Thursday, December 18, 2014

Commercial real estate boom continues

U.S. housing starts have almost doubled in the past 5 years, and according to Case Shiller, housing prices have recovered a bit more than half of their recession-era losses. But the recovery of the residential real estate market pales in comparison to the boom in commercial real estate, where prices have recovered substantially all of their recession-era losses and are rising at double-digit rates.


The chart above shows two measures of commercial real estate values as calculated by the folks at Co-Star Group. Their value-weighted measure of commercial property price indices has risen at a 10% annualized pace for the five years ended October 2014, and prices now exceed their pre-recession high. An equal-weighted measure is up over 14% in the past year. And these very positive trends continue. Here are some of the headlines:

Most major property types continued to benefit from minimal speculative construction, a firming economic recovery and rising rental rates.
The sale price-to- asking-price ratio narrowed by 2.5 percentage points in the 12-month period ended in October 2014 to 90.4% — the highest ratio since 2008. Meanwhile, the average time on market for properties listed for sale fell 4.3% in the 12 months ending in October 2014, and the share of properties withdrawn from the market by discouraged sellers continued to recede, falling to 35.3%.

We may be in a sluggish recovery, but that does not mean that everything is sluggish. I note that since October 2009, the total return of the Vanguard REIT (VNQ) is an annualized 19.5%, almost three percentage points per year better than the annualized 16.6% total return of the S&P 500 index. Year to date, the total return of VNQ exceeds that of the S&P 500 by over 15%. Wow.

Wednesday, December 17, 2014

Ex-energy inflation still 2%

The unexpectedly large decline in the November CPI (-0.3% vs. -0.1%) was almost entirely driven by falling oil prices. The CPI ex-energy rose 0.1% for the month and is up 1.9% over the past year.


The chart above shows the year over year change in the CPI and the "core" CPI (ex-food and energy). By these measures inflation has been bouncing around between 1% and 4% over the past decade, and currently looks to be declining a bit on the margin.


Most of the bouncing "noise" in the year over year measure disappears if we remove energy prices from the CPI. The chart above shows the CPI index ex-energy, and it uses a semi-log scale on the y-axis to show that the average annual rate of increase in the index has been 2.0% for the past 12 years. No sign of anything even remotely deflationary here. Once energy prices stabilize, we are likely to discover that CPI inflation is running right around 2% a year, as it has been for a very long time.

The Fed is unlikely to delay its plans to raise short-term interest rates just because the CPI index has declined in two out of the past four months (November and August). Any hint of deflation is entirely oil-related, and therefore not something that should concern the Fed.

Tuesday, December 16, 2014

The Laffer Curve at 40 years


This is my version of the Laffer Curve. What it shows is how basic economics and incentives work. If tax rates are zero, the government obviously collects no tax revenues. And if tax rates are 100%, the government also collects no revenues, because no one has an incentive to work. There is a tax rate "C" which maximizes the economy's strength and tax revenues. Higher rates produce a disincentive to work and invest, and thus reduce revenues, while lower rates also result in reduced revenues. If tax rates are too high (which is what Laffer originally asserted), then reducing tax rates can result in increased investment and work, thus increasing revenues by increasing the tax base.

But to see the original version and hear the key players recount their memories of where and when it was first drawn (forty years ago this month), and how it went on to impact fiscal policy during the Reagan administration, I recommend you read this BloombergBusinessweek article, "The Napkin Doodle That Launched the Supply-Side Revolution," which also includes a video.

Key takeaway:

How would you classify the Laffer Curve today?Laffer: It’s the same as always. It works. It’s not Republican, it’s not Democratic, it’s not conservative, it’s not liberal, it’s not left-wing, it’s not right-wing. It’s economics. People respond to incentives, and if you make something more attractive, they will do more of it. If you make something less attractive, they will do less of it. If you tax rich people and give the money to poor people, you are going to get lots and lots of poor people and no rich people. The dream in our country has always been to make the poor rich, not to make the rich poor.

As the BloombergBusinessweek article notes, the Laffer Curve proved to be one of the most special and disruptive events of the past 85 years. I consider myself lucky to have been mentored by both Art Laffer and Jude Wanniski.