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Fed Up Of Rate Hike Timing? Stay Invested In REIT-Focused Funds

Comments from key Federal Reserve officials and improving economic data have added fuel to rate hike hopes. In September, hopes of a lift-off had fizzled out as the date for the FOMC meeting approached. However this time, factors that will help in deciding on the rate hike have growing in numbers. Moreover, market volatility is now at a level that should help the cause against the high levels seen in September. Investors may be ‘fed up’ of Fed’s actions or inactions and the effects of both is a story that has been done to death. But we have to remind investors about funds that would be the best buys before ‘Fed ups’ the rate for the first time in a decade, even at the cost of repeating ourselves. Fed Comments Several Fed officials pointed toward a series of rate hikes at a moderate pace. Atlanta Fed President Dennis Lockhart stated that he was “comfortable” with a rate hike “soon.” Cleveland Fed President Loretta Mester said the central bank had not firmed up on a December rate increase. However, Mester added that: “Things are on track.” Fed vice chairman Stanley Fischer mentioned that “some major central banks” could quit the near-zero interest rate policy “in the relatively near future.” New York Fed president William Dudley and St. Louis Fed president James Bullard also made similar comments. According to a Dow Jones report, William Dudley said on Friday that the central bank may approach the goals needed to hike rates, but it still has time to decide on whether or not it will hike rates in December. The timing is data-dependent and Dudley expects to see indications of increasing inflation soon enough. He mentioned that the US economy is in “good shape”, helping the Fed meet the criteria for rate hike in the near future. Separately, James Bullard reportedly said that the central bank may move back to an era of uncertain rate hikes based on meeting-by-meeting basis after the first rate hike. FOMC Minutes Minutes from the Federal Open Market Committee’s (FOMC) meeting in October stated that most officials anticipated that conditions to lift short-term interest rates “could well be met by the time of the next meeting” in December. The Fed is waiting for further improvements in labor market conditions and inflation to touch its target rate of 2% before hiking rates. Fed officials with a hawkish stance also said that further delay in raising rates will show lack of confidence in the economy. Fed officials said volatility in the financial markets has subsided since September. According to them, “the U.S. financial system appeared to have weathered the turbulence in global financial markets without any sign of systemic stress.” Moreover, officials believe that there is “solid underlying momentum” in business and consumer demand, despite a slowdown in third-quarter GDP growth. Economic Data Last week, economic data was inclined toward the positive side. The U.S. Department of Commerce reported in its “second” estimate that the economy grew at a pace of 2.1% in the third quarter, compared to earlier projected growth rate of 1.5%. Also, third quarter’s growth rate came in higher than the consensus estimate of 2% growth. An upward revision in business inventories emerged as the main reason behind the expansion in quarter. Business inventories were revised upward from $56.8 billion reported in “advance” estimate to $90.2 billion. However, third-quarter growth remained below second quarter’s rate of 3.9%. The U.S. Department of Commerce reported that new orders for manufactured durable goods rose by $6.9 billion or 3% in October to $239 billion, significantly beating the consensus estimate of a 1.6% rise. Increase in demand for large, commercial airplanes was mainly behind the gain in October. It was preceded by a 0.8% decline in September. Moreover, the Labor Department reported that jobless claims in the week ending November 21 declined by 12,000 from the previous week to 260,000. According to the Commerce Department, personal income rose $68.1 billion or 0.4% in October, in line with the consensus estimate. It was higher than September’s increase of 0.2%. These strong data added to rate hike possibility. REITs: You Can Actually Buy Them Now Interestingly, we have a contrarian view about what to do with REITs. Many would say that REITs should be offloaded and they are not very wrong given that these thrive in a low rate environment. Low rates imply low borrowing cost for the Real Estate Investment Trusts (REITs) that allow them to purchase or develop real estate. Moreover, REIT stock yields become more attractive when Treasury yields fall (REITs are often treated as bonds because of their high dividend paying nature and therefore, Treasury yields end up playing a significant role in their price movement). Rising interest rates lead to an increase in interest costs as REITs usually look for both fixed and variable rate debt financing to pay back maturing debt, and fund their acquisitions, development and redevelopment activities. Therefore, REITs cannot practically run away from the impact of rate hikes. But the extent of such an impact would depend on the nature of their leases and funding activities. As for the contrarian view, an improving economy will step up REIT activities and thus an increased demand for space. Since supply has been slow with tepid economic recovery in the past, this increase in demand would lead to higher rents and occupancy rates. Also, if rate hike is gradual, REITs will get enough time to adjust. The REIT sector investors in particular should get a boost from a stronger U.S. job market, improving consumer confidence and stable housing recovery. Adjustments with the rate environment would be comparatively easier for sectors with the advantage of pricing power like hotel, storage and apartment REITs that have shorter-term leases. Meanwhile, a NAREIT study shows that out of the 16 periods of significant interest rate rise since 1995, listed equity REIT returns were positive in 12. This implies that REITs actually gather more steam amid rising rates. Moreover, REITs have been proactive in the capital market in recent years. They have opportunistically used the low rate environment to make their finances more flexible, which is encouraging down the line for their operational efficiencies. 