REITs Could Rebound from Here

By Tom Lydon, ETF Trends

Real estate investment trusts and related exchange traded funds have weakened in response to rising rate concerns. However, fundamentals may still support the market.

Over the past three months, the Vanguard REIT ETF (NYSEArca: VNQ) fell 8.9%, SPDR Dow Jones REIT ETF (NYSEArca: RWR) decreased 8.4% and iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) declined 7.9%.

Citigroup’s Michael Bilerman argues that after the sell-off, REITs have become increasingly attractive to net asset values, bonds and broad equities, reports Teresa Rivas for Barron’s.

Specifically, Citigroup analysts point out that healthcare REITs look better after the upward movement in interest rates weighed on recent performance. The sub-sector is especially sensitive to change sin rates because of its elevated external growth expectations and spread investing.

Hotels and lodging-related REITs also have solid fundamentals that remain intact, with improving demand, and will support the group through the second half of the year, Citi said.

Office REITs were weak over the second quarter, but Citi argues that the group could present opportunities for outperformance.

Citi is also overweight residential REITs as growth and valuations remain attractive. While new supply is coming online, demand for rental apartments is still high – recent data showed that apartment occupancy rates are at record highs.

Lastly, Citi sees increased demand among strips or mall-related retail REITs.

The various broad REITs ETFs allow investors to capture diversified exposure to these these sub-sectors. For example, VNQ includes 13.2% healthcare REITs, 7.4% hotel & resort REITs, 16.3% office REITs, 16.8% residential REITs and 25.1% retail REITs. RWR holds 18.4% apartments, 16.2%, regional malls, 12.4% healthcare, 10.8% office, 7.4% strip centers, 7.1% hotels and 3.9% mixed industrial/office space.

Additionally, investors would also be taking a broad view on economic growth with REITs investments. Some investment experts argue that since commercial property has a larger presence in the U.S. economy than REITs do in the equities market, investors could benefit from a 5% to 10% allocation to REITs to bring their investments more in line with commercial property’s significance in the overall economy.

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Vanguard REIT (VNQ) and Vanguard Ex-US REIT (VNQI) are components of the D2 Capital Management Multi-Asset Income Portfolio. Current yield on the portfolio is 6.01% (as of 5 July 2015).  

Disclosure:  I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.

Ride Those Real Estate Investment Trusts

By Richard Stavros, Investing Daily

Real Estate Investment Trusts are cheap now. The stocks have oversold, as investors overreacted to expected U.S. Treasury rate increases this year. Since the beginning of the year REITs are down 2.54% versus a 2% gain for the S&P 500.

And yet, the Federal Reserve doesn’t appear to be in any hurry to raise rates. Last week Fed Chair Janet Yellen said that she would raise rates this year only if the economy met her economic forecast.

Don’t bet on the economy catching fire anytime soon. A recent analysis by Bloomberg shows that since 2012 Fed policy makers have consistently overestimated the strength of the economy.

So, it’s possible that rate hikes will be more modest than expected. 

But even with rate hikes, REITs are a good deal, which gives us more faith in the Global Income Edge eight-REIT portfolio. REITs have been an excellent investment to preserve value during rate hikes, are good inflation hedges, and provide diversification because REITS don’t move in sync with the overall market.

For example, during rate hikes REITs have generated an average annual return of 11.4% over the six monetary tightening cycles that have occurred since 1979. And over the seven periods since 1979 when U.S. Treasury yields were rising, REITs generated an average annual return of 14.9%, according to a report by Cohen & Steers.

And three Wharton professors recently found the two assets providing the most dependable inflation protection have been commodities and equity REITs. Commodities equaled or exceeded inflation during 70.4% of high-inflation periods and equity REITs were close behind at 65.8%.

For example, inflation in the U.S. was 13.5% during 1979, the worst inflationary year since 1947. But dividend income from REITs averaged 21.2% that year, and total returns amounted to 24.4%.

So we hope investors will always keep in mind the value of diversification which REITs can bring, even as we recognize how powerful the promise of rate hikes in U.S. Treasuries can be to any income investor.

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Vanguard REIT (VNQ) and Vanguard Ex-US REIT (VNQI) are components of the D2 Capital Management Multi-Asset Income Portfolio. Current yield on the portfolio is 5.73% (as of 16 June 2015).  

