Friday, April 13, 2007

Chasing Yields

The more and more data that I look into, it becomes apparent that Fed Chairman Ben Bernanke may have been on to something with his notion of a liquidity "glut." I wouldn't use the term glut, because that implies an excess of what the market demands. I don't believe that is the case, as the supply of capital has shifted to the right in a traditional AD / AS framework, we would expect more investment at a lower interest rate. Let me fill you in on some of the research that I've done. First let me preface it with the conventional wisdom in Commercial Real Estate, which is that investors are chasing yields, and so are banks. This is true, low lending rates have driven down cap rates and in some cases, below lending rates, meaning the owners are what I call "momentum" investors. They are gambling that the market will appreciate. This is particularly evident in Southern California. Rule of thumb, anything below about a 6.25% cap based on actuals, is someone who is banking on momentum, or they are engaging in a redevelopment through conversion or rehab.

So back to the story, I am doing some research on India for my global macroeconomics class, and interestingly enough real yields on Indian debt have declined over the last several years. We can mark this off as coincidence, based on better management of inflation by the Central bank. Yet the key story is that inflation accelerated in 2006, from 3% to about 6% (according to the Economist Intelligence Unit), and interest rates did not respond. What was astounding to me, and this really connects into monetarism, is that the supply of M2 jumped from a growth rate in the teen, about 18% in 2005 if memory serves, to over 24% in 2006. Inflation up? Coincidence? I'll let you be judge. So, in India we have declining real rates of interest.

Across the small pond we call the Pacific Ocean, and across a few mountains, we come to lovely state of Texas. So how are India and Texas linked? From 1990 to 2002, gross nominal yields averaged about 17.5%. By 2006, those same yields had fallen to 11.6%. As they say, the plot thickens....

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