Market Commentary - Week Ending 1/20/2018
- U.S. stocks close at another record high with the Dow Jones Industrials topping 26,000
- China’s market surges with a year-to-date gain of +12.5%
- U.S. government bond yields hit multi-year highs
Is the poor performance of real estate a good reason to sell?
Real estate has not been a great investment for the past 4 ½ years gaining a cumulative +14% while the S&P 500 has surged +84% during the same time (see accompanying graph). Is this support for abandoning real estate in your portfolio? I don’t think so!
Source: ETF symbol RWR; S&P Compustat
2017 was a particularly disappointing year for investors in real estate with it gaining just +0.4% for the year while the S&P 500 surged nearly +20%. 2018 has not started any better as real estate, by far, has been the worst performing major asset class with a loss of -5.1% year-to-date while the stock market is higher by an equal amount. As frustrating as all of this can be for investors, know that this is very normal and actually the exact performance behavior you want in a diversified portfolio.
What is “Real Estate”?
Real estate, when referenced as part of a liquid investment portfolio, generally is in reference to publically traded companies (stocks) called Real Estate Investment Trusts or REITs. These companies own various types of real estate including:
- office buildings
- shopping malls
- apartment buildings
There are funds, both mutual funds and ETFs, that invest only in REITs. These funds provide investors with an easy way to own a diversified portfolio of real estate.
Let’s first start with the big picture. There is data on the performance of real estate going back 45 years to the start of 1972. As the accompany graph shows, during this 45 years real estate has performed better than the S&P 500 with a compounded annual return of +11.1% as compared to the S&P 500’s +10.6%. This is particularly impressive given the poor performance of real estate the past 4 ½ years.
Source: National Associated of Real Estate Investment Trusts and ETF symbol RWR; S&P Compustat
The long-term returns of real estate are one, very good, reason for investors to have a portion of their portfolio invested in it. A second reason, and in my opinion, equally or even more important than just the long-term return, is that real estate provides great diversification in a portfolio. The performance behavior of real estate, the timing of its ups and down and longer term cycles, are clearly not the same as the overall stock market. It’s this difference in performance behavior, all things not always going up and down together at the same time, that produces better and less volatile portfolio returns.
Cycles, like the last 4 ½ years, can be tough for investors to accept but it certainly is not always like this. Consider the accompany table and various cycles we’ve seen over the past 45 years between real estate and the S&P 500. There have been multiple, extended periods of time when real estate has performed exceedingly better than the S&P 500.
Source: National Association of REITSS; S& Compustat
As disappointing as an investor may be with the performance of real estate the past 4 ½ years, it’s just the way that it goes. Not all investments go up at the same time and by the same amount…you don’t want them to! This recent performance of real estate, based upon 45 years or historical performance, is entirely normal and no reason to eliminate it from a portfolio. Stay the course!
Market Performance Summary
Source: S&P Compustat, www.yahoo.com/finance for Commodities
Notable Market Headlines
Stocks continued their record-setting pace this week with markets gaining around the world. U.S. large stocks gained +0.9% while small stocks lagged behind up just +0.3%. Year-to-date it is a similar story with large stocks higher by +5.1% while small stocks are trailing behind at +4.0%. The leading sector in 2018 has been healthcare stocks gaining +6.6%.
The Dow Jones Industrials has been getting a lot of headlines as it breaks through 1,000 point levels. The Dow topped 26,000 for the first time closing the week at 26,071. The Dow may be getting a lot of the headlines but the tech-heavy NASDAQ continues its 2017 rally into 2018. Year-to-date the NASDAQ is higher by +6.3% while the Dow has gained +5.5%.
The stock market rally is not isolated to just the United States but instead is a global rally. International developed markets, tracking very closely to U.S. large stocks, this week gained +0.9% and are up +5.4% in 2018. Germany’s market was a highlight this week with a gain of +2.1% and outpacing the average developed market with a year-to-date gain of +6.7%.
Developed markets are impressively strong but emerging markets have done even better. China’s market, by far the largest international emerging market, surged this week gaining +4.3% and is now higher by a stunning +12.5%. Overall emerging markets gained +1.9% for the week and are higher by +7.0% year-to-date. Contributing to this rally is not only China’s market but several others including Latin American markets up +9.5%, Mexico’s gaining +6.5%, and Taiwan’s up +7.2% year-to-date.