3 REIT Funds to Buy On that note, investing in funds focused on REITs would be a prudent move. Below we present 3 funds, which have significant exposure to REITs and carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Cohen & Steers Real Estate Securities A (MUTF: CSEIX ) seeks total return. CSEIX invests a large chunk of its assets in common stocks of companies whose operations are related to the real estate domain and REITs. CSEIX is expected to invest not more than 20% of its assets in non-U.S. companies including that from emerging economies. CSEIX currently carries a Zacks Mutual Fund Rank #1. Over year-to-date and 1-year periods, CSEIX has gained 6.7% and 9.3%, respectively. The respective 3- and 5-year annualized returns are 15.4% and 13.6%. CSEIX has an annual expense ratio of 1.21%, which is lower than the category average of 1.29%. T. Rowe Price Real Estate (MUTF: TRREX ) seeks capital appreciation over the long run with growth in current income. TREEX invests a majority of its assets in companies from the real estate domain. TRREX also allocates a notable share of its assets in real estate investment trusts (REITs), including equity REITs and mortgage REITs. The fund may also invest in non-U.S. firms. TRREX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, TRREX has gained 4.7% and 7.1%, respectively. The respective 3- and 5-year annualized returns are 13.5% and 12.7%. TRREX has an annual expense ratio of 0.76%, which is lower than the category average of 1.29%. Franklin Real Estate Securities A (MUTF: FREEX ) invests most of its assets in securities of companies that qualify under federal tax law as REITs and in companies that earn at least 50% of their revenues from residential or commercial real estate activities. FREEX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, FREEX has gained 2.4% and 4.6%, respectively. The respective 3- and 5-year annualized returns are 12.3% and 12.4%. FREEX has an annual expense ratio of 0.99%, which is lower than the category average of 1.29%. Original Post

David Einhorn And Reasons Why Widely Followed Stocks Get Mispriced

Over the weekend, I was reading David Einhorn’s book Fooling Some of the People All of the Time. I’ve had it on my bookshelf for some time, and it has always taken a back seat to other books until I decided to pick it up recently. It’s an entertaining read, basically recounting his short thesis on Allied Capital in great detail. It is a good book because it provides a glimpse into the significant amount of research and due diligence that a great investor like Einhorn performs in his investment approach. Source: Columbia Business School Don’t Count Einhorn Out Einhorn – like many well-known value investors – has had a very tough year . But we have not seen the end of Einhorn’s run as a top-quality investor. To borrow an analogy I used in a post last year – just as so many were so quick to write off Tom Brady after an early season loss to Kansas City last year that left the struggling Patriots at 2-2 and looking like a shell of their former dominant selves, I think far too many people are writing off Einhorn (as well as others) who have had a bad year. As I said last year, if the Patriots were a publicly traded equity, the stock would have been beaten down after the Chiefs blowout and it would have been one of those rare opportunities to load up. Lo and behold (and as painful as it is for me to say as a Bills fan), the Pats rattled off a long string of consecutive wins on their way to their 4 th Super Bowl title, and continued that winning streak until a surprising upset loss last night to the Denver Broncos (coincidentally led by a young QB who is temporarily replacing another legend that many are also writing off-perhaps prematurely). Back to the book – there is one chapter where Einhorn describes a meeting he had with a well-known mutual fund manager. To put this meeting in context: Einhorn was in the midst of doing significant due diligence on a company called Allied Capital, a business development company (BDC) that used aggressive accounting practices, questionable reporting of their financial results, and very liberal valuations of the illiquid equity and debt securities that they held for investment. Einhorn had been short the stock for some time, and although it slowly was becoming apparent that Einhorn’s thesis was largely correct, the stock hadn’t fallen much and continued to trade in the same general range that it had prior to Einhorn’s famous speech where he announced his short thesis. So Einhorn was introduced to this fund manager through his broker, who thought that it would be good for both sides to hear each other’s thesis on the stock (Einhorn was short and this mutual fund manager had a large long position). Einhorn showed up to the meeting fully prepared with a briefcase full of his research, and the mutual fund manager came in with nothing but a