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As summer draws to a close in 2024, the United States economy presents a complex tapestry of resilience and vulnerability. Recent reports from two economists I consider to be among the best in the country, one at Piper Sandler and one at Apollo Global Management (APO), paint a picture of an economy at a crossroads, with conflicting signals that challenge easy categorization.

Let’s take a look - and read all the way to the end, where Premium subscribers get their first Stock of the Week!

Where We Are Today

On the surface, there is much to be optimistic about. Consumer spending remains a bright spot in the economic landscape. Americans are dining out, filling airport terminals, and flocking to Broadway shows in numbers that suggest confidence in their financial futures. This spending is bolstered by wage growth and the cushion of pandemic-era savings, which many households are now tapping into. The travel and hospitality sectors, in particular, are reaping the benefits of this consumer enthusiasm, with hotels reporting high occupancy rates and airlines seeing robust demand.

Corporate America, too, seems to be on solid footing, at least at first glance. The S&P 500's forward profit margins are hovering near record highs, indicating that many large companies have successfully navigated the choppy waters of recent years. Banks continue lending to businesses and consumers, providing the lifeblood of economic growth.

Yet, beneath this facade of prosperity, there are unsettling undercurrents that hint at a less optimistic reality. The shadow of inflation looms large, with some economists drawing uncomfortable parallels to the Nixon era, a period of economic upheaval characterized by price controls and monetary policy missteps. The fear of a historical repeat is palpable, underscoring the crucial role of the Fed in managing this risk.

One of the most significant threats to inflation management is the potential conflict between politicians and the Fed. Many politicians find it hard to resist the temptation to spend money to win votes, a practice that often runs counter to the Fed's efforts.

The labor market, a bright spot in the American economy for the last few years, is showing signs of strain. While unemployment remains low, layoffs are increasing, particularly in consumer-facing sectors and the once-booming tech industry. The decline in temporary staffing is often an early warning indicator, suggesting that companies are becoming more cautious about hiring.

This caution is mirrored in the slight weakening of new business formations, hinting at a growing wariness among entrepreneurs about the economic road ahead. This sentiment seems to be spreading across various sectors of the economy. The auto industry, for instance, continues to grapple with production issues despite a modest uptick in sales. Real estate, mainly commercial properties, faces rising delinquency rates, while healthcare institutions are confronting financial pressures.

Where We're Heading Next

Looking ahead, economic forecasters are increasingly concerned about the possibility of a recession looming. The Federal Reserve's delayed response to inflationary pressures has left it walking a tightrope – needing to cool the economy without tipping it into a downturn. The effectiveness of its policies in the coming months will be crucial in determining whether the U.S. can achieve a "soft landing" or will face a more significant economic contraction.

As we move into the latter part of 2024 and look towards 2025, the U.S. economy stands at an inflection point. American consumers' resilience and the government's willingness to spend money have thus far prevented a slide into recession. However, the cumulative weight of challenges—from inflationary pressures to sector-specific strains—threatens to tip the scales.

In this environment of uncertainty, policymakers, business leaders, and consumers alike must navigate with caution. The coming months will likely be pivotal in determining whether the current economic expansion can be sustained or the U.S. will face a period of retrenchment. As always, the American economy's strength lies in its dynamism and ability to reinvent itself. How it harnesses these qualities in the face of current challenges will shape its trajectory for years to come.

What You Can Do About It

In the current economic landscape, Class A apartments and offices are uniquely positioned to weather the storm and potentially thrive. These high-end properties offer distinct advantages that may be valuable in uncertain times.

Class A Apartments

Class A apartments, known for their luxury finishes and top-tier amenities, stand to benefit from several trends in the current economic climate. As economic uncertainty looms, there's often a "flight to quality" among renters who can afford it. Those with stable, high-paying jobs may seek the security and comfort that Class A apartments provide, viewing them as a safe haven in turbulent times.

The ongoing affordability issues in the housing market could also play into the hands of Class A apartment owners. As home ownership becomes increasingly out of reach due to high prices and potentially rising interest rates, some would-be buyers may opt for high-end rentals instead. This shift could drive increased demand for Class A units, particularly among young professionals and empty-nesters.

The continued prevalence of remote and hybrid work models further enhances the appeal of Class A apartments. These properties often boast built-in office spaces, high-speed internet, and other work-from-home amenities that have become essential in the post-pandemic world. Moreover, the focus on health and wellness that emerged during the pandemic plays to the strengths of Class A properties. Superior air filtration systems, spacious layouts, and health-focused amenities like fitness centers and outdoor spaces may command a premium in this health-conscious era.

From an investment perspective, Class A apartments offer some compelling advantages. They typically cater to higher-income tenants who may be more resilient to economic downturns, potentially leading to more stable occupancy rates and rent collections. In an inflationary environment, Class A apartments in desirable locations may also be better positioned to raise rents to keep pace with inflation, protecting real returns for investors.

Class A Offices

The office sector faces significant challenges due to evolving work patterns, but Class A offices may have some distinct advantages in this new landscape. As companies compete for talent and seek to bring employees back to the office, Class A properties in prime locations can serve as a draw and a symbol of corporate success. Their prestige and quality can be a powerful tool in the war for talent.

Health and safety features have become necessary after the pandemic, and Class A offices are often at the forefront of this trend. State-of-the-art ventilation systems, touchless technologies, and spacious layouts that address ongoing health concerns are more likely to be found in these premium properties. This focus on employee wellbeing can be a significant differentiator for companies looking to encourage a return to the office.

