- REITs historically have generated real income and outperformed other assets in a high inflationary environment.
- Strong demand for chips may persist in the coming years due to the increasing penetration of 5G smartphones, Internet of Things (IoT), and post-pandemic digital transformation that spurs demand for new generation data centers and cloud services.
- Biotech’s significant drawdown and underperformance this year have created a long-term growth opportunity at a reasonable price.
While the broad US equity market posted its sixth straight month of gains in Q3, the tug of war between value and growth has intensified, evidenced by record high volatility of return differences between value and growth indices.1 Meanwhile, our economists believe that although inflation driven by supply chain disruptions and pent-up demand during the pandemic recovery might be peaking, rising rent and housing costs may keep inflation elevated next year.2 While the market historically has tended to be bumpier in Q4, inflationary pressure and some secular industry trends may persist regardless of short-term market sentiment. Therefore, we see three industry opportunities for the final quarter of 2021.
REITs: Pursue Income and Total Return in an Inflationary Environment
With interest rates near pre-pandemic lows and actual inflation as well as inflation expectations elevated, US REIT funds’ ability to provide dividend income exceeding inflation has attracted investors this year. Because most leases are tied to inflation, income from leases and property values tend to increase when overall price levels rise. This supports REITs’ dividend growth and helps investors to pursue real income during inflationary periods. In all but three of the past 20 years, REITs’ dividend increases have outpaced inflation as measured by the Consumer Price Index.3 Although the dividend yield of the US REITs industry has declined to around 3% as some REIT share prices increase, this income level is still much higher than inflation expectations and yields of investment-grade bonds.4 As the REITs sector continues to recover from the economic downturn, increases in lease payments likely will boost dividend distributions.
From a total return perspective, REITs also provide investors a powerful tool for inflation hedging. Rolling 12-month average of CPI inflation rate has increased for six straight months in August and now sits at 3%, well above the historical median. While inflation has shown signs of peaking recently, it’s likely to remain elevated in the coming months as the economic recovery continues. And when 12-month average CPI inflation has been in the top two quintiles, REITs have outperformed broad equities, US Treasury Inflation-Protected Securities (TIPS) and high yield bonds and been on par or slightly exceeded broad commodities, as shown in the chart below. This underscores REITs’ total return advantage over other assets in a high inflationary environment.
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Footnotes
1FactSet, as of 10/1/2021. Value and Growth are represented by the S&P 500 Value and S&P 500 Growth indices.
2Weekly Economic Perspectives Quarterly Edition, September 27, 2021.
3Nareit, S&P Global Market Intelligence, as of December 2020.
4Bloomberg Finance L.P., as of 9/24/2021.
Glossary
Bloomberg Barclays US High Yield Corporate Bond Index
The index covers the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets (sovereign rating of Baa1/BBB+/BBB+ and below using the middle of Moody’s, S&P, and Fitch) are excluded, but Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. The index includes both corporate and non-corporate sectors.
Bloomberg Barclays US Treasury Inflation-Linked Bond Index
The index measures the performance of the US Treasury Inflation Protected Securities (TIPS) market. Federal Reserve holdings of US TIPS are not index eligible and are excluded from the face amount outstanding of each bond in the index.
CPI Inflation Rate
The change in the price index over a period of time
Price-to-Sales (P/S) Ratio
A valuation ratio that compares a company’s stock price to its revenues.
Real Estate Investment Trust (REIT)
Companies that own or finance income-producing real estate across a range of property sectors.
Semiconductor
Materials which have a conductivity between conductors (generally metals) and nonconductors or insulators (such as most ceramics). Semiconductors can be pure elements, such as silicon or germanium, or compounds such as gallium arsenide or cadmium selenide. In a process called doping, small amounts of impurities are added to pure semiconductors causing large changes in the conductivity of the material.
S&P 500 Index
The version of the popular benchmark for US large-cap equities that includes 500 companies from leading industries and captures about 80% coverage of available market capitalization in the US that reflects returns after reinvestment of dividends.
S&P GSCI Total Return Index
The S&P GSCI Total Return Index in USD is widely recognized as the leading measure of general commodity price movements and inflation in the world economy. The index is calculated primarily on a world production-weighted basis comprised of the principal physical commodities futures contracts.
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Originally Posted on October 4, 2021 – Spotting Trends: Sector Opportunities for Q4 2021
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