Emerging Markets Graph
Commodity prices eased this week as the price of oil pulled back from 3-year highs. Commodities slipped -0.6% for the week but remain higher year-to-date by +6.6%. Gold has a similar story with a loss this week of -0.4% and a 2018 gain of +2.2%. Real estate, as discussed extensively above, inched higher for the week by +0.1% but has suffered a 2018 loss of -5.1%.
Bonds have had a very tough start to the year including a -0.4% loss this week leaving them down -1.1% for the year as yields rise. The yield on the benchmark 10-year U.S. Treasury closed the week at 2.639% which was the highest since July 2014. Explanations include concerns about future inflation, confidence in the economy, and expectations of continued interest rate hikes by the Federal Reserve.
Winners and Losers by Sector
Source: S&P Compustat
Lam Research (LRCX), a leading manufacturer of the equipment used to make semiconductors, was upgraded by one analyst resulting in its stock gaining +10.1% for the week. This stock had a great 2017 gaining +74.1% but even after this week’s rally the stock remains below its 2017 high. The story is much the same for Lam’s biggest competitor and industry leader, Applied Materials (AMAT), with its stock higher this week but still below 2017 highs.
Wynn Resorts (WYNN), a casino giant with the most profitable casino in Vegas, had a slow start to the year in the stock market but climbed this week by +8.5%. There was no news in particular driving this move other than the apparent continued confidence of investors of the company’s rising sales and earnings being fueled by a strong economy. This stock was one of the best performers in 2017 with a gain of +94.9%.
General Electric (GE), once one of the market’s most admired companies and stocks, seems to announce one disappointment after another. This week the company said it will have to set aside $15 billion more than expected over the next seven years for insurance reserves. This came as a surprise to nearly every analyst and investor resulting in the stock falling -13.3% for the week wiping out another $21.7 billion of value. For the past decade, as the accompanying graph shows, is just nothing like previously was. For decades the company consistently grew earnings per share but that all changed in 2008 and the company has not recovered. GE’s stock peaked in 2000 with a total shareholder value of more than $581 billion…it has lost $440 billion since that peak.
Source: S&P Compustat
Ford (F), the global auto manufacturer, reported preliminary earnings results for 2017 that disappointed Wall Street pushing its stock down -9.3% for the week. In addition to the 2017 disappointment, the company also provided 2018 guidance that was not up to expectations. The company is struggling with higher costs and slowing auto sales growth. This stock has been drifting lower for 3-4 years but had recently gained about 25% from August 2017 lows. The stock now has a very attractive dividend yield in excess of 5%.
Economic Indicator - Reported
Industrial Production, a measure of mining, manufacturing, and utilities, surged higher by +0.9% in December. This more than doubled the estimate of +0.4% but was offset somewhat by a downward revision of -0.3% for the prior month. Mining activity continues to be the leader in this space with a 1.6% gain for the month and higher by 11.5% for the year. Manufacturing has been lagging behind but is still up +2.4% over last year. Increased vehicle production was one of the highlights this month for manufacturing.
Consumer Sentiment, as measured by the University of Michigan, remains near high levels but has slipped from its October peak. This month’s reading came in at 94.4 which was well below the estimate of 97.0. This survey of 500 households has multiple components with the that portion focused on current conditions weakening the most this month. This suggests the possibility of weak consumer spending and possible concerns about employment.
Housing Starts took an unexpected dip in December falling -8.2% to an annualized rate of 1.192 million. This decline was driven entirely by a sharp drop in single-family starts while multi-family starts actually improved. It is expected that much of this drop could be weather related as permits remained strong.
Economic Indicators – Upcoming
We will get the first estimate of fourth quarter Gross Domestic Product (GDP). Economists, on average, are estimating the quarter comes in at +2.9%. A reading below 3% could be a disappointment as some have hoped for what would be three consecutive quarters above 3%. Consumer spending is expected to be the biggest contributor to the quarter’s growth with a drop in inventories expected to be a negative.
Durable Goods Orders, orders placed with U.S. manufacturers, have been strong and are expected to remain strong in the most recent month with economists forecasting a +0.8% gain.
Economists expected New Home Sales to remain strong at an annualized rate of 683,000. This report is volatile and would be a drop from the November surge that was the biggest gain in 25 years. Existing Home Sales are also expected to be strong and remain near multi-year highs.