Profitability may reflect expense discipline rather than top-line growth

The bond super cycle is reversing after 35 years of rate declines

Trump kindled expectations of increased spending, declining tax rates, stimulus-powered growth

Factory output nears prerecession levels, but factory employment lags the prerecession count by 1.5 million jobs, or about 20%

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Donald Trump’s inauguration kindled expectations of increased government spending, declining tax rates and stimulus-powered growth as inflation hit 2.1%, crossing the Federal Reserve’s 2% target. The Fed raised the federal funds rate by 25 basis points with hints of three more increases to follow in 2017, suggesting diminished fears that rising rates will trigger a recession. Perhaps we have outgrown the notion that monetary policy is the magic that drives our business cycle.

Impressive 3.5% U.S. GDP gains in the third quarter of 2016, after anemic growth in the prior two quarters, accompanied a 5.2% rebound in corporate profit. However, these dramatic improvements echo 2012, when government spending accelerated before the election in an appearance of economic growth only to retreat in the fourth quarter. Profitability may reflect expense discipline rather than top-line growth. Slowing population expansion and an aging populace suggest slow growth will prevail in 2017.

The bond super cycle is reversing after 35 years of rate declines, with 10-year Treasury yields dropping to 1.87% just before the election from 15% at the cycle’s peak in 1981. 10-year Treasuries rose 50 basis points in a week, wiping out $1 trillion of bond values, although rates have moderated recently. We anticipate higher rates going forward with the 10-year yield around 3% by year-end 2017, but well below its 50-year average of 6.2%.

Threats to this prognosis are chiefly external: China’s slowing growth and ballooning debt, Japanese deflation, weak growth in the EU, and declining banking conditions for Deutsche Bank and dozens of banks in Italy.


1 First commercial U.S.-to-Cuba flight in more than 50 years landed in August.
2 Italian voters rejected Prime Minister Matteo Renzi’s reform referendum, suggesting Brexit-like implications, yet the Italian 10-year note rate at 1.93% still reflects economic stability.
3 China’s exports and imports grew in November after months of decline, providing signs of more stability.
4 The U.S. population grew 0.7% to 323.1 million in the year ended July 1 — its slowest rate since the Great Depression.
5 Fall college enrollment slid 1.4% year-over-year to roughly 19 million students in 2016, marking its fifth straight decline.
6 Factory output nears prerecession levels, but factory employment lags the prerecession count by 1.5 million jobs, or about 20%.
  7 To disrupt counterfeiting and tax-dodging cash transactions, the Philippines and Denmark promote electronic payments, the European Central Bank (ECB) plans to eliminate the 500-Euro note, and India declared 90% of its paper money no longer legal tender.
8 ECB extended bond buying until the end of 2017 but surprised markets with intent to slow the pace of purchases.
9 New vehicle sales edged higher in 2016 after six years of strong gains. SUVs and crossovers represented 63% of sales, up from 50% in 2013.
10 In 3Q16, bank earnings increased 12.9% from the prior year to $45.6B, while returns on assets rose to 1.10% from 1.03% a year earlier. Nonresidential loan growth was up 1.5% for the same period.
11 Only 51% of 30-year-olds in 2014 earned more than their parents at that age, versus 92% in 1970 and 58% in 1992.
12 Wal-Mart reported a 21% increase in e-commerce sales in the third quarter, along with 0.7% increase in foot traffic and 1.2% increase in same-store sales.
13 The Limited is closing all 250 brick-and-mortar stores; Macy’s is cutting 10,000 jobs and closing dozens of stores due to weak holiday sales; Kohl’s reported lackluster sales; and Edward Lampert pumped $1B into Sears as life support.
14 Household wealth climbed to a record $90.2T in the third quarter.
15 The high-yield bond market is trading at a spread of approximately 4.2% over Treasuries, less than half the 8.64% spread during last February’s market slide.
16 CalPERS earned only 0.6% on investments in fiscal year 2016, missing its 7.5% target a second year in a row; CalPERS’ officers recommended reducing actuarial target returns from 7.5% to 7.0%.
17 The Federal Reserve’s October 2016 opinion survey noted significant tightening of multifamily and moderate tightening of nonresidential lending standards.
18 The average cap rate for single-tenant, net-lease retail in 3Q16 was 6.1%, a historic low, according to The Boulder Group.
19 Global fund managers had a record $237B in dry powder at yearend 2016, more than doubled from 2012. The risk/return profile of debt funds has gained popularity through the recovery cycle.
20 Walker & Dunlop is exiting the CMBS market, citing low demand from core clients and higher capital costs associated with new risk retention rules.
Tom McNearney

the BRIEFING is an aggregation by Tom McNearney, Transwestern chief investment officer, of other articles and reports. Tom leads Transwestern’s capital market efforts for development and investment nationwide. Tom also serves on the firm’s investment committee and board of directors, and he directs the execution and expansion of the firm’s principal investment activities across the country.



Copyright © 2017 TRANSWESTERN. All rights reserved. No part of this work may be reproduced or distributed to third parties without written permission of the copyright owner. The information contained in this report was gathered by Transwestern from various sources believed to be reliable. Transwestern, however, makes no representation concerning the accuracy or completeness of such information and expressly disclaims any responsibility for any inaccuracy contained herein.
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