Good Economic News Becomes Bad

In the upside down world of the stock market, continued good news is bad news. The better employment becomes, and the longer GDP growth continues, then the ten year goes higher and the stock market goes lower despite near historically improving economic data.

The traders’ mentality is that rates will continue to rise as the economy continues to improve, and so capital will switch to bonds from stocks to bonds. While that is partially true, the underlying reality is the economy is doing great, consumers are spending, and factories continue to expand and increase production.

While the initial print on jobs was low, the revisions of past two months was 87,000, so the three month average was still excellent and the hurricane last month skewed the numbers for September. Wages continued up. There is concern that once the tax reform impact and QE wind down end in January, and the corporate guidance remains to suggest earnings will slow, then the stock market will supposedly drop a lot. That is one view.

For me, the much bigger issue is the possibility that the Democrats will get control of the House, and then all hell breaks loose, and nothing good happens. They have already said they will try to impeach Trump and now Kavanaugh if selected. This is how productive the Democrats plan to be next year. This will not stop Trump, but it creates enormous problems to move the trade deals, Tax 2.0, and other major legislation. And worst of all, Maxine Waters becomes chair of the House banking committee. If that does not give you nightmares, nothing will. She and Bernie will team with Warren for an all out attack on the banks, and that will be very bad for all of us.

If we assume the economy continues to do well with 3.5% GDP in Q3, and continued declines in unemployment to 3.6%- or less in October, then there will be a further rise in rates. However, if your deal or project cannot handle a ten year at 3.5% or even 4%, then walk from that deal, it will not work out. You need to pencil in a 5% ten year when stressing your proforma because over the hold period, it could easily get there. Assume the stock market does decline and earnings growth slows. All of this does not mean recession.

It is also very unlikely the ten year gets to 5% for a couple of years. However, the black swans are flying now, and risk is increasing, not for your project, but for politics and the economy. We really have no idea what the next few months, let alone years, will bring. Maybe the Republicans voters are so upset over the Kavanaugh matter, they rush to the polls and Republicans hold the House and shock everyone. Good for CRE. Maybe inflation remains around 2%-2.25%, as wages don’t rise excessively. Maybe the stock market is not overvalued, as some say, and maybe it has another run up as others say.

The point is, there is such a high level of uncertainty at the moment, that any forecast for a project needs a wide best and worst case scenario. While it appears from all evidence that the economy will remain very strong well into 2019, and maybe beyond, it is possible the ten year will move more quickly than most expect, and maybe corporations start to believe their own press releases of slower earnings going forward, and put off capital projects, and maybe the Democrats do win and crate such chaos that everyone pulls back. There is simply no way to know today.

The views expressed here are the author’s own and not that of ALM’s real estate media group.