Our real assets strategy benefited from its diversified make-up and posted a modest positive return of +0.08% for the quarter. As 2023 unfolds, global demand for crude oil appears set to outpace expectations and a confluence of geopolitical and macro developments may lead to further advances for gold. Global natural resource equities remain attractively valued and global infrastructure equities stand to gain from longer-term structural trends. On the other hand, US REITs may be buffeted by headwinds including lingering growth concerns and higher interest rates.
Global economy proved more resilient than expected despite geopolitical tensions, high energy and food prices and the effects of global monetary policy tightening. Inflation continued to slow but remained elevated with the services sector continuing to exhibit strength. Real assets surged in the initial month even with prospects of the effective federal funds rate peaking. Those hopes were dashed by the US central bank’s staunch commitment to fighting inflation and the flareup of the US banking crisis.
The real assets strategy benefited from its diversified make-up and posted a modest positive return of +0.08% for the quarter. The longer-term 3 and 5-year returns remained robust and have proven helpful to investors during this elevated inflationary environment. Since its inception in 2005, the strategy has provided an annual absolute return of 4.1%, exceeding the rate of US inflation.
During this period, the more defensive global infrastructure equities exhibited less volatility and printed gains. Industrials (airport services and highway/rail tracks) and energy distribution industries reflected January’s optimistic outlook and were complemented by utilities, which provided ballast during March. US real estate investment trusts (REITs) had a double-digit return in January, led by industrial and self storage sectors, while office continued to struggle. The US banking crisis put a spotlight on risks around commercial real estate.
Commodities and global natural resource equities came under pressure due to recession worries, odd weather patterns, and the stress in the banking sector. Only precious metals and miners were positive as the energy sector lagged, led by natural gas that fell by over 50% due to excess inventory and reduced demand given the warmer-than-normal winter.
Real rates had a rollercoaster ride before yields settled at the lower end of the range for the past six months. Market-based US inflation expectations, measured by five-year break-evens, increased to 2.48% as inflation proved to be a cause of concern with Core US Consumer Price Index (CPI) numbers ticking up over the past three months.
Commodities appear balanced in the near term. Geopolitical risks and underlying fundamentals are structurally bullish for the energy complex and precious metals appear poised to maintain their shine. As 2023 unfolds, global demand for crude oil appears set to outpace expectations. Global inventories are expected to witness a drawdown in the second half of 2023, resulting in an undersupplied market, given OPEC+ production controls, other production limitations and discipline from US shale producers.
As far as gold is concerned, geopolitical risks, the fallout from recent US banking crisis, forecasts of a declining US dollar and peaking real rates may lead to further advances for the precious metal.
Global natural resource equities remain attractively valued and are positioned to succeed from high commodity prices and potential demand surprise.
Global infrastructure equities stand to be rewarded from continued moderate economic growth, fiscal and private spending as well as longer-term trends of decarbonization and other green energy themes.
US REITs are positioned with strong balance sheets, but lingering growth concerns combined with higher interest rates have increased questions on earnings and will likely remain a headwind for 2023.
Real rates have been range bound over the past six months. If the US Federal Reserve (Fed) interest rate hiking cycle is near complete and market expectations for a decline by year end prove correct, a retreat in real rates will aid inflation-linked bonds.
Figure 3: Short- and Medium-Term Directional Outlooks
As we entered 2023, disinflationary signs had started to gain traction in the US with a moderation across both headline and core inflation. Energy was a big driver with prices collapsing, while the recovery in supply chains had pushed goods prices down. It appeared the worst-case scenarios for inflation were behind us – however, a string of data prints has challenged the disinflation narrative. In the US, the CPI, Producer Price Index (PPI) and even the Fed’s preferred Personal Consumption Expenditures Index (PCE) pointed to a slower decline than hoped.
Cognizant that a few hotter-than-expected prints do not change long-term trajectory, it is anticipated that inflation will continue to ease over the course of the year. However, achieving the Fed’s 2.0% inflation objective will be difficult, and the stickier elements are expected to keep inflation elevated for longer. The Atlanta Federal Reserve’s Core Sticky CPI Tracker illustrates the outsized impact that services inflation is having on recent CPI readings and how sticky inflation is elevated relative to historical readings and is edging higher (Figure 4).
Figure 4: Atlanta Fed’s Core Sticky CPI and Constituents of Headline CPI (%)
Real assets are poised to benefit from the prolonged inflationary environment that is moderating but anticipated to be higher for longer. Historically they have provided strong annualized returns during periods when inflation has lingered above 3%-4%, while equities and bonds have lagged.
At State Street Global Advisors, we have a seasoned, diversified multi-asset strategy that combines exposure to a broad array of liquid real asset securities that are expected to perform during periods of rising or elevated inflation.
The asset allocation is strategic and utilizes indexed underlying funds. It is being used by a variety of clients as a core real asset holding or as a liquidity vehicle in conjunction with private real asset exposures. The strategy is meant to be a complement to traditional equity and bond assets, providing further diversification, attractive returns and a meaningful source of income in the current environment.
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The views expressed in this material are the views of Robert Guiliano through the period ended 26 April 2023 and are subject to change based on market and other conditions.
This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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Investing in commodities entail significant risk and is not appropriate for all investors. Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates.
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate, precious metals and natural resources. Investments can be significantly affected by events relating to these industries.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
The major risks associated with investing in the natural resources sector, including large price volatility due to non-diversification and concentration in natural resources companies.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
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