30
Sep

3Q 2024 Macro and Timber Equities Update

Macro 3Q24

Author: S.C.

1. Executive Summary

The third quarter was characterised by rebounding lumber prices, sharply falling long-term yields and a sudden spike in volatility across multiple asset classes. Inflation continues its downwards trajectory and monetary policy continues to normalise, moving in the right direction for the real estate and construction sectors.

 

2. Macro Overview

The last quarter was characterised by major moves in asset classes. First of all, long-term yields fell sharply during the quarter, after the rebound at the end of Q2. The US 10y yield fell from 4.4% at the end of June to a low of 3.6% in September and rebounded slightly by quarter-end. The German 10y yield followed a similar path, falling from 2.6% at the beginning of July to a low of 2.1% in August, re-tested in September as inflation continued to fall and ended the quarter below 2%. Stocks globally suffered a sharp drawdown at the beginning of August – while disappointing US labour market data was largely blamed for the move, such a rapid unwind of carry and long-equity trades suggests that market positioning was stretched and leveraged. Short-term stock market volatility spiked to levels last seen only during the global financial crisis and during the covid pandemic.

Housing starts, the underlying driver of profits for timber construction stocks, continued to be very weak in Europe, in particular – and as already reported (see links) – in key markets for timber construction such as Germany, Austria, Sweden and Finland. Residential building permits for in Germany are now down to levels last seen in 2010 and around half the peak values reached in 2021. The recent normalisation of monetary policy in Europe (ECB) and Sweden (Riksbank) still needs some time to bear fruit, but it is at least going in the right direction for the real estate market in general. Lower policy and long-term rates in the U.S. led to a sharp increase in mortgage refinancing.

While any hypothesis for a trend reversal needs to be confirmed in the next 2-3 months, the most recent datapoints on U.S. housing starts showed signs of stabilisation in both single-family and multi-family construction activity. Single-family starts, so far very resilient, dropped sharply in July but rebounded in August, while multi-family recovered from the lows in March. Lower interest rates provide support for multi-family construction, and the recent improvement in the segment may reflect at least in part improved financial economics. The volatile pattern found in single-family might be driven by offsetting factors: struggling consumers on one side – the housing affordability index by the Atlanta Fed is at the lows since 2006 – compensated by lower interest rates and the low supply of existing homes for sale. While existing home sales remain at historical lows, they have stabilised over the last quarters and lower interest rates improve the relative economics of R&R and transactions in existing homes instead of new ones.

Figure 1: Housing starts in the U.S. Sources: U.S. Census Bureau and U.S. Department of Housing and Urban Development; Timber Finance. Data retrieved from FRED, Federal Reserve Bank of St. Louis.

 

Housing affordability has become one of the battlegrounds in the presidential campaign in the U.S., with both candidates promising to increase the supply of new housing units at more affordable prices.

During Q3, we saw central banks cutting rates again: the ECB reduced the deposit rate by 0.25% in September to 3.5%, while the Federal Reserve surprised markets in September with a 0.50% cut.

 

3. Timber Stocks

During Q3, the normalisation in interest rates supported real estate owners and developers as well as timberland REITs. These businesses naturally profit from lower long-term yields.

In Europe, French developer and timber pioneer Nexity, after a very volatile Q2, rallied again strongly and was the best performer. James Latham, the UK distributor of timber products also performed well. The rest of the European portfolio underperformed. After a strong start into the quarter, Steico disappointed the market when it reported results and the stock trended lower for the good part of Q3. At the time of writing, Steico trades around book value and a large discount to the price paid by Kingspan last year. While it is facing strong headwinds from the weakness in the German and other European construction markets, its business should benefit from the building decarbonisation trend in the medium and long term, and Kingspan has a very strong track record of growth and profitability.

Builders FirstSource and Louisiana Pacific were the strongest performers in the North American portfolio. The sharp decline in long-term yields and, consequently, mortgage rates support the underlying business. In the case of Builders FirstSoruce, in particular, lower yields should help the multi-family side of the business – it will be interesting to hear more from the company at the beginning of November when results are published. North American lumber manufacturers performed well, as lumber prices rebounded during the quarter. UFP Industries’ long-term and charismatic CEO Matthew Missad handed over to William Schwartz, president of the company’s retail division. Missad will stay with the company as Executive Chairman, at least for the leadership transition phase. In this setup, the odds that the company will continue to allocate and compound capital wisely and profitably are solid.

 

4. Disclosures and Conflicts of Interest

Some or all the companies mentioned in this report may be included in the Timber Finance Forest-Based Construction Basket tracker and are part of the Timber Finance Carbon Capture & Storage Index. Timber Finance Management and/or the Timber Finance Initiative may have commercial relationships or be in discussions with some of the companies mentioned in this report. Specifically, Stora Enso is a member of the Timber Finance Initiative association.

Please note that this research is prepared for information purposes and targeted to institutional investors in Switzerland. It does not represent investment advice and does not take into consideration the individual requirements, risk tolerance and goals of an investor. Recipients who are not Swiss institutional investors should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents.

The information presented in this report is obtained from several different public sources that we consider to be reliable. Nevertheless, we cannot guarantee the accuracy of the presented information. The information used may change quickly and we are not committed or obliged to modify the reports base on new information. The opinions and views expressed in this report reflect those of the author at the point in time of its compilation and may vary at any time. Valuation methods like DCF and any other analysis or expert judgement do not provide any guarantee that the target price or fair value will be reached, for example because of unforeseen changes in financial or economic conditions.

For more details and questions, please do not hesitate to get in touch with us at info@timberfinance.ch or:

Timber Finance

Ausstellungsstrasse 36

CH-8005 Zürich

Tel. 044 991 13 44

General disclaimer © 2023 Timber Finance Management AG (“Timber Finance”). All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of Timber Finance. Timber Finance Management AG makes no representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and Timber Finance Management AG and its third-party licensors shall have no liability for any errors, omissions, or interruptions of any index or the data included therein. All data and information is provided by Timber Finance “as is”. Past performance is not an indication or guarantee of future results. This document does not constitute an offer of any services. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments offered by third parties that are based on that index.

Copyright © 2023 Timber Finance Initiative. All rights reserved.

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