We hosted our Investment Outlook 2021 event virtually on January 26, 27 and 28. To view that presentation, click on the video following the below text.
The following questions were posed by viewers of our Investment Outlook but we ran out of time to answer them then. Our analysts and portfolio managers have answered them here below (they have been edited for clarity).
Do you anticipate a correction in the housing market in the next 12-24 months?
No, we do not anticipate a housing market correction in the foreseeable future. Mortgage rates are at generational lows and demand for housing has been enhanced by the pandemic. More people working from home has translated into a desire for bigger and better homes for existing homeowners, and for renters, the desire to have more private space that they own. Housing inventories are at-or-near record lows in nearly every market, and though we do think the market will loosen up to some degree post-pandemic, what we would expect is a flattening of prices, not any type of material decline. Two inputs are key for real estate – 1) employment and 2) the level of 10-year U.S. Treasury rates, which is key to determining mortgage rates. The U.S. economy is in recovery and the labor market continues to heal. With mass vaccinations likely to be achieved in the second half of this year, we believe the still struggling services portion of the economy will rebound – the airlines, hotels, gaming companies and restaurants. As business picks up at the service companies, they will bring back laid off employees, thus creating further employment gains and better overall consumer confidence. The return of service jobs should, at the margin, help improve demand for housing. We would say the biggest risk to the housing market at this point is a spike in interest rates that makes mortgages more expensive and housing less affordable. While we think long-term interest rates may trend higher over the next couple years, we do not expect them to spike. As inflation goes, so goes interest rates, and with notable excess capacity still remaining in labor markets, the likelihood of a surge in inflation is low.
What is the rationale behind investing in Versus real estate fund rather than investing in individual REITs?
We invest in Versus Capital Real Estate Fund rather than individual REITs to invest in private real estate. Versus Capital invests the fund among private real estate managers in order to get a broad exposure to the asset class. Private real estate has the advantage of providing returns and volatility that is commensurate with the real estate asset class. REITs are in many cases as volatile as small company stocks due to trading on public markets which can be irrational. In reality, if you look at an institutional real estate asset such as an office tower, the value of the building and cash flow changes very slowly. Private real estate investing provides a smoother and more consistent return that more closely mirrors the returns of the underlying asset.
Please give perspective on increasing inflation in the U.S. economy and the impact on the U.S. Dollar as the printing presses of the U.S. Treasury continue to operate 24/7. Will the U.S. Dollar still be the world's reserve currency by 2030?
Both current and prospective inflation has normalized since the depth of the COVID-19 market disruption in March of 2020. There are many ways to measure inflation and the Fed's favorite is the personal consumption expenditures (PCE) which is running around 1.4 percent annually. The Fed has indicated that they are willing to let inflation run hot to see the economy recover fully prior to increasing interest rates. By running hot, inflation could run at 2.5 percent for a time to pull the average up to 2 percent. Inflation has not been a problem for the last 20 years and the factors that were deflationary prior to COIVD-19 are still in place after COVID-19. There is a worldwide glut of savings, labor is oversupplied globally and aging demographics in the developed world are all deflationary in addition to a host of other factors. We do not see elevated unscripted inflation on the investable horizon. That said, if the economy is running at full capacity at some point in the future and there is still easy money from central banks you could see elevated inflation.
While the money supply in the United States has expanded dramatically, the velocity of money has remained low.* This means that an incremental dollar in the system has diminished impact due to a lack of spending and investment that creates a multiplier effect with excess money supply.
The dollar will most likely still be the reserve currency of the world in 2030. The only two other candidates at this time, the Euro and Yuan, have deep flaws that would make it unlikely that they ascend to such status. The 19 countries of the Euro's bond are getting weaker as time goes on and we could see some countries leave the Euro over the next decade. As for the Yuan, wealthy Chinese citizens’ behavior suggests that they are uncomfortable with the currency via asset purchases around the world, thereby sending money out of the Chinese currency. While not perfect, the dollar is backed by a stable government, rule of law and strong property rights.
The wildcard is a cryptocurrency that would come along and gain wide acceptance by consumers. It would need to be stable in value, perceived as safe asset and nearly frictionless in the ability to transact. This supposed cryptocurrency does not exist at this time and there is still significant innovation that would need to occur before it could be exist.
What is your fixed income outlook? Where do we go from here? How will it affect your investment mix?
