Now What's Wrong With The REITs?

| About: Medical Properties (MPW)

The Market Performance of the REITs

By the way the REITs performed in the market this year you'd think that Mr. Rubric and not Mr. Market was in charge of pricing stocks. On June 28, I wrote an article called "What's Wrong with the REITs?" and stated that during the month of May they peaked and then became one of the weakest groups in the market. In the four months prior to that they were the strongest group among the 22 that I follow. "On the way up they led the market by a wide margin. On the way down they gave back all of their gains. On the way up the investment community must have thought the REITS were godsends. And when it reversed its opinion, decided they were going to hell."

I concluded that there really wasn't much wrong with the REITs to account for the poor performance other than the fact that the momentum traders were bailing out of the ETFs, which they piled into previously. And, I provided data relating to the trading patterns and volumes of the three main REIT ETFs to support my conclusion. There was also a lot of chatter among the Wall Street pundits that Fed tapering was imminent and that would lead to higher interest rates, which would arrest the growth prospects of the REITs while making their high dividend yields less attractive in comparison to the higher rates on bonds that would ensue. I debunked those considerations by providing charts and tables to show that such speculation was greatly exaggerated.

The Specter of Higher Interest Rates

Once again the performance of the REITs indicates that the investment community is of the persuasion that the REITs are going to hell. And once again we hear that Fed tapering will begin at some time in the not too distant future and eventually wreak havoc upon the REITs. There is nothing more maddening than trying to talk sense to the insane. So I will not waste time re-hashing the argument that I presented in the June 28 article. If anyone truly believes a rise in interest rates on 5-, 10-, and 30-year Treasury issues from their current levels of 1.42%, 2.75%, and 3.84%, respectively, to 3%, 4%, and 5%, respectively (which are their historical norms) will be the death knell for the REITs, that is his problem and certainly not mine. The higher interest rate environment that is likely to occur would be a return to a normal situation for the REITs and that shouldn't be much of a problem for them. The REITs fulfill a vital role in the functioning of our free enterprise economy. They did well in times past with interest rates at historical norms and they should be able to adjust and do so again. Nevertheless, when such an idea causes investors to dump shares on the market their prices will tumble to the consternation of investors holding positions in them. I will deal with this matter below when I consider the current technical merits of the REITs.

As far as comparative yields are concerned, the average yield on 34 prominent equity REITs and 240 industrial stocks that I follow are 4.2% and 1.9%, respectively. If prospective high yields on bonds (which have no growth potential) are going to make the yields on the REITs (which have growth potential) uncompetitive, how uncompetitive will the industrial stocks be with their much lower dividend yields? For perspective consider this: In 1951, the Fed lifted its peg on the 1-year T-bill and the 30- year T-bond. At the beginning of the 1950s the yield on the S&P Industrial Index was 2.5 times the yield on the 30-year T- bond. By the end of the decade the T-bond had a higher yield than the S&P index. In recent days the relative price action of the REITs was bad (and also indiscriminate) compared to the industrial stocks (and also indiscriminate), which increased. If higher interest rates will be bad for the REITs, why wouldn't it be even worse for the industrial stocks? The historical evidence suggests such should occur.

The stock market is what it is so it does what it does. George Bernard Shaw said that "The rational man adjusts to his environment while the irrational man tries to change it. Therefore all progress depends upon the actions of irrational men." Being rational (at least I hope so,) I am not a Don Quixote who is determined to change people's behavior or reform Wall Street. If Wall Street is ever reformed, it will be because Judgment Day has arrived and the rascals there finally got religion. So we may as well resign ourselves to the fact that we have to tolerate the fads and fallacies that are recurrent in the stock market. Therefore, as far as I am concerned the gyrations taking place in the market are nothing more than a continuation of the normal (abnormal?) ways of doing things. Today's investor, like those in times past, has to cope with the bulls and the bears. The alternative is to quit investing altogether. After all, when you're in a barroom environment it's a good idea to drink up or get out.

A Common Sense Consideration

I am very much interested in (and a student of) the behavioral patterns of Mr. Market. The price of a stock changes according to the law of supply and demand whether market participants are rational and well informed or not. And Mr. Market is the only one who can tell what the balance is between supply and demand for any stock at any particular point in time. When the investment community's propensity to buy a stock is greater than its propensity to sell it, the price goes up. And, of course, the opposite is also true. And over any given period of time, Mr. Market is forever vigilant as he responds to ever changing supply-demand balances by changing the prices of all stocks traded on all exchanges simultaneously. (But he does get unwelcomed assistance from the high frequency traders and others of such ilk who front run the market.) The process would quickly drive any mortal insane very quickly. But Mr. Market is not mortal. He is real even though he is only a symbolic figure. And, he is always perfectly informed about supply and demand balances any time he decides to change stock prices.

