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What Is In Store For REIT ETFs Ahead?

As the timeline of the first rate hike after a decade is approaching this month, interest-rate sensitive sectors like REITs are falling out of investors’ favor. REIT ETFs emerged a winner last year thanks to widespread volatility, but are mostly in the red this year as the Fed liftoff is looming large (read: Top ETF Stories of November ). Notably, REITs own and operate income-producing real estate. They are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends and can in turn deduct the payout from their corporate taxable income. The basic idea is that a rise in interest rates will undoubtedly lead to a high borrowing cost on which the REITs are highly dependent. Moreover, high-dividend yielding stocks like REITs usually become less attractive when treasury yields rise. At this point of time, we can say that a policy tightening is unavoidable in the mid-December Fed meeting; at least the Fed officials and economic progress are giving such cues. Minor lack in some economic readings wouldn’t come in the way of the Fed decision. Recent comments from the Fed have certainly influenced Treasury bond yields too. With the yields increasing, several investors may now be turning away from REITs. But do REITs deserve such negligence? Are investors overreacting? Let’s find out. Short-Term Yields Rising Faster Investors should note that the 10-year benchmark Treasury bond yields jumped 21 basis points to 2.33% (as of December 3, 2015) since the start of the year, a relatively slower ascent than what we saw in 2013 due to Fed taper talks. It was the short end of the yield curve that was hit hard (read: Short-Term Bond Yields Rising: Timely ETF Bets ). Yields on the six-month U.S. Treasury bonds surged 34 bps to 0.45% (as of the same date) since the start of the year as the Fed hikes the benchmark rate. In such a situation, investors can very well bet on the income-producing securities like REITs as long-term Treasury yields are not rising as fast as feared. Moreover, the Fed repeatedly asserted that it will take a slow stance in policy tightening giving yet another reason not to worry much over REIT securities. As investors continue to search for income, REITs can give them some market-beating yields which will in turn make up for capital losses also, if there is any. Economic Strength to Bode Well The negative correlation between rising rates and REITs, in all cases, is a common misconception. Notably, when rates rise on the back of a pickup in the economy, REITs actually outperform. As per reit.com , “in the 16 periods since 1995 when interest rates rose significantly, Equity REITs generated positive returns in 12.” The REITs business is associated with basic consumer requirements like apartments, shopping malls, warehouses, lodging and dining, office, hospital among others. In a growing economy, people consume and spend more in malls for discretionary purchases. An uptick in the U.S. housing sector is now a known fact; job growth will push office REITs and hospital REITs are always a stable area, irrespective of the market condition. Now, as the Fed is viewing the economy as strong enough to gobble up the first rate hike, there should not be much downside risks in REIT stocks and ETFs. After all, the job market is healing and inflation is inching up. REITs stand to gain with growth in occupancy and hike in rents. The consistent increase in rent will also help REITs to keep pace with inflation. Overvaluation Concerns However, there are hurdles in the path too as REIT ETFs are not all cheap investments. The popular Vanguard REIT Index ETF (NYSEARCA: VNQ ) trades at a P/E ((ttm)) of 34 times against the SPDR S&P 500 Trust ETF’s (NYSEARCA: SPY ) P/E of 19. So, just as the Fed pulls the trigger, a correction, probably a short-lived one, is expected in the REIT space. Below highlight three REIT ETFs that were relatively less hit by rate worries in the last one-month frame and proved sturdier in the pack. iShares Residential Real Estate Capped ETF (NYSEARCA: REZ ) The $319-million fund is heavy on Residential REITs and Health Care REITs. The 37-stocks fund charges 48 bps in fees. However, the fund has concentration risks as its first two holdings take about 23% of the basket. The fund yields 3.25% and was down just 0.02% in the last one-month frame (as of December 3, 2015). IQ U.S. Real Estate Small Cap ETF (NYSEARCA: ROOF ) The fund holds 60 small-cap stocks in the basket. It is an unpopular choice with about $86 million in assets. The ETF charges 69 bps in fees per year from investors. The product is less concentrated across its top 10 securities as no stock accounts for more than 3.50% of the basket. ROOF was down 2.5% in the last one month and yielded 5.68% as of December 3, 2015. The fund currently has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook. iShares Cohen & Steers REIT ETF (NYSEARCA: ICF ) This $3.57-billion fund holds 30 securities. Industry-wide, retail, residential, specialized, office and health care REITs get double-digit weights. The fund charges 35 bps a year in fees. The fund lost about 2.9% in the last one month and yielded 3.22% as of December 3, 2015. Link to the original post on Zacks.com

