modest increases in interest rates in 2021, these are expected to remain low. The latest Consensus Forecasts average places short-term interest rates at 0.2% at year-end 2021 while the 10-year interest rate is projected to rise to 1.2%.
Secondary and Suburban Growth Markets Will Continue to Outperform Their Urban Counterparts
In 2021, we’ll likely see continued, diversified interest in secondary and tertiary markets. Investors will continue looking for hidden gem markets that are currently proving their resilience in the face of pandemic-related lockdowns. And as for geography, Gay Cororaton, a senior economist at the National Association of Realtors (NAR) says:
“Secondary/ tertiary metro areas [will] do better than the top-tier cities like New York, Boston, San Francisco, the primary reason being affordability. This is based on the job growth prior to the pandemic and the migration trends in these areas, as people are moving out of expensive areas like the Bay Area and New York. Tech workers may also be able to work from home permanently, which will mean increased out-migration from the Bay Area. My bets for the geographic markets that will do well are Atlanta, Raleigh, Charlotte, Jacksonville, the D.C. metro area, Dallas, Phoenix, Boise, Colorado Springs, and Salt Lake City.”
Companies will increasingly move towards a hub-and-spoke model. The office hub-and-spoke concept is nothing new. Companies have used it for years. Their headquarters serves as the hub of the business, while the spokes are a geographically distributed network of offices, usually based on talent and client needs. The headquarters is generally in a core location accessible to public transportation, and it acts as the cultural center of the business.
Like many things in commercial real estate, COVID-19 has acted as an accelerant for the hub-and-spoke model. “It’s inevitable that COVID has forced companies to rethink their space and logistical needs, and this model is evolving,” says Bryan Murphy, CEO of Breather. “With more and more companies becoming comfortable with their employees working from home and as a result, extending their work from home policies comes a change for the future of work.”
We’re seeing a drastic reduction in commuting, the ability of people to leave expensive metro areas and repopulate smaller markets that provide a better quality of life, and the ability of companies to lock in the best talent regardless of geography. On top of greater happiness, these changes all provide huge increases in productivity and efficiency, which are the building blocks of human prosperity.
Investing With These Trends in Mind
Good, optimistic investing comes from enduring difficult periods in order to enjoy long-term returns, knowing that the effect of compounding over years of accrued interest during prosperous periods will drive positive growth. At Excelsior Capital, we have been investing in undervalued secondary markets for the past 10 years, piggybacking a demographic shift that saw population redistribution from urban metros to suburban markets. Our investment thesis centered around maturing millennials entering the family formation process later in life (compared to previous generations) and desiring to live in higher value locations offering them affordable single family housing and access to quality public education. Employers took notice, and as a result, the jobs followed.
We identified a demographic shift earlier than most and felt that our thesis had been validated heading into 2020. The pandemic, however, has accelerated this trend and suddenly there is newfound investor interest in suburban office assets. Because of this, our portfolio has remained resilient in the face of mass disruption brought on by the pandemic. At Excelsior, the glass is half full (for lack of a better cliche). We’re excited about the prospects of 2021 and remain committed to navigating whatever the investment landscape brings in order to target and syndicate the best opportunities for our investors.
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