Disclosure:  I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

The Case for Dividend-Paying Stocks, Now and Later

By ThinkAdvisor

Financial advisors concerned about the outlook for stocks given the length of the current bull market — now in its seventh year — expectations of a Federal Reserve rate hike and a slowing U.S. economy might want to consider favoring dividend-paying stocks for their clients.

In a recent note to clients, Goldman Sachs equity strategists wrote that dividends and buybacks will be “the sole contributor to the total return in stocks for the next 12 months” because stocks are expensive. The median stock in the S&P 500 is trading at 18.2 times earnings — the 99th percentile of historical valuation price-to-earnings ratio, creating a “limited scope for further upward expansion,” according to Goldman.

There are other reasons to favor dividend-paying stocks this year:

—The yield on the S&P 500 is 1.92%, which, according to John Buckingham, chief investment officer of Al Frank Asset Management, is competitive with the 2.2% yield on the 10-year U.S. Treasury. Moreover, stocks have a much greater potential for capital appreciation than Treasuries.

— Stock dividends have been rising and could rise more this year. Buckingham says 381 companies in the S&P 500 hiked dividends in 2013 and 375 did so last year, but “payout ratios are still relatively low so corporate America continues to have the capacity to increase dividends.”

Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, says companies paid out a record $93.6 billion in the first quarter, continuing a trend of rising quarterly dividends that began two years earlier and has room to grow.  “Investors are getting more than they ever got before, but that doesn’t mean companies are being generous,” says Silverblatt. “Companies are paying out only 37%-38% of GAAP earnings to dividend holders, but historically they paid out 52%.”

— Dividend-paying stocks, like many stocks, have historically performed well in past periods of rising rates, despite reports to the contrary, says Buckingham. The key for performance will be earnings. “If the stocks have higher growth rates, and can raise the dividends as interest rates rise, these stocks will be less sensitive to interest rates and likely a good place to be invested,” writes Ryan Wibberley, CEO of CIC Wealth, a financial advisory firm in the Washington, D.C. metro area, in Forbes. Six months before and 12 months after, stocks overall have gained ground, notes Buckingham.

But if stock prices fall this year—because of earnings disappointments, a long overdue correction or a Fed rate hike -- dividend-paying stocks could still perform relatively well because their payouts will cushion losses.

— Dividend-paying stocks outperform in the long run. Looking beyond this year, Buckingham says dividend-paying stocks are a better investment for the long term. From 1927 through 2014, dividend-paying stocks have had an annual total return of 10.4%, trumping the 8.5% for non-dividend payers, says Buckingham, citing data from famed value champions Professors Eugene Fama and Kenneth French. The larger the dividend, the greater the outperformance, says Buckingham, who hosted a webinar on "The Case for Value Investing in 2015 and Beyond," which focused largely on the appeal of dividend-paying value equities.

— Dividend payers are less volatile. The volatility of dividend payer, as measured by standard deviation, is 18.3% compared to 30.1% for non-dividend paying stocks. That could calm investors' fears during a market correction, which is not unexpected.

“Given the historical evidence, we believe that dividend payers deserve a large portion of any equity allocation,” says Buckingham.  He favors dividend-paying value stocks, which have outperformed growth stocks 80% of the time, though not lately. “The fact that value has underperformed increases the odds in favor of value versus growth,” says Buckingham. 

Longer term, says Buckingham, “while not risk-free, of course, neither value nor dividend stocks as a group have ever lost money for those who held for 15 years or longer.”

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Why You May Want to Be (and Stay) in Bonds

By Heather Pelant, Personal Investor Strategist for BlackRock.

Perhaps no asset class is as lingo-loaded as bonds. Fixed income, rising (or falling) yields, junk bonds, Fed tightening, TIPS, spreads, mortgage-backed securities – there’s no shortage of jargon for this supposedly “boring” investment that most of us own in our portfolios.

Bonds are admittedly complicated, and it’s easy to feel intimidated or confused by what’s happening in the news. Fortunately, you don’t need to be a numbers geek to be an informed investor. So let’s get past the industry-speak and focus on what you really need to know about bonds.

What are they?

My BlackRock colleague Matt Tucker regularly explores bond basics. In short, bonds are loans that investors make to governments, companies, pools of mortgage owners or many other types of issuers. In exchange for your money, the borrower promises to pay back the principal at maturity, with regular interest payments along the way. That interest income is a bond investor’s primary source of return, although bond prices can also appreciate or decline in the marketplace.

