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Alternatives Research | Liquid Real Assets | Weekly edition - January 10, 2024


RETRACEMENT DRIVES REAL ASSET RETURNS TO START 2024 



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MARKET COMMENTARY

Most asset classes meandered to start the new year ahead of fresh economic data
releases and full-year 2023 company earnings results. Broader equity markets are
down ever so slightly to start the year, having recovered much of their earlier
losses in recent trading sessions. The path of inflation appears poised to
remain among investors’ top concerns in 2024 as it will influence central banks’
policy decisions over the coming months. Elsewhere, the world remains on edge,
with tensions in the Middle East escalating by the day. Among Real Assets,
Global Infrastructure securities are leading the broader markets by a slim
margin on a relative year-to-date basis (as of January 10th), though they are
also down marginally. TIPS, Commodities, and Global Real Estate are lagging
broader markets modestly, while the sell-off in Natural Resource equities has
been more pronounced. At a sector level, we have witnessed some mean reversion
relative to 4Q23, with natural gas recovering from an abysmal end to the year.

Why it matters: If inflation fails to decelerate further (or reaccelerates),
investors will need to reset expectations on the future path of interest rates.
A soft landing for the U.S. economy has now become consensus, in stark contrast
to dire views entering last year. Economic growth is still expected to slow in
the U.S. and around much of the world in 2024; hence, any number of events could
tip growth into contraction, albeit likely mild. Furthermore, there is yet
another policy deadline ahead, as the U.S. still needs to pass a fiscal budget
or risk a government shutdown. Have we mentioned that 2024 is an election year,
not just in the U.S. but in several countries around the globe, in which the
outcomes could shape global policies for years to come. 

Macro Dive: Below, we take a look at the latest inflation data and its impact on
central banks’ expected next moves. We also review recent congressional
negotiations on the budget standoff and some of the global elections occurring
this year, with one of the more important ones taking place this weekend.
Finally, we provide an update on the Middle East, where tensions continue to
rise.
 * Will the Fed “cut” to the chase: The U.S. received some mixed messaging on
   inflation this week. First, the December Consumer Price Index (CPI) came in a
   bit hotter than expected and accelerated from the prior release on both a
   monthly and annual basis, which were reported at 0.3% and 3.4%, respectively.
   Core CPI (which excludes food and energy) met expectations and was unchanged
   at 0.3% on a monthly basis, while the year-on-year print of 3.9% was just
   ahead of expectations and dropped 10 bps from November’s report. The
   following day, Producer Price Index (PPI) data was better than expected,
   declining from the prior release on a month-on-month basis with a headline
   print of -0.1% and core at 0.0%. Year-on-year prints were better than
   expected but did accelerate slightly from November, with headline at 1.0% and
   core at 1.8%. Following the release of both, investors have increased their
   expectations for the U.S. Federal Reserve to begin cutting rates in March,
   with the futures market now implying an ~80% chance of a cut at that meeting.
 * Maybe the third time’s the charm?: With the January 19th expiration of one of
   the two continuing resolutions (CRs) quickly approaching, the U.S. Congress
   is back in negotiating (and bickering) mode. While House Speaker Johnson
   previously promised there would be no more CRs this fiscal year, it appears
   that another short-term fix may be in the works. Speaker Johnson, a
   Republican, appears to be willing to compromise with Democrats on spending
   measures, but a small, extreme faction within his own party seems to be the
   primary holdup, having already sunk a procedural vote on rules earlier this
   week in protest of the Speaker’s bipartisan negotiating efforts. Every day
   that passes without a CR, full bill, or even an agreed plan further risks a
   partial government shutdown before the end of the month. Hopefully, this
   situation can be resolved soon, as the second CR expires just two weeks later
   on February 2nd.
 * Political hot potato: This year will see major elections in several of the
   world’s countries, with estimates that these areas represent between 50% and
   70% of the earth’s population. These include the U.S., the UK, the EU, India,
   Mexico, Russia (any guesses on the winner there?), and several others.
   Perhaps one of the most important is occurring in Taiwan this weekend. The
   current front-runner is Lai “William” Ching-te of the Democratic Progressive
   Party (DPP). While there is still a chance that an opposition party candidate
   could prevail, a win by the DPP would signal the people’s aggregate will
   towards separation from China, a move the Chinese government would strongly
   protest. While there are still many unknowns, this could escalate China’s
   aggressive stance towards Taiwan, a move that would have global
   ramifications. While we put low odds on a full invasion of Taiwan, estimates
   suggest this tail risk could cost the global economy $10T or about 10% of
   global GDP. For more on this and other political insights, we encourage you
   to read the most recent blog of Senior Political Strategist for DWS, Frank
   Kelly.
 * Showdown in the Red Sea: As we write, the U.S. and the UK have launched
   multiple strikes on Houthi targets in Yemen. This follows increasingly
   frequent attacks in recent weeks by Houthis on merchant vessels traveling
   through the Red Sea and attacks on U.S. military personnel in Iraq and Syria.
   The Houthis, which are believed to be backed and trained by Iran, claim they
   are only targeting Israeli-owned vessels in protest of the Israeli invasion
   of Gaza and have vowed to retaliate for the strikes in Yemen. Iran itself
   recently seized an oil tanker off the coast of Oman and sent a warship to the
   Red Sea. While we will be monitoring how this situation unfolds, in the
   immediate aftermath of the U.S. strikes, crude oil prices jumped by about 4%,
   and we have previously noted the increased shipping costs and delays as some
   shipping companies are choosing to sail around the African continent rather
   than risk traveling the Red Sea.