notepad and a pen. As it turned out, this fund manager hadn’t even read Einhorn’s research – this is despite being long a stock that was very publicly criticized by Einhorn and others who had published significant and detailed research laying out their thesis for everyone to see. Einhorn couldn’t believe that this fund manager owned a large block of stock and not only did he not do his own primary research, but he didn’t even read the secondary research that was easily and freely available for him to read regarding the potential problems at Allied. What’s the point here? I’ve always thought that there are two main reasons that stocks generally get mispriced: Disgust Large-cap stocks that get mispriced are almost always due to disgust. These stocks are large companies that are widely followed by investors and analysts. There is very little information that is not widely known by all market participants. However, sometimes these large companies run into a temporary problem and investors sell the stock because the outlook for the next next quarter or the next year is poor. Investors can take advantage of this situation by: a) accurately analyzing the situation and determining that the nature of the problem is in fact temporary and fixable, and b) be willing to hold the stock for 2 or 3 years – a timeframe that most individual and institutional investors are not willing to participate in. Some investors refer to this concept as “time arbitrage”. It just means that you’re willing to look out further than most investors and willing to deal with near-term volatility and negative (but temporary) short-term business results. In addition to a company specific “disgust”, these large caps can also get beaten down when the general market environment is pessimistic. In bear markets, companies with no problems at all often see their stock prices get beaten down because of macroeconomic worries or general market pessimism. So although many value investors look at small caps because they feel this is where they can gain an informational advantage, I think taking advantage of this “disgust” factor is just as effective and is an important arrow to have in the quiver. Neglect Often times, the most mispriced stocks in the market are small-cap stocks that are underfollowed and neglected. The obvious advantage here is to locate a situation that no one else has discovered by looking under a lot of rocks and in the nooks and crannies of the market. Sometimes things slip through the cracks. I would also put special situations in this category. Sometimes companies are misunderstood as well-but this is usually because they are neglected to a certain extent. The market has collectively not been willing to put the effort into understanding these situations sufficiently, and this creates potential mispricings. Einhorn’s Experience Einhorn talks a lot about “the guy on the other side of his trade”. In other words, each stock trade has a buyer and a seller and both think that they are getting the better deal (or they wouldn’t be engaged in the transaction). I don’t really spend a lot of time thinking about this angle, but it is interesting to consider who might be selling you shares that you are buying, and the reasons why. In this case, Einhorn thought he might be selling (shorting) shares to sophisticated institutional investors who disagreed with Einhorn and believed Allied was undervalued. However, as Einhorn learned, this wasn’t the case. The institutional investor was “too lazy or too busy”, as Einhorn put it, to put the time and effort into understanding what he owned. So, I’m not sure which category this type of situation would fall into, or maybe ignorance deserves its own category. But the experience with the mutual fund manager that Einhorn describes is certainly evidence of how sometimes even widely followed stocks get mispriced. If an investor is buying millions of shares for reasons that don’t have anything to do with the intrinsic value of the company, then there is the potential for a mispricing to occur. To Sum It Up I think most investors intuitively understand that it’s occasionally possible to find a bargain in an underfollowed stock, but I think just as often, large caps (or more widely followed) companies get mispriced for these reasons (disgust, ignorance, short-term thinking, or irrational behavior). Here is the passage of the book I referenced above where Einhorn met the mutual fund manager: “…so James Lin and I walked over with a briefcase full of our research. We met with Painter and Stewart in the conference room. Stewart brought nothing but a legal pad and pen. “Okay,” he said, “go ahead.” I thought this was supposed to be a two-way dialogue. “First, what did you think of our analysis?” I asked him. “Do you see anything wrong with it?” He said he hadn’t read it. While I could believe that Allied’s shareholders might generally be too busy to have read the lengthy analysis we put on our website, it was hard to imagine a professional, who was the second largest Allied holder, would come to a meeting with us and acknowledge such lack of preparation. So I asked him why he held the stock. Stewart said that in the tough market he felt it was a good time to own a lot of high-yielding stocks and his Allied holding was really part of a “basket approach”… Einhorn concludes: “I left with a new understanding of what we were up against. It wasn’t an issue of investors understanding our views and disagreeing. In addition to the small investors, Allied’s other investors were big funds managing lots of other people’s money-too busy or too lazy to worry about the details, other than the tax distribution.”