Our view is that low interest rates are here to stay until further notice which should result in muted fixed income returns. That said, interest rates should increase slightly in 2021. Currently, the 10-year U.S. Treasury is around 1.06 percent and we believe it should climb to 1.25 percent to 1.50 percent by the end of the year. That situation would see interest rates going up for the right reasons: namely, resumption of growth and normalization of the rate of inflation. In this environment it is difficult to make money in bonds and we are thinking of bonds as more like insurance during stock market declines. We are generally underweight bonds in client accounts and overweight alternative assets to add incremental return and income generation.
Please discuss the short- and long-term pros and cons of investing in Grayscale?
While we won’t make recommendations with regards to a particular security or product here, this company serves as a good example through which to discuss cryptocurrencies.
First, let’s look at the instrument mentioned. Grayscale is a company that invests in cryptocurrencies and charges an annual administration and safekeeping fee between 2.0 and 3.0 percent for their various digital currency products. For exchange-traded products, this is at the top of the range of fees assessed. Also, these are exchange-traded trusts which may trade differently than the underlying investment. Looking at their largest trust, the Bitcoin Trust (GBTC) it trades at an average of 38 percent premium to the underlying Bitcoin. That is to say that the exchange-traded product is valued at 38 percent more than the digital assets it holds. This number has fluctuated from a slight discount to 132 percent over the last five years. For those who can, it would be cheaper and simpler to buy the digital coin directly. All this should be said with a warning: digital currencies are still in their relative infancy. Digital wallets need security.
As to the larger issue of digital currencies, please find our colleague Dean Dordevic’s writings in our Market Letters Q1 2014 and Q2 2018 they are very well written and age well.
Setting the investment merit aside for a second, some other things to think about when owning a digital currency:
1. Regulation is coming. It isn’t exactly the wild west, but there will definitely be more regulation at some point.
2. Security. It bears repeating that digital currencies are a target for thieves for the same reasons they appeal to investors.
3. Taxes. The tax story is being written right now and cryptocurrencies can cause a headache for accountants.
4. Volatility has not been commensurate with a fiat currency. If you are looking for a store of value, it moves significantly more than real assets like your house.
One comment on the investment merit: digital currencies represent nearly a trillion dollars. That’s not small. But the volatility, relative infancy and lack of regulation has most people putting it in a bucket closer to gambling at this point in time.
There are definitely momentum swings that investors are trading but the risks are still high, so we caution clients to consider it a speculative investment.
What is the status of your ESG strategy?
Our Global Sustainable Investing (GSI) strategy has been a great success for our firm. It has been the fastest-growing strategy in our history with current assets above $250 million and more than 50 clients invested. We are most proud that since we launched the strategy in January 2018, performance has played out how we designed. That is, the strategy enables clients to align their investments with their values without taking on added risk or reduced returns. To that end, the GSI has outperformed its benchmark since 2018 by about 1 percent annually on average. Similarly, performance has tracked closely with our traditional strategies.
What is your view on the possibility of significant estate tax changes now that Democrats control both House and Senate?
Estate taxes are an easy target for politicians because they are perceived to “tax the rich,” but estate tax revenue collected does not represent a meaningful portion of total taxes collected by the IRS (0.5 percent in 2019). For these reasons, it is hard to predict if politicians will push for estate tax reform in 2021 or defer this effort until after they have pursued individual, corporate and employment income tax reform (>90 percent of IRS collections with correspondingly higher revenue impact). What we do know is individuals who have the potential to benefit from the current gift and estate tax exemption (the amount you can give away without paying tax) of $11.7 million, could save over $2.3 million (per spouse) in federal estate taxes through proper planning, even if the exemption were to drop to the high-end of projections. Current proposals include increasing estate taxes through a reduced exemption amount, higher tax rates (currently 40 percent federal) and/or the triggering of capital gains tax at death. For more information, join one of our Wealth Management Insights Forums on February 23 or 25.
How would you recommend avoiding new taxes?
We like to say our tax system favors the well-informed. The best course of action comes down to your specific circumstances and goals. Right now, there are many unknowns, but we can guess that income tax rates, capital gains taxes and employment taxes may be higher in the future to help offset the significant fiscal stimulus of 2020 and 2021. If the goal is to reduce your lifelong tax exposure, and you believe rates will increase, you may want to consult with your tax advisor about accelerating income (e.g., a business sale, Roth IRA conversion) or deferring deductions (e.g., charitable giving, expenses). Of course, these tactics would be expected to increase your current tax bill, run in the face of traditional tax advice, and could ultimately be detrimental or beneficial. There are many other strategies that may be appropriate for you to consider in consultation with your tax advisor and portfolio manager.
We encourage you to reach out to your portfolio manager with any further questions.
*Source: Bloomberg