Displaying items by tag: rates

Entering the year, there was optimism around real estate stocks given consensus expectations of rate cuts due to inflation falling to the Fed’s desired level and a weakening economy. However, the economy has defied skeptics and remains resilient, while inflation is plateauing at higher levels. As a result, the Fed will be less dovish than expected, and the market has tapered back expectations for rate cuts to between 1 and 2 by year-end. 

Another consequence of the data is that mortgage rates are trending back to last year’s highs, with the 30Y at 6.9%. The real estate sector sank lower following last week’s inflation report, led by self-storage companies, office REITs, and homebuilders on the downside. 

Over the past month and YTD, the Real Estate Select SPDR Fund (XLRE) is down 4.6% and 7.8%, respectively. The current environment of rates at a 23-year high is clearly a major headwind. And there are no indications that the status quo will meaningfully change until there is improvement in terms of inflation or more damage to the economy. The impact is evident in terms of Fed futures. At the start of March, odds indicated more than a 50% chance that there would be four or more rate cuts by the end of the year. Now, these odds have plummeted to 5%. 

Finsum: Real estate stocks have sunk lower in the last month, along with the odds of aggressive rate cuts by the Fed. As long as ‘higher for longer’ persists, there will be considerable stress for the weakest segments of the real estate market.

The Energy Select SPDR ETF (XLE) is up 14% YTD, which is the second-best performance among sectors. This follows a year of underperformance in 2023 due to concerns of a recession impacting energy demand, while strong US production offsets the impacts of OPEC cuts. Last month, OPEC announced that production cuts of 2.2 million barrels per day would continue in the second quarter.

This year, oil prices have risen due to increased tensions in the Middle East. Additionally, recent economic data has clarified that the US economy is not near a recession, and there are some indications of a pick-up in economic growth. The near-term macro picture looks bullish for energy stocks given increased demand, tighter supply, and intensifying geopolitical tensions. On the supply side, OPEC has demonstrated discipline in terms of members abiding by agreed-upon production cuts, and US production is expected to not increase further.

Given valuation concerns about many parts of the market, energy stocks are also cheap, trading at 13 times expected earnings vs. 21 for the S&P 500. XLE also pays a 3% yield, which is more than double the S&P 500’s yield of 1.4%. Further, historical research shows that energy stocks have posted the best performance in high-rate environments, which is likely to persist for longer given recent economic data. 

Finsum: Energy stocks have had a strong start to 2024. Recent economic data is supportive of increased demand, while the supply side is being impacted by OPEC cuts and heightened geopolitical tensions. 

Investors are selling their private equity holdings at a discount on secondary markets in order to reduce exposure to the asset class. Last year, there was $112 billion in secondary market transactions, the second-highest since 2017. According to Jefferies, 99% of private equity transactions were made at or below net asset value last year. This is an increase from 95% and 73% in 2022 and 2021, respectively. 

It’s a result of the depressed atmosphere for M&A and IPOs, which have been the typical path for private equity exits. However, these outlets have been offline for most of the past couple of years due to the Fed hiking rates to combat inflation. 

Many of the sellers have been pension funds that are required to make regular payments to beneficiaries. Prior to this cycle, private equity was lauded for its steady returns and low volatility, leading pension funds to increase allocations from 8% in 2019 to 11% last year. 

Private equity’s appeal has also dimmed, given that higher rates can be attained with fixed income and better liquidity. In contrast, private equity thrived when rates were low, as it led to robust M&A and IPO activity in addition to more generous multiples. 

One silver lining is that as the Fed nears a pivot in its policy, there has been some narrowing of discounts. According to Jefferies, the average discount from net asset value has dropped from 13% to 9%. 

Finsum: Many investors in private equity are exiting positions at a discount due to liquidity concerns. Now, some institutional investors are rethinking their decision to increase allocations.

Meredith Whitney, who previously forecasted the financial crisis in the mid-2000s, sees downside for the housing market, driven by changes in behavior among younger men. She sees the beginning of a multiyear decline in housing prices as the lower levels of household formation among men negatively impact demand. 

On the supply side, she sees more homes for sale due to the aging demographics of homeowners. Whitney’s perspective deviates from the consensus, which sees home prices as remaining elevated due to a lack of supply, coupled with a bulge in demand as Millennials enter their peak consumption years over the next decade. This year, most Wall Street banks are forecasting a mid-single digits increase in home prices. 

Another factor impacting housing supply is that the vast majority of mortgages were made at much lower rates. While many asset prices have declined due to the impact of high rates, home prices are an exception. Whitney contends that “normally you would think as rates go up, home prices would go down, and that hasn’t happened over the last two years. I think home prices will normalize because as more inventory and supply come on the market, you’ll see a true clearing price that is lower than it is today. So, I would say 20% lower than it is today.” 

Finsum: The consensus view is that home prices will continue rising due to low supply and demographic-driven demand. Meredith Whitney, well-regarded for predicting the financial crisis, is bearish on the asset class.

REITs have had an uneven start to the year due to the outlook for monetary policy becoming less dovish. Many investors are interested in taking advantage of this weakness, given the sector’s solid fundamentals and attractive yields. Yet, they may want to minimize exposure to volatility, which is likely to persist given an uncertain outlook for monetary policy. So, here are two lower volatility REITs for more conservative investors.

W.P. Carey (WPC) owns commercial and industrial properties across North America and has a 6.2% dividend yield. WPC is extremely diversified, as no single industry accounts for more than 10% of its tenants, and its biggest single tenant accounts for less than 3% of total revenue. 

In addition to its diversification, WPC also has less risk than competitors due to being a net-lease REIT. This means tenants cover taxes, insurance, and maintenance. The company also negotiates rental rate increases that are built into contracts, providing another layer of security.  

Digital Realty Trust (DLR) provides exposure to data centers, pays a 3.4% yield, and has hiked its dividend every year since 2005. This segment saw massive growth over the last decade due to the rise of cloud computing and should enjoy another healthy tailwind over the next decade due to artificial intelligence. 

DLR’s data centers enable the distribution of technology to users for consumer and commercial applications. The company has more than 300 data centers in over 25 countries and counts companies like Meta, JPMorgan Chase, and Verizon among its customers.   

Finsum: REITs have underperformed to start the year. Yet, the sector still holds appeal due to attractive yields and solid fundamentals. DLR and WPC are two REITs with lower volatility that may appeal to more conservative REIT investors.