A Look at Real Estate

I received a request (thanks, Cheri) to give my view of the (securitized) Real Estate market. While I include it as a part of my weekly sector analysis top down look at the markets, I typically look to other areas for investment of risk capital. It’s not because I dislike it or have a bias but rather because almost all my clients live in California and have more than their fair share of real estate holdings when considering their homes. As such, adding more real estate into their portfolios (even though it may be a bit different --- commercial REITs vs residential) I don’t feel comfortable over-weighting a portfolio unless everything is perfectly aligned.  We are risk managers first and foremost.

Below is a 5 year chart of IYR (with no dividends reinvested so we can get an idea of movement of price appreciation). In the middle pane, the green bars are the weekly price movement of IYR. Over the past 5 years, the price, without dividends, is up around 20%. In the lower pane is the ratio of IYR to the SP500 stock index. Because the ratio is falling that tells us that real estate (using IYR as a proxy) has under-performed the broader market stock index, SP500.  It may be hard to tell from the chart, but the amount of under-performance has been more than 20% over this 5 year look-back.  And to insure I am comparing apples to apples I have it set up such that this ratio DOES take into account dividends for both holdings.

Finally, you will see behind the green bars (IYR price) in the middle pane I have included another plot of the 10 year bond yield with a purple dashed line. You can see the almost perfect inverse correlation that exists between bond yields and real estate. The relationship tells us that as interest rates rise the price of IYR falls.  And vice versa. Intuitively, hopefully this inverse relationship makes sense.

With the potential for higher interest rates in our future a real probability, if that were to occur one would expect real estate to struggle. When combined with real estate’s ongoing struggle against other risk assets options (ie. non-real estate global stocks) and my client’s existing exposure, I still find no compelling reason to commit risk investment capital to this part of the market. If and when the economy slows down and interest rates begin to reverse course or the FED changes direction, I will be more than happy to change my mind but until then, there are much better opportunities available for your investment dollar.

Two Notable Breakouts

While the broader indexes were choppy and non-committal, two markets broke out above long-term resistance to new highs last week. The first inside the US, the biotech sector, IBB, had tried to get above the $300 level at least 4 times in the past year and a half and failed each time. Apparently the fifth time was the charm as it surged almost 10% last week on huge (>3x) volume. This has room to run as it used a rising 200 day moving average as a trampoline.  $340 should provide near term resistance but if this has legs the rectangle pattern target is $360 and above that, the prior $400 high.

The second breakout occurred in the Taiwanese stock market. This chart below goes back 21 years so the fact their market broke out above this level on its fifth attempt is more confirmation of investors (current) desire for risk assets. Whether this is due to the lack of interest in bonds or just an extension of this bull market only time will tell. Regardless, a break to all-time highs in such an important financial market as Taiwan can be viewed as extremely bullish. 

When looking at alternative markets, it’s important to view them in context of the US and global indexes. It makes no sense to commit financial capital unless the alternative can outperform your current holdings. In the bottom pane of the chart below is the plot of the Taiwan market against the SP500.  As you can see it has been in a steep downtrend lagging the SP500 since 2009 by 50%.  What should stand out is the ratio has bottomed and has made (ever so) slightly higher highs and higher lows, signaling a high probability the downtrend has ended and a reversal is at hand.

Blockbuster or a Flop?

US bank stocks went on a tear after the Trump election. The promise of a pro-growth agenda combined with higher rates the FED was proclaiming set up an ideal environment for them to prosper and roll in the dough. Unfortunately, the promises and proclamations ran into political reality and as such that ideal environment is becoming a distant memory.  As you can see in my chart of the US bank sector ETF, XLF, below, banks ripped higher, topped and are close to breaking down out of a very symmetrical and almost ideal head and shoulders (topping) pattern. A breakdown below the blue horizontal neckline and hold, points to a downside target at, T1.  Since there is little support at that level, it is likely if T1 is hit, they continue lower down to the T2 zone as that is a level of major support.

On the flip side, some European banks which, many were on the precipice of default and setting up the potential for another 2008 banking-type crisis, look exactly like the US banks.  Except upside down.  A good example of this is represented in the chart of Deutsche Bank, DB, below. Like their US brothers, they have not broken out of their almost symmetrically ideal (inverse) head and shoulders (bottoming) pattern. A break and hold above the blue horizontal neckline points to an upside target at T1, some 40% higher. If it really has some legs and slices right through T1, the T2 zone represents a level of major resistance where it will likely struggle as supply is likely plentiful. I find this situation unique and interesting as investors are potentially setting their sights on Europe.  If so, this would be a major fundamental shift.

Patterns in development are nothing but a potential setup for a future investment.  Until either one of these confirms they should be viewed only as you would a trailer to an upcoming movie. Something to grab your interest but sometimes turn out to be the highlights of a studio flop.

$60 Trillion of World Debt

I saw this chart posted by visualcapitalist.com and had to forward it along. While it has little to do with investing, it is an obsession of mine. I am a firm believer that one day we will have to face the piper and have our day of reckoning.  While debt isn’t evil, the level of debt we (the US) have almost fits that description. But the interesting thing is, and maybe provides some solace, is looking across the global landscape it appears as if there are a few countries/regions that may have to face the piper before we do. Ultimately though, our day will come.

As you can see the chart breaks down $59.7 trillion of world debt by country, as well as highlights each country’s debt-to-GDP ratio using color. The data comes from the IMF and only covers public government debt. It excludes the debt of country’s citizens and businesses, as well as unfunded liabilities which are not yet technically incurred yet. All figures are based in USDollars.

The numbers that stand out the most, especially when comparing to the previous world economy graphic:

• The United States constitutes 23.3% of the world economy but 29.1% of world debt. It’s debt-to-GDP ratio is 103.4% using IMF figures.
• Japan makes up only 6.18% of total economic production, but has amounted 19.99% of global debt.
• China, the world’s second largest economy (and largest by other measures), accounts for 13.9% of production. They only have 6.25% of world debt and a debt-to-GDP ratio of 39.4%.
• 7 of the 15 countries with the most total debt are European. Together, excluding Russia, the European continent holds over 26% of total world debt.
• Combining the debt of the United States, Japan, and Europe together accounts for 75% of total global debt.  Yet, combining their population they account for less than 25% of the world’s total humans

Wow, That was Fast!

Back on March 1st I wrote about the inverse head and shoulders pattern developing setting the stage for a big rally in Beef prices in “It’s What’s for Dinner”.  At the time cattle future prices were hovering around $55/contract and the pattern’s upside target was some 45% higher at $80.  I am happy to say that last week that target was hit. While it is massively overbought, there is no divergence and as such looks like it may want to make another push higher after the current pullback is complete. Anyone who followed the call should consider taking at least partial profits. 

It’s important to remember pattern opportunities don’t always work out this well and when they do, it is rare they move this quickly.