One important concept to understand is yield, which is the annual income on a bond, based on its market price; it’s sometimes used interchangeably with “interest rates.” Matt recently took a closer look at yield when discussing yield curve basics.

Today, yields are exceedingly low. In Germany, for example, some government bond yields are negative, meaning that investors are actually paying the government for the privilege of lending it money. U.S. yields are somewhat higher – around 1.9% for 10-year Treasuries – but the big question for bond investors right now is, how much higher they might go?

Why do people invest?

Investors look to bonds to meet a number of key financial goals. These are the top three:

Diversification. This should always be on everyone’s list. Bonds help serve as a true diversifier to a stock portfolio, meaning they almost always react differently to economic and financial conditions. If you go back to 1926 (88 years), stocks were negative in 24 calendar years. Bonds were negative in only two of those years. That divergence can help smooth out your overall returns, and add a cushion when stocks go down.

Income. The regular interest payments of bonds have historically provided a steady stream of investment income. With yields so low, however, investors have had to think differently about how to source it, either by taking on a little more risk or investing in bond funds that specifically target income.

Capital preservation. Bonds – specifically core, high-quality, intermediate-term bonds – have been significantly less volatile than stocks, making them a good anchor for your portfolio. Diversifying across different types of bonds can further help manage risks such as inflation, rising rates and default implosions, which can hurt bond prices.

How do I get in?

Most investors should own some bonds, at least for diversification. And investors have a wide field to choose from, whether it’s through actively managed bond mutual funds or low-cost exchange-traded funds (ETF), or a combination of both. 

How much, how many and what kind will depend on your own risk tolerance, financial circumstances, goals and so on. This is a great conversation to have with your advisor or someone else you trust.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Why International Diversification Matters Today

By Russ Koesterich, CFA, Chief Investment Strategist for BlackRock.

Given the breadth and diversity of the U.S. economy and market, it’s understandable that many U.S. investors feel comfortable keeping their money within U.S. borders. Indeed, over the past six years, U.S. investors have been rewarded for staying close to home.

Since the start of this bull market in March 2009, one of the longest in history, a 60/40 split of U.S. stocks and bonds would have been hard to beat. The S&P 500 has gained roughly 200% during this time period, while U.S. bonds have been surprisingly resilient.

However, while the tendency to invest close to home is understandable, it may not be optimal. Case in point: A big U.S. equity overweight has been less successful year-to-date, given the recent pullback in U.S. equities and particularly strong performance from Europe and Japan. While three months of relative performance shouldn’t change anyone’s long-term asset allocation, recent events are a useful reminder that U.S. outperformance isn’t pre-ordained and that it’s important to consider having exposure to international stocks. In fact, there are three reasons why international diversification matters now more than ever for U.S. investors.

Relative valuations.

A willingness to pay up for U.S. equities has resulted in several years of steady multiple expansion. While the current premium on U.S. stocks makes some sense in the context of low inflation and low rates, valuations look stretched relative to stocks in the rest of the world. This is particularly true based on the price-to-book (P/B) measure. Currently the P/B on the S&P 500 Index is roughly 75% higher than for the MSCI ACWI-ex U.S. Index. This is the highest premium since the market bottom in 2003. Longer-term metrics, such as cyclically adjusted price-to-earnings, or CAPE, ratios, are even more troubling, suggesting that U.S. stocks are likely to produce, at best, average to below-average returns over the next five years. The U.S. may have the best fundamentals, but U.S. equities have rarely posted stellar returns from today’s valuation levels.

U.S.’s declining share of world GDP.

While the U.S. is still arguably the world’s most dominant economy, its relative share of the global economy is shrinking. Thirty years ago the United States accounted for roughly one-third of global output. Today the number is closer to 20%. Depending on the exact methodology, China is now the world’s largest economy or soon will be. While China’s rate of growth is slowing, China along with India, Indonesia and many other emerging markets may continue to outgrow the United States and other industrialized countries for the foreseeable future. This suggests that owning a predominately U.S. portfolio underweights the potential dominant and fastest growing portion of the global economy.

The basic tenets of portfolio construction.

