Evening Brief – 05.08.24
REIT Revival?
The uptrend in the U.S. equities, aside from the pullback in April, has been led by relative strength in the communications services and energy sectors, which are both outperforming the broader market.
The Communication Services Select Sector SPDR Fund (XLC) and the Energy Select Sector SPDR Fund (XLE) are both showing strong year-to-date returns, with each ETF posting a 12.2% return. These gains represent moderate premiums over the broader market’s performance, as measured by the SPDR S&P 500 ETF (SPY), which has returned 9% year-to-date.
The performance of key equity sectors year-to-date reflects varying degrees of strength relative to the overall market, based on the SPDR S&P 500 ETF (SPY). While most sectors have posted gains that either match or fall short of the overall market’s multi-month advance, real estate stands out as the worst performer among the sectors.
The performance of real estate shares, which are admired for their comparatively hefty payouts, have suffered as U.S. government bond yields have risen. The increased competition in risk-free government bonds seems to be contributing to the sell-off in real estate investment trusts (REITs).
According to Morningstar.com, the Real Estate Select Sector SPDR (XLRE) ETF, which has declined 6.9% year-to-date, now yields 3.69% for the trailing 12-month period. Comparatively, the U.S. 10-year Treasury yield is 80 basis points higher at 4.49%.
For some analysts, the slide in real estate shares represents a buying opportunity, despite recent delays in expectations for rate cuts by the Federal Reserve. “From where listed REITs are currently priced, I don’t believe the market needs to expect rate cuts for REITs to deliver solid performance,” said Janus Henderson Investors’ Gregory Kuhl.
“We have view recent performance trends from a contrarian standpoint and believe the sector is poised for a turnaround in the coming months and are recommending that investors use its current weakness as a dip buying opportunity,” added chief investment strategist Brian Belski, BMO Capital Markets.
The comparison between the performance of the utilities sector (XLU) and the real estate sector (XLRE) sheds light on the nuanced dynamics affecting REITs beyond just yield differentials. While both sectors are sensitive to interest rates, their divergent performance year-to-date (XLU is up nearly 10%) suggests that sentiment for real estate may be influenced by additional factors beyond attractive U.S. yields.