The stock market didn’t exactly react well to the Fed’s non-decision to keep the targeted Fed funds rate unchanged last week. The S&P 500 and Dow both spent most of Thursday and Friday in freefall, and as I’m writing this, both are only modestly in the black today.
But one cornrner of the market has held up a lot better than the rest: boring, “bond-like” real estate investment trusts, or REITs.
You see, while stock prices dropped like a rock, bond prices actually enjoyed a nice rally. And REITs, which have come to be seen as bond replacements in this era of ultra-low bond yields, have followed suit. I’ve written about this recently.
This chart shows a bunch of REITs against the S&P 500:
Not bad. And they could do even better if the Fed keeps rates low like I suspect they will.
If the Fed is too scared to raise rates, that tells you that there are enough macro risks out there to keep bond yields low for awhile. If and when the Fed finally does get motivated to raise rates, I don’t see that translating to higher long-term bond yields, or at least not for a while. A higher Fed funds rate is disinflationary, which is good for bond prices.
So for the time being, we seem to be in a sweet spot for bonds where, irrespective of what the Fed does, bond yields should stay low for a while.
And as long as bond yields stay low, REITs should continue to outperform the broader market.
Besides that, short sellers have been punishing the sector for months in the view that higher interest rates would wreck the sector.
But here’s the thing – they haven’t! And here’s the other thing – all those short sellers are obligated to buy those REIT stocks back.
That’s what happens when you short a stock. So these overly-punished REITs could be looking at a nice bump.
To toss out a few examples from the list above, Realty Income (“O,” very tip top, black line) has a short interest currently equal to more than 10 days’ worth of daily volume. VEREIT (“VER”) has a short ratio of 8 days to cover. And Digital Realty (“DLR”) has an almost ridiculously high short ratio of 18 days to cover.
So with REITs showing strength right now, I expect those short sellers to start bailing… and soon.
Even though they generally have a low correlation to the broader market, REITs are still stocks. And if we have another volatile rough patch like August, you can expect them to fall alongside the rest of the market, at least temporarily.
But I still expect REITs to massively outperform the broader market for the remainder of 2015, particularly if the shorts get squeezed.
Editor, Dent 401k Advisor