‘Commercial real estate situation worsening,’ Scotiabank strategists say

Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow

Scotiabank real estate analysts and quantitative strategists combined for a timely report called CRE Situation Worsening; Office in the Spotlight – Implications for Portfolio Strategy, REITs, Banks. Here are some excerpts,

“Within CRE, Office is receiving the most scrutiny due to some high-profile defaults and vacancy rates challenging the early ‘90s levels. A higher-for-longer interest rate scenario is likely to inflict more pain on the CRE space … The CRE situation is likely to get worse, adding to our macro concerns. We still expect challenging equity markets, and would reiterate our UW [underweight] stance on RE and [financials]/Banks. Within RE, Office is least appealing, while Industrial could do better. Banks lending will keep slowing with PCL [provisions for capital loss] rising … We see access to capital (via new debt or asset sales) as the biggest issue facing the sector. In our view, REIT valuation metrics that are real-estate-centric, (P/NAV, implied cap rate, implied price-per-foot) are now less relevant for Office REITs in a declining asset value market (we estimate office values have declined 30 per cent to 50 per cent since 2021 … The large Canadian banks all have a very small exposure to office loans (and an even smaller exposure to U.S. office loans) when measured as a percentage of total loans, but that exposure does become more meaningful when scaled against earnings. What that means is that while the risk to capital from a potential CRE credit cycle is very low, the potential for losses to materially impact earnings in any given quarter is real. Based on commentary from this past Q2 earnings season, that earnings risk is manageable for now, but we think that investors should not remain complacent”

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BMO chief strategist Brian Belski is disappointed in TSX earnings,

“The negative earnings headlines and results from Canadian banks dampened an otherwise strong first-quarter earnings season for the TSX. In fact, if we exclude the Financials sector, the S&P/TSX is beating expectations by 6 per cent on average with the more cyclical areas of the market continuing to recover. However, the net miss by the big three sectors has been a key drag on S&P/TSX bottom up 2023 EPS estimates which are now 3 per cent below our 2023 EPS target. .. While we continue to expect earnings to normalize in the back half of 2023, our models suggest the earnings contraction could be slightly deeper than initially expected. This could be exacerbated further if Financials and Resources continue to see net negative revisions, as these three sectors make up 59 per cent of the index ... In our opinion, the earnings contraction in 2023 and subsequent recovery in 2024 will not be smooth and synchronized across sectors, which highlights the importance of a more selective investment approach and more emphasis on active portfolio management”

“BMO strategist disappointed in TSX earnings” – (research excerpt) Twitter

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Citi analyst Maximilian Layton recommends investors add to copper holdings over the next six months,

“We recommend consumers and long-term investors gradually build copper exposure over the next 6 months or so, depending on the timing of a potential substantial easing in China policy. We see good risk-reward with this strategy due to our expectations of 50 percent upside and 10 percent downside from current price levels by 2025… We suggest remaining cautious in 2H’23 through 1Q’24 on a base case assumption of extended ex-China growth weakness and a gradual, services-led, China growth recovery that is less metals intensive… We see a cyclical global growth upswing driving prices to an average of $12k/t in 2025 in our base case. If the pace of decarbonization-related investment accelerates at least in line with a 2-degrees pathway, then we see $15k/t in this bull case by 2025. Our base case of $9-10k/t copper long-term is enough to ensure sufficient supply if the world decarbonizes at its current pace, on average.”

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Diversion: “Eating Disorder Helpline Takes Down Chatbot After Its Advice Goes Horribly Wrong” – Gizmodo

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