Risk assets enjoyed a smooth upward ride in Fourth Quarter. Investors are learning to ignore short-term political volatility and any suspense surrounding intermediate-term uncertainty involving the next chairman of the FOMC and the Republican tax plan seemed manufactured at best. There was some passing of the baton back and forth between secular growth (FANG stocks) to cyclical (airline, oil stocks, etc.) but in reality, there was just too much money chasing too few goods as amply demonstrated by the meteoric rise of crytocurrencies, breathlessly covered by CNBC reporters.
Economic data released during the quarter was good. The third estimate of Third Quarter GDP growth came in at 3.2%, compared to 3.1% for Second Quarter 2017 and average GDP growth of 1.9% and 2.0% in 2016 and 2015, respectively. According to the Bureau of Labor Statistics, changes in total nonfarm payroll in the past three months were 211,000, 252,000 and 148,000, respectively, an average of 204,000 compared to an average of 157,000 for the 12 months prior. The yield on the 10-Year Treasury Note rose from 2.326% to 2.405%.
The Wilshire US REIT Index (“Index”) was up 1.7% in Fourth Quarter, lagging both the S&P 500 and Russell 2000 Indices which advanced 6.6% and 3.3%, respectively; this is the sixth consecutive quarter and second consecutive year of REIT underperformance. For the year, the majority of the constituents in the Index did produce positive returns. Not surprisingly, M&A targets led their sectors, including DuPont Fabros, the best performing REIT for the year (+53.7%). Retail REITs dominated the laggardboard with CBL & Associates Properties posting the worst returns for the year (-44.2%).
As suggested in the prior quarter’s REITView, improved readings of the economy and positive fourth quarter seasonality did lead to outperformance of Value over Price Momentum. All three Retail sectors outperformed, aided in no small part by a flurry of M&A activity and speculation (reported investment by large, well-known activist hedge funds) surrounding a number of regional mall companies. Perhaps shares of the retail REITs have priced in record store closings in 2017 (and more anticipated in 2018)? Interestingly, none of the M&A activity involve landlords of lower quality assets despite 30%+ discounts to Net Asset Values, suggesting that investors are making a real distinction between value and value traps. An investment case for high quality retail real estate trading at double digit discounts to private market valuations does not rely solely on M&A; a tightening labor market should lead to wage growth and increased consumption which should accrue to the benefit of retail landlords.
Underperforming sectors in Fourth Quarter included two of the best performers for the year, Industrial and Industrial-Mixed, as investors took a breather chasing these names. Apartments underperformed as investors reassessed valuations in a sector with the highest level of anticipated supply and Health Care underperformed due to fears of interest rate sensitivity of long-dated leases.