Relative Strength In Rising Rate Environments

By Andy Hyer With wide expectation that the Fed will raise interest rates this month, it is worth considering how a momentum strategy tends to perform in a rising interest rate environment. Invesco PowerShares addressed this topic in their September 2015 paper Harnessing the Power of Factor Investing . According to their findings, momentum was able to generate excess returns in both rising rate and declining rate environments. However, the excess returns were higher in rising rate environments. (click to enlarge) (click to enlarge) Some thoughts on why this pattern may occur: By the time rates rise you are typically well off the market bottom and well out of a recession. On average, stocks are at least fairly valued at that point and there aren’t a ton of bargains to be had that are really cheap for obvious reasons. At that point investors look for growth and that is what momentum is good at picking up. Late cycle also means fewer stocks participating in the rally, which is also good from a momentum perspective. Good momentum stocks usually don’t have to rely on cheap financing (they can generate cash flow organically) so they don’t get crimped like value stocks do when rates rise. While many seem to fear what affect a rising interest rate environment will have on stocks, it is worth remembering that rising rates have tended to be good for a momentum strategy. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

Heading Into Winter, Propane Sales Look To Repeat 2014 Results

Summary Propane distributors like Suburban Propane and AmeriGas Partners count on the next few months for substantially all their income. With propane supply near all-time highs, wholesale prices have fallen through the floor. Consumers look to benefit this year, but pricing spreads indicate a repeat of 2014 results. The early indicative data for propane distributors such as Suburban Propane (NYSE: SPH ) and AmeriGas Partners (NYSE: APU ) is a mixed bag heading into the incredibly important winter season. This period running from November-March of each year is an incredibly stressful time for these propane distributors, who derive substantially all of their operating income during the winter heating season. The first hurdle for these companies is the weather. The chance of a deep winter chill currently looks decent for some areas of the United States and mediocre for the rest . Most meteorologists forecast above average temperatures for the Northeast, with below average temperatures for much of the Southeast and East Coast. As the South and Midwest form the largest markets for propane, these forecasts end up being a mixed bag and are hard to call as solidly favorable in one direction or another. (click to enlarge) * Source: EIA.gov From a market perspective, available supply of propane continues to peak well above long-term historical averages, due to the significant bounce in production of the commodity from ever-increasing domestic production. Shortages that were widespread in many markets in 2014 seem unlikely to repeat themselves this time around. This excessive supply has brought wholesale and residential propane prices down, yielding what should be solidly lower prices going into this year’s heating season for consumers. This is a bright spot for those that count on propane to heat their homes, but what does it mean for propane distributors? Fixed Margin Pressures Usually, low propane prices provide a boost for propane distributors like Suburban Propane and AmeriGas Partners. All else equal, low propane costs increase the demand for their products and protects against customers switching to alternatives, such as heating oil or electricity. With propane and other alternative heating fuels more commonly used among rural homes with lower annual incomes, these consumers are much more cost sensitive to price changes than the heating markets served by traditional utilities. Propane distributors, while keeping that fact in mind, still try to maintain a fixed spread between the wholesale and residential cost of propane. This is where they can derive their profit, and we can see the results of that in a comparison from 2014 to 2015 below. (click to enlarge) Trying to protect this fixed margin per gallon is why we see the current market situation in propane today with resiliently high residential propane prices. While wholesale propane prices are down 46% from a year ago according to EIA data, skirting along at $0.50/gallon in 2015 from $0.93 gallon in 2014. Residential prices have remained stubbornly high in the meantime, and are only down 19% year/year. In my opinion, wholesale prices in the U.S. cannot fall much further, so this year will be as good as it can get for propane consumers. At these prices, it is barely worth it for producers to ship, store, and market it for sale. Look for propane exports to increase, as unlike natural gas, propane is more easily shipped abroad for sale, and these price declines make exporting increasingly attractive. (click to enlarge) Heating oil, a chief competitor of propane, looks more profitable going into the winter of 2015/2016. The profit spread is up, but heating oil is primarily used in the Northeast , where it heats nearly 30% of all households. If we remember our 2015 weather forecast data, this area is at this point expected to be a little warmer than usual. The demand may not simply be there for the product compared to 2014. Conclusion With margin spreads down and supply up, propane producers are counting on a chilly winter to drive some additional demand to make up the difference. Without old man winter swirling up some unexpected cold, investors should expect operating income flat to slightly down from 2014 levels. Suburban Propane has the most opportunity for surprise earnings upside over 2014 due to its heating oil exposure, but only if the Northeast comes in much colder than expected. Heating oil is set up to be better currently year/year, and with supply running at long-term averages, a cold shock in the Northeast could drive significant demand for the company.