John McCollA Comment -- General Comments From an ExpertA CommentaryTOP PICKSep 25, 2002

The public markets have underwritten that higher rates are going to have negative ramifications on commercial real estate. His team says that's not the case. Yes, we've had a big rise in rates recently. But there are a couple of silver linings in the commercial real estate market, which the public market isn't fully appreciating.

The first one is falling new supply. It's cheaper to buy than build today, due to those increased interest rates. Publicly traded companies have access to capital, with credit markets wide open. We've seen resilient cashflows across commercial real estate companies. During recent US earnings season 70% of REITs beat consensus, and 86% increased full-year guidance.

The last thing we're seeing is M&A. We've seen 21 takeovers of REITs in the past 2 years. The private market's looking at the public market and asking if it's on sale.

All that combines to present a big opportunity.

In Canada, we have an interesting setup. Rates have moved higher, though not nearly to the same level as in the US. In certain sectors, we're seeing growth and strength. Think about seniors housing, retirement homes, grocery-anchored shopping centre REITs.

The offset to the headwind of higher rates has been higher income growth, especially in more recession-resistant sectors and those that are tariff-resilient.

A historically volatile month, September this time has been more choppy than volatile. There's been an orderly decline, moderate weakness, in the TSX, while the U.S. has gone sideways. Causing this is sector rotation, from weakness in mining, strength in energy while the banks go along in Canada; in the U.S. there's back and forth between AI semis and software battling it out. Looking ahead, he's focused on the US Midterms, the 4 weeks before then after those elections, which are usually volatile. On top of that, we have earnings season. Politics, such as tariffs have had such an impact on markets. Meanwhile, treasury yields and rates are impacting companies, including AI ones.

The U.S. PCE number will be released on Wednesday. The Fed pays more attention to this than CPI, because PCE better tracks what consumers spend. Recent months have sent mixed messages with higher oil prices, then settlement, then rises again. Friday, we see the labour number. Lots to chew on. More important is earnings season in October. Expectations remain high for earnings growth, but he's concerned with what's happening beneath the surface. Is a little worried about rising yields; the cost financing the U.S. debt is getting out of control. Nov. 5 is the next quarterly re-funding announcement--how the treasury finances the debt. Congress needs to send less, and the Congress could change after the Midterms and result in gridlock.

The percentage of stocks above their 200-day average. The S&P is well above its 200-day, especially now, but the percentage of stocks that are above fell sharply last week. Now, more stocks than not are breaking their long-term trend. This is called a decay in market breadth and is a leading indicator. As it decays, eventually the top is formed. Another chart shows the number of stocks making new 52-week highs and lows. In the last 2 weeks, we saw a serious decay where the market is grinding higher to make new highs, but fewer stocks are participating. The warning signs are there, so maybe rebalance or take some profits, but don't sell a lot. Markets can still go higher for a while.

The 10 Year US Treasuries are at 5 1/4 and this is one of the biggest issues with the market. The 10 year bond rate affects everything globally. The treasury market has changed a lot in the last 10 to 15 years and is more in the hands of investors who are very price sensitive and have other options. The period of very low rates was very unusual and since then rates have normalized. How fast it moves is the concerning part. There are other variables coming together to increase rates: the war in the middle east, higher inflation, big debts in the US and elsewhere, all creating treasury market turmoil.

What's holding up the equity markets is a combination of things: some is AI, some is very good earning numbers in the US and in the world. Also companies have been able to navigate problems. Markets and rates are relative to the strong economy. However something has to give if rates still go up.

The question was on buying gold. He doesn't own gold or gold companies. If you want gold it is best to buy an ETF to reduce production risk. It is OK to buy gold up to 5% of your portfolio. Gold is not likely to have the massive run-up it has had before.

Interest rates are probably top of mind for most investors, and something his team is watching. Not only the level of rates, but also the 10-year to 2-year spread. The spread has been compressing recently and moving toward zero. It's always something to be aware of, as it means that the market thinks economic activity could potential be slowing into 2027.

Everyone's watching oil prices, which have a big impact on inflation.

It's anyone's guess. If we were to see some type of resolution, he'd think the price would go down. Does it go back to previous levels? No, because damage has taken a fair bit of production offline, and it'll take a significant amount of time to come back on.

Even if we saw peace tomorrow, we'd probably see something in the $70-80 range. Without a declaration of peace, and compliance on that peace, he sees it above $80.

For every $1 that a barrel of oil moves up or down, it equates to around 3 bps of inflation in the US. If we were to see it move down from here, you could see inflation starting to tick down; if it goes up, inflation moves the other way.

The thing to focus on, heading into the first part of 2027, is that we're going to see higher numbers on the previous year's inflation rolling off. So we should start to see inflation trickling down. Unless we see another dramatic move up in inflation from where it is right now.

They certainly have an impact. But the market is heading into what tends to be the best time in the 4-year cycle. Just before midterms (end of October), and all the way through to the next presidential election, is the strongest period in the market cycle. Next year would actually be the strongest year of that cycle.

We're going through weakness right now (last half of September to the first part of October) where the market tends to be the most weak in a presidential cycle. After that it starts to accelerate.

If everything went completely wrong, markets would probably still go up. That seems to be what's happening anyway. He was sure (as sure as God made little green apples), with the new US Fed chair as Trump's boy, that there was no way they were going to raise interest rates before the midterm elections. They did. 

And the market hit new highs.

Yes, US earnings have been robust. Despite all evidence to the contrary, there's evidence of tremendous optimism still out there in the market. You can say it's because there's nowhere else for people to put their cash, or because of the greater fool theory, or because (in real terms) interest rates are still quite low. (The stated interest rate is 3% or so, but he doesn't know of anything that's gone up only 3% in the last year.) 

There's a lot going on out there psychologically that we don't understand. It's also possible that it's just AI and the first step toward singularity.

It's already catching up. Look at today's news surrounding ORCL and pipeline delays. Energy is an input, and there's a cost to running all of this technology. There are a lot of challenges around energy.

There's a lot of demand for energy that's not going to stop. So the price of energy will continue to be robust, which won't necessarily be a terrible thing for Canada.

He's looking for companies that are able to raise their prices, and that have control over their own markets to a much greater degree. It'll be interesting to see what happens with the banks, Canadian ones in particular, which had a huge run earlier this year.

With this rising interest rate environment, it could be a good thing for the banks. They've done very well in a low-interest rate environment. Typically, falling rates are better for banks. It'll be interesting to see how the financial services sector does from here.