The amenity-rich environments typical of Class A offices align well with the current push to entice workers back to physical workspaces. On-site fitness centers, diverse dining options, and carefully curated outdoor spaces can make returning to the office more appealing. Furthermore, Class A offices are often better equipped to handle hybrid work models' technology and space requirements, with features like hot-desking areas and advanced teleconferencing facilities that seamlessly blend in-person and remote work.

Energy efficiency is another area where Class A offices often shine. Many of these properties are newer or recently renovated, making them more environmentally friendly and cost-effective. This can be attractive to environmentally conscious companies and can help control operating costs in an inflationary environment.

There may be a flight to quality in the commercial sector, as in the residential market. Companies weathering the economic uncertainty well may take advantage of market conditions to upgrade to Class A space, potentially on favorable terms. Should demand for traditional office space remain suppressed, Class A offices in prime locations may have advantages for potential conversion to other uses, such as residential or mixed-use developments, due to their superior locations and building quality.

It is important to note that while these advantages exist, performance will still largely depend on specific locations, market dynamics, and property management. Class A properties in strong markets with robust employment bases are likely to fare better than those in struggling markets, regardless of classification. Owners and operators of Class A properties will need to stay attuned to evolving tenant preferences and be prepared to invest in upgrades and adaptations to maintain their competitive edge in this challenging economic environment. The key to success will be flexibility, innovation, and a keen understanding of changing market demands.

The Big Five

In what may be the most significant sign that malls have survived the story of the past several years, famed corporate-raider-turned-gentleman-activist Carl Icahn has thrown in the towel on his multi-billion short debt issued by mall operators. Uncle Carl started shorting mall credit default swaps back in 2019, and using a phrase the Queens-born and bred investor will understand, he’s had his frigging teeth kicked in.

Mall REITs are the only strong survive arena under this economic outlook now, but the outlook for REITs like Big Five member Simon Property Group is positive and improving.

(If you haven’t checked out my free special report on The Big Five REITs and why you should own them, click here!)

Boston Properties (BXP) took advantage of the access office EITs still have to capital markets to refinance debt and lower interest costs this week. The REIT agreed to sell $850.0 million of 5.750% senior unsecured notes due 2035 in an underwritten public offering through J.P. Morgan Securities. The notes were priced at 99.961% of the principal amount, yielding 5.756% to maturity.

Industrial remains the most attractive market, but some crosscurrents are in play in the sector. As we move through 2024, the industrial real estate market in the United States finds itself at a fascinating crossroads. According to the latest Marcus and Millichap report the past year and a half has seen a steady rise in vacancy rates, reaching 6.1% by June. This increase comes on the heels of a massive expansion in supply, with nearly 629 million square feet of new industrial space flooding the market over six quarters, boosting overall inventory by 3.5%.

At first glance, these numbers might set off alarm bells for developers and investors. The average asking rent even dipped for the first time in over a decade during the second quarter of 2024, following a five-year period that saw rents skyrocket by 44%. However, digging deeper into Marcus & Millichap's midyear report reveals a more nuanced and ultimately optimistic outlook for the sector.

The vacancy story, it turns out, is largely a tale of five cities. Atlanta, Dallas-Fort Worth, Houston, Riverside-San Bernardino, and Phoenix account for a disproportionate 27% of current vacancies. These high-demand metros are set to receive another flood of new space which will likely keep their vacancy rates elevated in the short term.

But beyond these hotspots, the industrial market's fundamentals remain strong. The report suggests that new completions may fall short of long-term demand in most markets. This optimism is rooted in several key trends reshaping the industrial landscape.

E-commerce continues to be a major demand driver, with giants like Amazon, Walmart, and Home Depot expanding their logistics footprints. Simultaneously, the rise of automation and robotics pushes companies toward newer, more technologically advanced facilities. This shift is evident in the construction pipeline, where over 35% of projects are massive facilities of one million square feet or more – the only size category to see improved net absorption over the past year.

Interestingly, the market is not just about mega-warehouses. Smaller facilities boast the lowest vacancy rates and have seen increased trading activity. This segment is poised for growth, buoyed by federal initiatives like the CHIPS Act and a broader push for domestic manufacturing.

The manufacturing subsector itself presents a compelling picture. With the lowest vacancy rate (4.5%) and 92% of new space already pre-leased, demand for production facilities remains robust, even if rent growth has been more modest.

From a financing perspective, the industrial sector attracts favorable attention from lenders. Insurance companies have stepped up their involvement, accounting for a quarter of all industrial financing in 2023, while regional and local banks remain the go-to for smaller loans.

The industrial real estate market appears well-positioned to weather its current challenges. While some markets may experience short-term growing pains as they absorb new supply, the overall trajectory points to continued demand and opportunity in this vital commercial real estate segment.

This bodes very well for Big Five constituent Prologis (PLD).

None of our stocks are anywhere close to a technical point that would trigger any sort of action on our part. Even the office and retail components are now in an uptrend, and while it is in the early stages, demand appears to be in control for now.

None of our REITs are depressed to the point where we would pop change corks and have the kids work an extra weekend job for more cash to put into them, but they are at levels that are still attractive entry points.

You should be a lot wealthier before any of the Big Five come anywhere close to being at ridiculously overbought levels, which might make us consider even some limited profit-taking.

After acting like they might trigger enough fear to level up and go big, both high-yield credit spreads and the VIX have pulled back.

We are in the early stages of a multiyear recovery, and buying on pullbacks should be very well rewarded for patient, aggressive investors.

Stock of the Week

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