Finally, owning a portfolio solely focused on the United States may lead to sub-optimal risk-adjusted returns. In other words, investors may be taking on risk that could otherwise be managed with diversification. This is a particularly important point today as stock correlations have fallen to their pre-crisis level, suggesting a greater benefit to diversification. To be sure, diversification isn’t a magic elixir, and it may not protect against market risk or loss of principal. The biggest caveat is that it’s least likely to work when most needed, i.e. during a crisis. Instead, the benefits are derived, almost imperceptibly, over a multi-year time frame. But given the state of the U.S. market and economy, while international diversification may be a sensible idea for most U.S. investors, its benefits are even more likely to accrue in the coming years.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

What a Rate Hike May Mean for Stocks

By Russ Koesterich, CFA, Chief Investment Strategist for BlackRock.

By the end of the year, investors will likely be contending with the first Federal Reserve (Fed) rate hike in nearly a decade.

While the pace of monetary tightening is likely to be gradual, more than a few investors are worried about the equity impact of any marginal tightening, believing that the entire edifice of today’s bull market has been built on a foundation of cheap money.

I would agree with the view that monetary policy has been one of the principal catalysts and sustainers of this bull market. But I’m skeptical that an initial rate hike will herald the end of the rally, though history does suggest that it could result in a modest correction.

Not only is any tightening likely to be gentle and from an exceptionally low base, but tighter monetary conditions are generally associated with more volatility and downside risk, not bear markets.

When you look at S&P 500 performance during rate cycles for various periods going back to the 1970s, a clear pattern emerges. Regardless of the period, 3-month returns following the start of a period of steady tightening were on average negative and more volatile, as markets initially reacted negatively to the start of a tightening cycle. However, looking out at 6 or 12 months, markets rebounded and generally produced positive, albeit subpar, returns. The chart below looking at forward 3-, 6- and 12-month returns on the S&P 500 following an initial change in the Federal Funds target rate shows this pattern.

The averages above do hide a significant amount of variation in returns, and the direction of equity valuations at any given point in time also matters. Indeed, in the past, U.S. equity markets have been more resilient to tightening monetary conditions if valuations were flat or lower over the preceding 12 months. But if valuations had been rising in the previous year, the S&P 500 has historically performed much worse following the start of a tightening cycle.

Put differently, markets characterized by multiple expansion—in other words, when investors are paying more per dollar of earnings—are more vulnerable to a change in monetary conditions. The fact that U.S. equity multiples have been consistently rising since 2011 suggests that markets are at greater risk for at least a modest correction following a rate hike. In addition, one area of the market – namely small caps – may be particularly vulnerable and warrants caution. Historically, small caps have been more sensitive than large caps to the reduction in returns associated with monetary tightening.

To be sure, this will be a very different tightening cycle than previous instances. Rates have never been this low for this long, and the Fed will be forced to adopt a new set of monetary tools to wind down its bloated balance sheet.

As a result, the equity market’s reaction to tightening is more unpredictable than it has ever been, a fact likely to increase anxiety and uncertainty throughout the cycle. Still, a normalization in U.S. monetary policy is unlikely to herald a catastrophe.

Starting this fall, investors should, at the very least, expect more volatility and a heightened likelihood of a correction.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Guaranteed! Make LESS money investing!

Recently a new client came to the office.  His small Roth Individual Retirement Account was not doing very well.  He opened the account a few years ago with a company well known for working the "Middle America" and "Main Street" marketplace and constantly trying to recruit folks to pitch their offerings.

At first glance of his Account Statement I noticed that the person responsible for managing the account was not referred to as an "Advisor" but rather he was a "Dealer."  Dealer?  I expect to see "dealers" in Las Vegas, and not on someone's individual retirement account.

Then I looked further into the account.  There I saw why the poor fellow's account was underperforming.

He had taken the responsible steps of making $150 contributions monthly to his Roth IRA.  But out of that $150, only around $141 was being invested.  Each month the "investment company" was skimming almost six percent in sales charges on each transaction.

So right off the bat his investment was in the red six percent.  He has to earn all that back just to break even!

Then we looked at just where the money was being invested.  It was in a single mutual fund that held conservative large companies based in the United States.  There were no mid-sized or small-sized companies.  No global companies either.  All of the eggs were in a single basket with no diversification.  While this fund would serve as a good cornerstone for a portfolio, it was missing entire chunks of the total stock market which would significantly increase the value and growth of the portfolio.

Obviously the new client was both surprised and distressed over the findings.  Going forward we're going to work our hardest to make this account perform significantly better.  You only have one shot at retirement.  Make it count.

Lesson learned?  If you want to gamble your money with a "dealer", then go to Las Vegas, Best Bet, or Victory Casino Cruises.  If you want competent, impartial and professional investment advice consult with a registered investment advisor.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.