Real Assets, Real Insights: This week, we review a recent office deal, reckon
with the cold, hard reality of winter storms’ impact on utility companies and
implications for electric grid systems, explore an overlooked asset type that
stands to benefit from a recovery in home building, and finally, satisfy our
cravings with a granulated look at commodities.
 * An office building goes back to school (Real Estate): An office campus on the
   west side of L.A. jointly owned and redeveloped by two listed REITs was
   recently sold to UCLA. Hudson Pacific Properties (office) and Macerich
   (regional malls) sold One Westside and Westside Two to the Regents of the
   University of California for $700 million. Initially built as an enclosed
   mall and named Westside Pavilion in 1985, the property was extensively
   redeveloped in recent years to provide flexible, tech-oriented office space
   and was mostly leased to Google through 2036. However, Google never occupied
   the space, and UCLA now plans to convert the complex to a medical and
   engineering research center. While the pricing of over $1,000 per square foot
   appears to be welcome news for office owners and may demonstrate resilient
   demand at healthy price points for high-quality new space, it might not be a
   fair comp given its unique attractiveness to UCLA, based on the property’s
   flexible design and proximity to their main campus in nearby Westwood, and
   the likely large lease termination fee from Google. 
 * Neither snow nor rain nor heat… (Infrastructure): We’re not talking about the
   mail carrier, but rather utility companies. With many of our readers sitting
   out the winter storm and a polar vortex crossing the U.S. this weekend, we
   note that extreme temperatures in either direction can result in increased
   loads (i.e. more heating or more air conditioning), which can create
   inordinate stress on the grid. Damage from storms can lead to lost revenue
   due to outages and create expensive repairs for the utility, as well as
   inflict reputational damage due to the harm borne by its consumers. The
   Department of Energy estimates that power outages cost the U.S. economy up to
   $70B annually. The good news is regulated utilities are working hard to
   improve grid resiliency and create on-demand sources of electricity
   generation, which should support their growth in the foreseeable future. This
   growth will be funded in part by the Infrastructure Investment and Jobs Act
   of 2021, which sets aside ~$65B for investment to “upgrade our power
   infrastructure to deliver clean, reliable energy across the country.”
 * You CAN grow money on trees (Natural Resources): That is, if you hold
   timberlands or the stocks that own them. Lumber and board prices have bounced
   off their 2023 lows; while perhaps not out of the woods yet, prospects appear
   to be improving. Single family home construction is among the largest end
   uses of lumber, and U.S. privately‐owned housing starts in November (the most
   recently available data) increased to 1.56M on a seasonally adjusted annual
   basis, nearly 15% higher than the month prior and over 9% higher than the
   prior year. Permits for starts also increased, and when coupled with mortgage
   rates receding from their recent highs, demand may increase as new homes
   become more affordable. An uptick in lumber usage could provide a catalyst
   for the timber companies as 2024 progresses. 
 * “Cane” sugar repeat its 2023 performance? (Commodities): After being one of
   last year’s top-performing commodities, sugar is back at it in 2024, having
   risen over 4% already. We’ve recently seen some bullish developments for the
   sweetest commodity, driven mainly by rising supply concerns in Australia,
   Thailand, and India. Severe flooding across Australia’s far northeast last
   month has washed away sugar crops (and damaged key rail infrastructure),
   which will likely lead to production losses. Thailand’s Sugar and Cane Board
   has cut this year’s production forecast by about 15% from last year, and in
   India, while the production outlook is slightly better than last year, courts
   are reviewing the validity of the government’s decision to bar the use of
   sugar cane juice and B-molasses to produce ethanol, which could have negative
   implications for sugar supplies. In addition to these developments, we will
   be closely watching weather dynamics in Brazil, which leads global sugar
   production


MARKET INDEX RETURNS
WEEK TO DATE SINCE JANUARY 3, 2024 AS OF JANUARY 10, 2024



Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global
Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural
Resource Equities = S&P Global Natural Resources Index; Commodity Futures =
Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI
World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow
Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources
Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source:
Bloomberg, DWS. Past performance is not indicative of future results. It is not
possible to invest directly in an index.

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