Global real estate will continue to fare well, given the favorable backdrop of accommodative monetary policy, improving economic drivers and restrained supply. Commercial real estate (CRE) and REIT investors have been major positive benefactors of central bank policy. In the years leading to the Great Recession, monetary policy was lax and accommodative, leading to unrestrained appetite for real estate. Financial exuberance ensued. Because central banks introduced even more accommodative and experimental policies after the financial crisis, CRE prices have now soared far above their previous highs. Abundant liquidity and the lack of alternatives support these prices. But CRE investors have other reasons to be optimistic: solid fundamentals, improving economic drivers, and steady income streams. Indeed, CRE assets are in a “goldilocks” scenario: Growth is sufficient to generate sustainable tenant demand without triggering a new supply cycle, while uncertainty is still a concern, which maintains demand for trophy markets. Preferred markets include Japan, the Eurozone and Australia.
The global search for yield – not an improvement in EM fundamentals – is what has been driving the EM rally this year.
Having turned dovish in February, the Fed has enticed investors to sell U.S. dollars and pile into commodities and risk assets. This phenomenon escalated following the late June Brexit vote. The uncertainties over Brexit and global deflationary pressures led investors to conclude that the Fed would be unlikely to tighten policy meaningfully anytime soon. As a result, the search for yield has gone exponential and flows into EM have skyrocketed.
There is a limit to how far financial demand can propel commodities prices and EM risk assets in the absence of stronger final demand and corporate profits. If final demand disappoints, commodity prices will roll over and drive EM risk assets lower. The chart above demonstrates that there is still a very high correlation between EM share prices and industrial metals prices.
Bottom Line: The global search for yield has driven EM risk assets higher amid lingering poor fundamentals. Our EM strategists believe investors will eventually re-focus on EM macro fundamentals and corporate profits. Once this happens, it will produce a major reversal in EM risk assets: share prices, currencies and high-risk bonds.