Must Read Research

Also featuring commentary from Global Economic Weekly

March 10, 2024

Candace Browning

Candace Browning, Head of BofA Global Research

Simplicity is the ultimate sophistication. This week we discuss more sunshine for the Land of the Rising Sun, why mREITs with office exposure have a tough job ahead and what’s feeding power-hungry data centers.

 

Japan’s Nikkei index is already up 19% this year.

 

While Japan strategist Masashi Akutsu acknowledges a tactical correction is possible, he sees it going even higher by year-end and raises his Nikkei and Topix targets yet again. Real wage growth could help lift earnings in service sectors including restaurants, apparel, consumer durables and convenience stores. Beyond the consumer, the recovery in global manufacturing is a positive for many export industries and the semiconductor recovery should broaden to include servers, data centers and eventually other categories. Though Japan equities have been one of the best performing markets in the world over the last year as strength has been underpinned by an earnings recovery. Masashi sees a broadening of performance ahead and is focused on quality cyclicals and lagging stocks.

 

Financials analyst Eric Dray is cautious on commercial real estate mortgage REITs (CRE mortgage real estate investment trusts).

 

Office property fundamentals are weak and higher rates weigh on valuations. Eric’s three-factor framework helps contextualize challenges across the sector. First, office comprises about 30% of CRE mREIT portfolios. Low occupancy and slowing rent growth make cash flows less sustainable. Second, more than half of CRE mREIT loans were originated when the Fed Funds rate was below 1% and >90% of loans were originated with rates below 3%. Third, upcoming loan maturities increase re-financing risk.

 

Discussions about the power needs of AI servers were so pervasive at last week’s Utilities, Power and Clean Energy conference in NYC that some investors dubbed it the “Data Center” conference.

 

Independent power producers with uncommitted merchant capacity are the clear beneficiaries in the view of Senior Utilities Analyst Julien Dumoulin-Smith, and demand from new data centers will likely materialize in 2026 and beyond. From Texas to the Mid-Atlantic, there’s recognition that more may have to be done to attract investment in generation. Indeed, power procurement issues have limited the supply of new data centers, which has helped pricing for existing capacity. Senior Telecom Analyst David Barden believes we’re still in the very early stages of the AI opportunity for data centers which are focused on capturing early-stage AI training opportunities.

Featuring Commentary from Global Economics Weekly

Claudio Irigoyen

Claudio Irigoyen, Head of Global Economics, BofA Global Research

What to expect when you are expecting

Payrolls is always a market moving event, in particular after the massive January number. The February print was above our expectations and the longer-term equilibrium level, but it was accompanied by downward revision to prior data. On the other hand, Powell did not add much guidance and his speech was not market moving. Our U.S. Economics team still expects 3 cuts this year starting in June, in line with market pricing.

 

Are markets too sensitive to the Fed?

As we have written before, you can make the case of higher for longer by combining a few factors: a strong economy running above potential, a still tight labor market, and a goods-driven disinflation due to the normalization of supply chains and commodity prices, and the fact that we are approaching a polarized and contested presidential election.

 

In search of the path of least resistance

The market consensus indicates that with the observed progress in disinflation, the path of least resistance is for the Fed to start cutting rates around June. It is worth asking the opposite question: with so much evidence that the economy is running above potential, upside risks to inflation, and presidential elections approaching, isn't the path of least resistance to apply proper risk management and keep rates high for longer?

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