Twitter: How Emotional Investing Can Kill A Portfolio

Summary Twitter is a great example of emotional investing. How long can one hope for a turnaround? Twitter is also an example of how emotional investing can lead to big time losses. I have a difficult time understanding why many people want to hold onto Twitter (NYSE: TWTR ) and speak of its potential. The analyst community, who are supposed to be an unbiased group, does not want to openly admit that they were wrong about the stock. According to Investopedia the hold rating from the ownership perspective means that if you own the stock do not sell it. Therein lies the problem. It appears to me that analysts themselves have not invested their own money. If they did, they would not tell investors to hold onto a stock that has lost over 50% of its value. I do not mean to sound harsh, but cutting your losses is one of the first fundamental investment principles taught. You can always go back in if the stock starts performing again. If not, take your capital and move on to another security. (click to enlarge) Source: Yahoo Finance Dollar-Loss Averaging Dollar-cost averaging plays on the psychological aspect of human emotions as well. It adds to our nature of wanting to be right all of the time. We can interpret our deceptive actions as having a positive effect on our position. (I like to think of the concept as dollar-loss averaging.) Unfortunately, it is one of the worst concepts mainstream finance preaches. Basically if you buy Twitter at $60 and it goes down to $50 and $40 and so on you buy more because instead of paying $60 per share you effectively paid $50 per share assuming equal purchase amounts. However, this is very deceiving. Initially you paid $60 total, but now you paid $150 total. You have allocated more capital to a bad investment. Overhead Supply There is also another concept called overhead supply. According to Investor’s Business Daily , “Overhead supply represents price levels at which a stock’s recovery is impeded as it tries to rally back from a steep decline.” It is due to investors who got into a specific stock earlier and are waiting to get out at breakeven. Once the price hits specified levels a wave of selling hits the stock making it difficult to climb. This is exactly what is happening with Twitter. So many people want to get out of this stock that it is having a difficult time climbing higher. IBD also pointed out that this specific behavior is due to the loss avoiding nature humans have. Is Hanging On Worthwhile? Assume for a minute, Twitter stays in this $20-to-$30 range for the next 10-to-20 years or never recovers. Don’t think it’s possible? Take a look at the chart of General Electric (NYSE: GE ) below. You were much better off investing in the SPY (NYSEARCA: SPY ) or some other broad market fund. (click to enlarge) Source: Yahoo Finance Is Getting to Breakeven With Twitter Worthwhile? Additionally, I am assuming those in Twitter are hoping for a breakeven investment. For that, I have two scenarios to consider. Let’s say in a simple scenario you bought Twitter at its peak and it does recover in 10 years. Let’s also say you purchased the SPY ETF for the same monetary value. What have you gained? Getting back to breakeven after 10 years is no accomplishment for your Twitter holding. With the SPY, assuming its 10% annual return continues to hold, you more than doubled your money. You made approximately 159% of your initial capital. [(1.1^10)-1]/[1] Now let’s take this one step further with a much more concrete example. Assume you invest $10,000 in Twitter. Let’s say you were so emotional about the investment even though it was slowly declining. It finally got to the point where you could not take more pain and took a 50% loss. After taking a few hours to recollect yourself, you decide to invest the $5,000 you have left from Twitter into the SPY ETF. After 10 years, your account is $12,968.71. [(5000*(1.1^10)] Both are much better alternatives than hoping for a breakeven trade. Conclusion For those in Twitter, if you manage to make money, that is great. I am happy for you, but do not try to bank on luck. I think it is best to take the pain if you are in the stock.