The Wilshire US REIT Index hit its peak on August 1 and has since been on a steady decline in absolute and relative terms versus both the S&P 500 and the Russell 2000 Indices. During the same time period, the yield on the 10-Year Treasury Note has moved upward from 1.458% to 1.608%; perceived as being interest rate sensitive, REITs have been victimized as have other “bond proxies” like utility stocks.
Bond prices have been pressured by two short-term factors: one, rising inflation expectations/oil prices and two, a recent Bloomberg report suggesting that ECB officials may be contemplating a tapering of its QE program which sent sovereign bond yields in the Eurozone higher with a spillover effect onto bonds in the US.
The Federal Reserve Bank of San Francisco identifies two types of inflation: demand-pull inflation (“one potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money”) and cost-plus inflation (“rapid wage increases or rising raw material prices are common causes of this type of inflation”). Given the potential consensus building in the ECB for reducing monetary accommodation and the apparent desire on the part of many members of the FOMC to increase rates despite benign readings on inflation, inflation from the demand side seems unlikely. As for the supply side, the uptick in the unemployment rate accompanying an increase in the nonfarm payroll of 156,000 in September suggests that there is still slack in the labor market. True, oil prices have seen recent increases but they are virtually unchanged from the end of Second Quarter and have not been joined by the prices of other commodities.
Longer term, there are arguments being made that the anemic recovery subsequent to the 2008/9 recession is symptomatic of secular forces rather than cyclical. According to a recent paper titled Understanding the New Normal: The Role of Demographics by three Federal Reserve economists, Etienne Ganon, Benjamin K. Johannsen and David Lopez-Salido, the trend of baby boomers retiring with all their capital is creating an imbalance of capital to labor; to the three economists, it is demographically preordained that the return on that capital will be underwhelming, leading to persistently low GDP growth and interest rates.
If the short-term forces putting pressure on sovereign bond yield world-wide are limited in scope and there are convincing arguments being made for a longer-term cap on economic growth/interest rates, are we not potentially seeing a reprise of 2013, a resetting of expectations of monetary accommodation, Taper Tantrum II, so to speak? With the fickle marginal buying interest from the generalist community having been absorbed, REITs are trading 10% below the peak, many below Net Asset Values. Aren’t REITs worth another look?
Plus ça change, plus c’est la même chose – Jean-Baptiste Alphonse Karr, 1849.