Real Assets

Three Signals Our CIO is Watching

Article

Mar 17, 2023

We recently sat down with Paula Horn, Chief Investment Officer (CIO) for Brookfield’s Public Securities Group (PSG), to discuss what is top of mind for her as she helps PSG’s investment teams navigate their real asset strategies in today’s uncertain market environment. She shared three signals she’s watching closely.

The inverted yield curve. Of all of the recessionary indicators, the shape of the yield curve has proven to be the most predictive, Paula says. An inverted yield curve—when long-term rates drop below short-term rates—has preceded every recession over the last 50 years, with no false negative or positive indications save for the pandemic period. Paula notes that the yield curve today is dramatically inverted relative to recent history, as it’s more negative than it was before recessions over the past three decades.

“While some schools of thought suggest that this time is different, I don’t necessarily believe that. It may just be a matter of timing and that it takes longer this cycle  for a recession to rear its head,” Paula says. She noted that the recent well-publicized closures of two U.S. financial institutions were primarily due to poor management and lax risk control and oversight, but also illustrative of the complexities of business models founded on borrowing at low rates and investing long term.

With at least a shallow U.S. recession on the horizon, she says PSG’s equity investment teams hold underweight views of the U.S. relative to their benchmarks. Similarly, she says, PSG’s real asset debt team has adopted risk-off positioning, favoring investment-grade credit.

real asset

U.S. earnings and valuations. U.S. corporate earnings (as represented by the S&P 500 Index) are down year over year, something we haven’t seen in close to a decade, and downward revisions continue. Costs have remained high, with wages in particular hurting the bottom line. To preserve profits, companies will have to cut more overhead, Paula says, with layoffs beyond the tech industry likely.

Against this backdrop, ironically equities have become more expensive vs. bonds. A measure of the valuation gap between the two asset classes known as the equity risk premium (ERP), which subtracts the forward S&P 500 earnings yield from the 10-year Treasury yield, has fallen to its lowest level since 2007, just before equity and junk bond markets collapsed. With history as a guide, equity risk premiums typically rise into a recession. In our view, the current ERP of 170 basis points and a forward price-to-earnings multiple of 18x imply limited upside for U.S. equities and meaningful downside should a soft-landing consensus fail to materialize.

She says PSG’s real estate and infrastructure securities teams are playing defense in the U.S., focused on investing in companies with quality earnings, good balance sheets, and solid cash flows. According to Paula, PSG’s real estate team is finding such quality in the health care, industrials and apartment sectors, while the infrastructure team sees quality in towers and toll roads.

real asset

China. Finally, Paula is closely watching China’s reopening, and rising tensions between the U.S. and China. The reopening has created opportunities across real estate and infrastructure equities, she says, benefiting both commercial and residential developers and landlords, as well as utilities and communications infrastructure companies in the Asia Pacific region. Yet the deteriorating relationship between China and the U.S. is a concerning geopolitical risk, Paula says. “China is creating areas of opportunity and risk all at the same time.” Read more in the full Real Assets Monthly.

Read More

Disclosure Information

This material is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All information is current as of the date of this material. Views and information expressed herein are subject to change at any time. Brookfield Public Securities Group LLC disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources however, Brookfield Public Securities Group LLC does not warrant its completeness or accuracy. This presentation is not intended to, and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Brookfield Public Securities Group LLC is not licensed to conduct business, and/or an offer, solicitation, purchase or sale would be unavailable or unlawful. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.