The price of a stock never goes up automatically because the subject company announced a good earnings report, increased its dividend, developed a new product, or whatever else deemed a favorable news item. It goes up because interested parties within the investment community reacted to the news item by increasing their propensity to buy the stock. But, what about the propensity to sell? Was the propensity to sell altered by the news item? Sometimes it is and sometimes it isn't. And if altered, to what extent? Mr. Market, in his inimitable way, is the only party able to detect the net affect because it will be reflected in the supply-demand balance and, Walla, the price will be changed to reflect that. Every investor should get to know and respect the behavior patterns of Mr. Market. Pay attention to what he is doing and you will find clues on the price charts relating to trends and trend reversals that should help you to improve your investment results.

Price Charts of the Beleaguered REITs

Let's take a look at some price charts relating to stocks in various sectors of the REIT industry and go on from there. They were constructed from data in my workbook. The first chart compares my index of 34 REITS with the market and the REIT ETFs.

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Pictured in the chart are the RSP market index (the white line) and my index of 34 REITS (the yellow line). The three major ETFs are the iShares (NYSEARCA:IYR) the brown line, Vanguard (NYSEARCA:VNQ) the red line, and the SPDR Dow Jones fund (NYSEARCA:RWR) the blue line. As can be seen all of the REIT indexes move together because they include many of the same stocks. During the five months shown they all underperformed the market as measured by the RSP.

The IYR is the largest of the three ETFs and it is the favorite among momentum traders as they ply their trade. While the market was up sharply on Friday, November 8, as measured by the RSP, the IYR was down sharply (along with the VNQ and the RWR) on abnormally heavy volume. It had been trading 11.9 million shares per day but on Friday 17.5 million shares traded, up from 9.7 million shares on Thursday. When one buys a share of the ETF he buys it from the ETF and is, in effect, buying into a basket of stocks. The outflow from the fund on Friday was about $520 million and required it to sell baskets of REIT shares. That is one important reason why so many of the REIT shares were down sharply on the day. I'm sure many investors were wondering what was wrong with the stocks they own when nothing really changed regarding the fundamental investment merits of the stocks they own.

The next chart shows the performance of REITs in the five sectors that I follow.

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My index of 34 REITs includes all stocks included in the four sectors shown other than the mREITs. You can peruse the chart however you wish but I just want to call your attention to the sharp drop in prices on Friday that was pervasive.

In light of what is going on with the REITs now-a-days, what is an investor to do? Instead of writing in vague generalities to express my opinion, let me show you what I am doing on a real time basis.

The next chart is that for the Medical Properties Trust (NYSE:MPW), which was selected as a focus article at Seeking Alpha last week.

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(1) The bold black line on top is price and the bold pink line below it is relative strength. (2) The three dotted lines (black, blue, and red) are moving averages and there is a set of those for price and a similar set for relative strength. They are used to define trends and detect trend reversals. (3) The 5 sets of gray parallel lines and the 10 sets of orange parallel lines (the two overlap half of the time) that frame the price action are 22-day and 11-day trading ranges. Their progression shows how the trading ranges shifted during the 110 days charted. And (4) the two wavy-blue hashed lines that straddle the price line are Bollinger Bands. They are used to detect overbought or oversold situations.

Any of the items listed as (2) or (4) is independent of the others and it could be considered as a valid technical indicator for making buy or sell decisions. But in order of importance, the moving averages are of primary importance while the trading ranges and the Bollinger Bands are of secondary and tertiary importance, respectively.

During the first 22 days of the 110 days charted (and for the 88 days, or four months, prior to that) MPW and the REITs as a group outperformed most industry groups in the market by a wide margin. Since peaking five months ago, they grossly underperformed the market and most major industry groups. While the market as measured by the popular averages peaked when the REITs did, it rallied after a brief sell-off and went on to make new highs for the year. It backed off in recent days but is still trading near its high. MPW and many other REITs couldn't sustain their attempted rally and are now priced at or near their lows for both the five months charted and 2013 to date.

