United States: A Tale Of Two Years; This Time Will Be Different

Last Updated: September 6 2017
Article by Richard D. Jones

The Wall Street Journal reminded us this month that it was ten years ago, August 9, 2007, that the first regulatory domino in The Great Recession fell as BNP Paribas froze a series of resi investment funds for lack of a functioning market to value the securities. One could quibble about whether The Great Recession could be so precisely dated. Were there the blackened equivalent of green shoots earlier in the year? Did The Great Recession really only begin when the trouble in the subprime resi market morphed into all other credit markets? But that's merely a cavil. August 9, 2007 is, for me, the date the world changed.

As regular readers of this commentary may know, I have something of a fascination with the moments before great change. Across the sweep of history, it does seem that we have a tendency to be willfully blind to the reality of dancing on the lip of the apocalypse. Remember in July of 1914, the world was riveted not by the death of Archduke Ferdinand and rumblings of war in the Balkans, but, by the trial of Henrietta Caillaux who shot and killed Gaston Calmette, editor of Le Figaro over Messrs. Calmette's publication of an embarrassing letter about her ex-husband, then the Minister of Finance of France (she bought a gun, shot him 6 times in the chest and was found innocent; she was young, pretty sympathetic and apparently very well represented). While the world was riveted with this trial, events were occurring in the Balkans that would soon lead to the death of over 20 million people and very, very few saw it coming. Really fascinating stuff.

Well, here we are in the summer of 2017 and I seriously don't think that we are at that sort of inflection point, but it's a useful time to look back and look forward over 2017.

I get the fact that July 1 is the mathematical midpoint of the year, but for me it is always August. August was when The Great Recession started. August was when the Russian debt crisis started years before that. For many years in between, the optimism of a good first half of the year regularly withered in the sweaty doldrums of August and never recovered. So where are we now?

Our view from the trenches is that after the Trump election and excitement over the Trump bump, the capital markets went on a sustained pause. Was this a moment of reflection? Concern about whether the election really mattered? Or just fundamental indecisiveness? For whatever reason, the year didn't really begin to rock and roll until late spring. Since then the gnawing need for yield, the renewed investor fascination with floating rate debt and an eagerness in the real marketplace to refinance while interest rates remained low has led to a sustained period of superheated activity.

But it's August. So, will the good times expire on the shoals of geopolitical risk and the noise coming from the clown car which is our nation's capital again this year? I don't know about you, but having soldiered through many cycles, I have gotten to the point where good times make me as anxious as bad. So, essentially, I'm anxious all the time – anxiety informed by the certain knowledge that markets turn quickly and unexpectedly. There is never a tell. But this August I'm pretty mellow. Maybe it's the meds talking, but I really don't feel that bad right now.

I just finished my mid-year re-forecast here at Dechert and we have concluded that this time will be different and the second half of the year will be as good, if not better, as the first. That's not happened; finance markets putting together four solid quarters, in a long, long time.

With a nod to the old Ford Theatre joke (how was the play?), assuming we ignore for the moment (and the market seems to share this view) North Korea, China, Russia, the Middle East, Venezuela, Charlottesville, et al., macroeconomically it does seem that there is little out there that would suggest that the wheels are coming off this long grinding recovery. The economy is likely to continue to expand for several more quarters at least. The commercial real estate business mirrors the broad economy. Most sectors inside commercial real estate are strong, or at least not weak. I know the retail sector has got everyone aflutter, but sector rotation is a common feature of our business and when one sector weakens, another often strengthens. Moreover, since I have been hearing about the failure of the overbuilt retail sector on and off for 30 years, I'll take the current soundings of the alarm with a grain of salt.

So if the broader economy is holding up and commercial real estate is essentially okay, what else? Interest rates? Interest rates are behaving in ways that people with PhDs in economics don't seem to understand (that really doesn't trouble me because no one actually expects economists to get it right, just so long as their conclusions are larded with jargon and salved by large quantities of really nifty math). One-month LIBOR has moved out 100 bps from the Great Quietude in the early part of the decade, but hardly seems to be on a tear. It's hard to see the ten-year coming in materially from where it stands today, but it's almost equally hard to see it go roaring out. The old economist's joke, "I'll tell you what, or I'll tell you when, but I won't tell you what and when." comes to mind. While it does seem certain that at some point we'll see a 4% ten-year, God only knows when. Frankly, even a slow deceleration of our economy, a small recession and increasing interest rates, does not represent a significant risk to the business of capital formation.   Slow moving seems to have been the leitmotif of the past many years and slow is good. Seems to still be the watch word of our economy. It's only the riptide of an unforeseen and rapid change that scares us all. There's no riptide in sight.

So absent some geopolitical disaster (and that couldn't possibly happen, right? ... right?), the environment seems amiable for the delivery of twelve months of solid capital flow for commercial real estate and other fixed income assets; something that hasn't happened for a long, long time.

Maybe the White House Follies (our version of the Parisian Trials?) are distracting us from impending doom. Maybe we are so fascinated by the noise of the geopolitical antics of governments and politicians that our awareness of the underlying reality is weakened. But, the hell with it, I think the rest of 2017 is going to be just fine. That's my story and I'm sticking with it.

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