The Resilience of the U.S. Economic Growth and the Role of the Federal Reserve
At this writing, Q3 GDP economic growth, according to the Atlanta Fed, defies projections again with a 4.9% estimate. The impressive growth stands opposite of projections of near break even at the beginning of the quarter.
Correspondingly optimistic, Yardeni Research projects S&P 500 operating profits to increase 20% by the end of 20251.
Federal Reserve Projections Through 2026
In terms of guiding economic growth, the Federal Reserve has set forward some projections. According to the projections by the Federal Reserve published during September show growth slowing to just under 2% with inflation moving down to 2% over the next 3 years while the Fed Funds rate is lowered to a more normal 2.5%. The short-term obsessions with the next move of the extended Fed tightening cycle appear to miss the point of longer-term projections. One likely impact is increased valuations for high cash flow assets between now and 2026.
Commercial Real Estate Storm Cloud Warnings
The Fed is likely to be forced to begin reducing rates faster than their projections. Raising the base rate of capital costs have resulted in commercial capitalization rates (cap rate) moving up from approximately 6% to 8% according to Bloomberg.
Capitalization Rates: Divide the free cash flow by your target cash return plus appreciation. A building with free cash flow after expenses of $1 million would be worth $16.7 million at a 6% “cap rate.” At the current 8%, the value drops to $12.5 million, a 25% likely decrease in value across the market.
Add an estimated 20% reduction in office occupancy, $800,000 in free cash flow is only $10 million for the same building. Already, foreclosures and “renegotiations” are hitting the market. At a 40% reduction in value, many properties cannot be refinanced and the banks, while healthy now, will likely take extra loan loss reserves to prepare. The Fed is aware that higher rates are impacting their constituency, the banks. Given the changes steered by the Federal Reserve’s actions and the effects on economic growth, the commercial real estate market is facing challenges.
Our view is that real estate investment trusts are likely to be bargains during tax loss selling NEXT year, 2024.
Relentless Pursuit of Superior Client Profits
In our wealth management strategy, the investment committee meets each Wednesday and often by email in pursuit of the best bargains and to replace or eliminate underperforming assets.
Selling underperformers in tax loss harvesting for MGWM has been completed in Q3 to avoid selling pressure in Q4 for underperforming sectors and raise cash for bargains in December. We are researching future bargains for additions daily, in the meantime.
Global High Yield
Current yields are available near 9% at a near 25% discount in well managed global high yield bond funds. Assuming the Fed fulfills its own projections, an additional imbedded capital gain can result. From a wealth management perspective, understanding the projections and moves of the Federal Reserve helps in analyzing global high yields.
Energy Infrastructure, Historically an Inflation Hedge
According to Recurrent Advisors in Houston, energy infrastructure is producing near 16% free cash flow with current valuations at near 6x cash flow. Given the dynamics of economic growth and the policies of the Federal Reserve, the industry is buying back about 7% of shares outstanding each year according to Recurrent Advisors. This potentially increases our assets under control per share with an attractive dividend that has been rising. Current yields are near 7% after recent dividend increases.
Oil recently topped $92. JP Morgan at the end of September said a surge to $150 is possible.
With an eye on economic growth trends, medical dividend companies, pharmaceutical technology companies, and insurance, are considered inflation friendly due to pricing power. The category has a history of rising dividends and capital gain potential.
Growth and Innovation
As we tap into sectors contributing to economic growth, for the Growth Units and Total Return Units, we are adding selective strong performances in innovation. Software, profitable solar, nuclear, and batteries are currently included in the allocations.
Excellence in Service
Our team of 10 is the most extraordinary that we have seen in our careers. Each of us with expertise above and beyond the average our industry. At McGowanGroup Wealth Management, our focus is not just on wealth management, but also on understanding the intricacies of economic growth and the Federal Reserve’s impact.
Please welcome Michelle Brady as the 10th team member of McGowanGroup Wealth Management as our client services specialist!
Wealth Management: Coordination of Tax and Estate Planning
In our holistic approach to wealth management, during Q4 we will be uploading tax planning documents to the client portal for CPA’s to complete a preliminary 2023 return.
In your next review, we are happy to review your current estate plan and provide bullet points for discussion with your estate planning attorney to evolve your plan.