QueensGiant Capital Markets Outlook 2024

As we embark into 2024, the global market continues to evolve, presenting a myriad of challenges and opportunities for businesses and investors alike. Through a keen understanding of market narratives, one can position themselves to seize opportunity in this exciting market.  Let’s explore the unfolding themes that will undoubtedly influence our economic landscape.

Liquidity Navigation

In 2024, we anticipate liquidity being brought to the markets. Since November of 2023, reserve balances at the Fed rose partly due to the Fed’s new program, the Bank Term Funding Program (BTFP). This program allowed banks to find profitable arbitrage, borrowing from the BTFP at 4.8% and depositing in their Fed reserve

accounts earning 5.4%. In 2019, the Fed introduced their concept of

 “ample reserves” which made it so reserves in the banking system had to hold around $1.6 trillion. This floor rose over the past couple of years and Jerome Powell has made it clear that Quantitative Tightening (QT) will conclude when the Fed perceives reserves being near that floor of “ample reserves.” We will also be witnessing the rebirth of the Standing Repo Facility (SRF) that can supply additional liquidity to the market and the banking system through repos. Prepare for the Fed to use the SRF to resolve liquidity issues the way that they used to, prior to Quantitative Easing (QE).

Interest Rate Outlook

In the rates landscape for 2024, there is a prevailing sense of optimism, albeit accompanied by a notable discrepancy in the public perception of the economy's health. Despite positive indicators such as GDP, inflation, and stock market performance, sentiment appears disproportionately low, reflecting a lag in public perception. There has been a sharp rise in sentiment in January as consumers’ fears are fading, yet the measure is still about 20% lower than before the pandemic hit in 2020. There does exist a concern over the rationale behind rate cuts when there is neither a pressing need to combat crushing inflation nor an indication of an economic recession.

The high and stable rates are viewed as less detrimental to merger and acquisition (M&A) activity, especially with recent losses in court by the government for antitrust cases. The rebounding activity in M&A aligns with this sentiment, reflecting a strategic response to the economic landscape.

Pent Up Investor Demand

 Notably, the end of 2023 and beginning of 2024 provided an uptick in deal volume, indicating positive momentum in the M&A landscape.  Private equity (PE) firms are poised to re-enter the marketplace, focusing on returning value to investors and raising capital. The anticipated offensive nature of deal activity suggests that market participants view the current environment as an opportunity to propel themselves forward and strategically position for long-term competitiveness. The equilibrium and understanding about pricing between buyers and sellers is crucial, and will lead to an increase in transactions. Rebounding sectors, particularly in major segments like technology and healthcare, are expected to drive greater M&A activity.   Expect to see a more active IPO market for technology, as there was only one IPO that raised at least $1 billion in 2023 compared to a dozen in 2021. Significantly higher valuations should bring increased deal volume in 2024 Another theme to keep an eye out for is the risk-on mentality from not only traditional financing markets, but direct lenders as well.

In the second-half of 2023, the market accepted that rates were going to be “higher for longer,” and we began to see market participants adjust  accordingly. Direct lenders played a massive role, financing 86% of LBOs in Q3 of 2023, and have even begun to make their way into strategic M&A. This reflects substantial investor appetite, as direct lenders historically relied on smaller, riskier companies. Their involvement in large-cap leveraged acquisitions projects exciting opportunity on the horizon.

Make-or-Break Year for Commercial Real Estate

Commercial Real Estate (CRE) stands at a critical point, facing a make-or-break year with a plethora of challenges. CRE loans pose a significant risk to the balance sheets of banks, aggravated by decreasing property cash flow and a concurrent decline in commercial property values. The sector grapples with formidable refinancing challenges, fueled by higher interest rates that impede the ability to refinance. The looming maturity of asset loans in the next few years intensifies the difficulty of rolling over debt, creating a potential path to default.  Alarming statistics reveal that 15% of CRE loans are already underwater, with 45% of these attributed to office loans. The catalyst or make-or-break moment for CRE hinges on the impending maturity of many loans in the coming year. Even if refinancing were possible, the new rates on loans are anticipated to be higher, with annual cash flows unable to cover the costs. The CRE market faced a record number of maturing loans, reaching $541 billion in 2023, and with projections indicating over $2.2 trillion maturing by the end of 2027, the road ahead remains cautionary. Property owners are grappling with higher interest rates, increased vacancies, and weakened cash flows. In January 2024, we noticed a substantial increase in delinquency and distress rates for U.S. CMBS, with a 10% rise in the delinquency rate to 4.61% and an 11% increase in the distress rate to 7.39%.  The office sector experienced a notable distress rate increase of 233 basis points to 10.88%, with newly distressed loans totaling $3.4 billion, primarily stemming from imminent or actual maturity defaults.

 The weak property sales market has further complicated negotiations between borrowers and creditors, reflecting the broader challenges faced by the commercial real estate sector as maturing loans and economic uncertainties converge. The macro impact of CRE distress risk looms large, with the potential for default rates reaching 10-20%, akin to the challenges faced in 2008. Estimating the effect with a 10% discount rate reveals a significant impact on the banking sector, accounting for 10% of assets banking balance sheets. In 2024, CRE must execute in navigating treacherous waters with the looming threat of defaults and a complex web of financial challenges.

Conclusion

 The fabric of the global economy unfolds with liquidity solutions, nuanced interest rate dynamics, pent-up investor demand, and crucial challenges in commercial real estate. To navigate these complexities requires not only astute decision-making but the flexibility to remain positioned for excellence, emphasizing the importance of understanding market narratives as our compass in seizing opportunities amidst the evolving landscape.