The Federal Reserve’s hawkish tilt is upending real-estate
investment trusts and other stocks with juicy dividend yields that had been
thriving in a lower interest-rate environment.
S&P 500 real-estate stocks fell 1.2% last week, hurt by
the Fed’s decision to lift interest rates on Wednesday and its signal that the
bank could pick up the pace of future rate increases. Those real-estate shares
are down 4.3% for the year, among the worst performances of any S&P sector
and well below the broader index’s gain of 4%.
REITs’ underperformance is another sign of how the Fed’s
response to a strengthening economy is rippling through the stock market.
Investors often buy shares of real-estate firms and other
stocks like utilities for safe, bondlike returns. But as the Fed accelerates
the pace of policy-tightening, the payouts on U.S. government bonds are rising
and forcing investors to consider whether they are better off shifting money
into bonds that are poised to see higher yields. The Fed plans
to increase rates two more times this year, eventually pushing the
fed-funds rate to a range of 3.25% to 3.5% by the end of 2020.
“We’re at the point where interest rates are starting to
actively compete with high dividend yielding stocks for investors’ dollars,”
said Steven Violin, senior vice president and portfolio manager with F.L.
Putnam Investment Management Co., a firm that manages about $1.7 billion in
assets.
The yield on the benchmark 10-year U.S. Treasury note
briefly rose above 3% after the Fed’s decision Wednesday and continues to hover
around that level. That is just below the 3.1% dividend yield offered by
real-estate stocks in the S&P 500, which is among the highest in the index.
Wells Fargo recently
downgraded its outlook on the real-estate sector. In a research report, John
LaForge, head of real asset strategy at Wells Fargo Investment Institute, said
real-estate investment trust “performance often moves in an opposite direction
from interest rates.” REITs were also hit hard by the February spike in 10-year
Treasury yields.
Real-estate stocks in the S&P 500 have risen the last
four years, when interest rates were at or near zero, and posted a 7.2% gain in
2017.
Wells Fargo says the average REIT trades at a roughly 7%
discount to its underlying real-estate holdings, keeping valuations relatively
attractive since such investments have averaged a 2.3% premium since 1990.
Appealing valuations kept Wells Fargo from downgrading the sector beyond
neutral, the bank added in its note.
Commercial real-estate prices have also been steadily
gaining, providing some support to the sector amid the changing interest-rate
environment. The Green Street Commercial Property Price Index, for example, has
steadily risen since 2010.
Fund managers who actively manage their portfolios have
already cut exposure to the real-estate sector to a six-month low, according to
a Bank of America Merrill Lynch report.
Investors pulled another $71.8 million in the last week
from the Vanguard Real Estate exchange-traded fund, bringing the roughly $30
billion fund’s total outflows this year to $2.6 billion, according to FactSet.
Utility stocks, which also generate hefty dividends and
tend to underperform in rising-rate environments, are also struggling, falling
6.7% so far this year. Of the 11 major S&P 500 sectors, active managers
have the least exposure to utility and real estate, Bank of America Merrill
Lynch said in its report. Utility ETFs managed by State Street Global Advisors,
Vanguard Group, BlackRock and Fidelity Investments have all suffered outflows
so far this year, according to FactSet’s data.
Rising interest rates aren’t necessarily bad news for stock
investors. Shares of financial firms such as banks tend to benefit when
interest rates rise because it makes their lending operations more profitable.
The KBW Bank Index, which includes 24 different banks including large lenders
like Bank of America Corp. and
smaller firms likeKeyCorp and Comerica Inc., is up 1% so far
this year.
Shares of consumer-staple companies, which have struggled
lately with trade tensions, rising costs and shifting consumer preferences, are
also getting more interest from investors lately. Active fund managers have
upped their exposure to the sector for four months running, Bank of America
Merrill Lynch said, a defensive posturing in the current environment since
those stocks sell everyday essentials like food and beverages that tend to do
well in the latter stages of an economic cycle.
Retail investors are taking notice too, and have
contributed to the $219 million that has flowed into the Consumer Staples
Select Sector SPDR fund, FactSet said.
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