During the past 22 trading days, as shown on the chart, the price action of MPW was such that (1) the price line completed a reversal of its moving average trend lines, (2) the relative strength line also showed improvement and the stock could start to outperform the market instead of underperforming it as has been the case, (3) the trading range is shifting upward, (4) It appears that a hard bottom was put in place about 33 days ago at $11.55. The stock's 52-week trading range was $11.04 to $17.73. And (5) on Friday the stock dropped 19 cents to $12.81 despite the fact that the company announced a 5% increase in the dividend rate. That announcement would likely have had a salutary effect on the stock's price on a day when REITs were not being dumped on the market.

With the company's strong fundamental merits, its FFO growth accelerating and well defined through 2014, the current dividend yield of 6.6% on the increased dividend, and favorable technical merits as evidenced by the stock's evolving performance on the price chart, I bought shares at $12.48 and still rate the stock a "buy" at this time.

However, with the REITs out of favor with the investment community at this time and shares being dumped on the market I intend to buy additional shares by putting in "low ball" bids and take advantage of trading opportunities that I can identify. I will be working with MPW, and two other stocks that I own, National Retail Properties (NYSE:NNN) and the RAIT Financial Trust (NYSE:RAS), which were also recent focus articles here at Seeking Alpha. And, I will also be looking at other REITs. Putting in "low ball" bids makes a lot of sense. It's better to put in a low-ball bid and not get a fill than buy at the market and be stuck with a loss. Chasing bids is the way to get whipsawed. A lot of technical damage has been done among the REITs and it is likely there will be some backing and filling during the days ahead.

Being Informed about Your Investments

Investors should stay informed about the equities in their portfolios. Seeking Alpha and Yahoo Finance are excellent sources for investment information. Since you are reading this on SA, I assume that you are well versed on what it has to offer. There are two features about Yahoo Finance that I would like to tell you about. I use both fundamental and technical analysis in doing what I do. I doubt that many of you are well versed on technical analysis, but that should not deter you from doing it. Anybody can do a credible job when it comes to technical analysis of a stock. But before proceeding, I want to warn you that what works for a stock doesn't work very well when it comes to the general market indices such as the SPY or the RSP because there are breadth and diffusion considerations that are of overriding importance.

Just follow these instructions:

(1) Go to Yahoo Finance and type in the ticker symbol of interest.

(2) From the menu on the left select "Basic Tech. Analysis."

(3) From the menu on top, compare your stock with the S&P Equal Weight Index ((NYSEARCA:RSP)) or the S&P Industrial Index (NYSEARCA:SPY). That will show you how your stock has been performing in comparison to the overall market. You want your stock to be a leader in the market and not a laggard.

(4) Then from the moving averages, select 10, 20, and 50 (they must be selected one at a time). These aren't the time intervals I use but they will do.

(5) Having done that, you are now ready to render an informed opinion as a "market technician." If the stock's price is above the trend lines, the indication is that it will go higher; if below, it is likely to go lower.

(6) Trend reversals are difficult to forecast in advance but they don't have to be. They occur when the trend lines as indicated by the moving averages are newly broken. In order for the reversal to be complete, all three of the moving averages have to be broken. Once broken, you either have a "durable" reversal or a "false" reversal. With lots of practice, you can learn how to (A) make decisions early in the reversal process and (B) distinguish between durable and false reversals.

(7) Technical analysis is a continuing process and it doesn't forecast anything by itself. It shows you the up-to-date end of the stock's price history. With that as guidance you can be the forecaster and make an informed guess regarding the stock's price action beginning with the next trading day, which is, of course, the growing edge of the future. Try it. You'll like it.

(8) Technical analysis is an art and not a science. Stay up to date and you'll take the mystery out of stock price movements. Become self-reliant and you'll chain the wheel of fortune and never have to sit in fear of its rotation as far as the stock market is concerned.

Another technique that could be used to keep up to date on stocks of interest to you is as follows: (1) go to Yahoo Finance and click on the "Portfolios" tab. (2) Create a portfolio by listing your stocks as directed. (3) Create a shortcut so it appears on your desktop. It's that simple. When you want to see your portfolio, click on the shortcut. You will get up to date quotes on the stocks chosen. Furthermore, below those quotes you will see a list of current news items on each stock in the portfolio.

Yahoo and Seeking Alpha are truly excellent sources for investment information, and you can't beat the price. It's zero with a double your money back guarantee. If you have a problem with the people at Seeking Alpha or Yahoo, just tell them that Tom sent you.

Disclosure: I am long MPW, NNN, RAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.