The Bullish HiRise

Is it the right time to buy real estate investment trusts in your portfolio? REITs operate differently than real estate you purchase privately. A REIT can be comprised of many different types of properties including apartment blocks, retirement homes, commercial buildings and mall space. All of these properties produce income so part of the price is a reflection of the value of future cash flow from the properties that make up the REIT. The other part of the price is the actual property value, which may be harder to determine so when the market prices the REIT, the price is somewhat speculated by investors.
The largest contributors to the iShares Canadian REIT Sector Index Fund (XRE) are Riocan REIT (24.61%), H&R REIT (15.51%), Can REIT (11.96%), Boardwalk REIT (9.61%) and Calloway REIT 99.12%). Over the last year it has risen from a low of $6.76 to a close of $11.79. The current price crossed the 50-day & 100-day moving averages back in April of 2009 and went through the 200-day moving average one month later. Since then it has been “all technicals go”. Back in August I wrote that the trend was bullish and it appears this trend is still bullish from a technical perspective.
There is fundamental support for the real estate market. Saturday’s Globe and Mail points out that the Canadian real estate market is once again heating up. “Across the country, the Canadian Real Estate Association (CREA) said Friday, December sales increased 72 per cent from the same month in 2008, to 46,805 units, while prices gained 19 per cent to an average $337,410.” In addition, housing starts were up a 3rd month to the highest in 14 months as both single family and multi-unit homes rose. In a recent article in the Economist online entitled, “After the Crash”, January 6, 2010, they argue that house prices are on the rise again around the world. They also provide you with an interactive chart to compare house prices in Canada vs. other countries around the world. It is quite revealing. We have not risen nor fallen as much as most other countries.
Homebuilders tend to be a leading indicator for REITs. So does this mean that REITs will continue their upward trend? Some challenges that the REIT sector faces are upcoming renewals of leases and the impact of slowing sales. Retail sales for December were lower than expected and investors are keeping a hawkish eye on revenues even if earnings have improved. One of the reasons earnings are improving is because expenses have been cut. One of the expenses is a lease, which are being negotiated down. One of the questions being raised is whether this increase in activity is due to low interest rates and our ability to finance real estate purchases. Since REITs are highly leveraged investment vehicles, interest rates will also have an impact on their earnings in the future, especially if interest rates rise. Keep in mind that REITs have mirrored the overall market over the last 2 years so it may be a “HiRise” without a strong foundation. According to The Globe and Mail, Commercial real estate in Toronto had it’s worst year in a decade, however, had a 4th quarter bounce with improving credit conditions. This may be the turning point. In addition, real estate tends to be an inflation hedge so we may see a bullish trend continue for a while yet.
Contact us for our Rallies & Reversals sessions live where we take a more in-depth look at Real Estate.

Enter the Dragon

According to the Economist, China’s share of the world’s market increased during the recession and it will continue to do so. It has overtaken Germany to become the World’s largest exporter. In “Fear the Dragon”, written January 7, 2010 in the Economist print edition, several things support a long-term bullish outlook for China.
Let’s explore the investment opportunity with FXI-N, iShares Xinhua China 25 ETF, an iShare listed on the New York stock exchange. The iShares FTSE/Xinhua China 25 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE/Xinhua China 25 Index. The top sectors in this fund are 45.84% Financials, 16.67% Telecommunications, 13.44% Basic Materials, 12.04% Oil & Gas and 8.93% Industrials.
The FXI has gone from a low of $22 in March 2009 to closing at $44 on Friday Jan 8, 2010. The current price crossed the 50-day and the 100-day moving average in April of 2009 and has had strong support all along, until recently. In December, the current price crossed below the 100-day moving average and then was followed by the 50-day moving average. With the most recent rally MACD (moving average convergence divergence) has turned positive and it looks like the current price is about to cross the 50-day moving average with pretty good relative strength. Technically, it is looking bullish again by these measures.
Let’s step back to some of the fundamental support for the future by exploring some of the arguments for and against the case of China. Both exports and imports are increasing in China. According to the Economist article, China is taking an even bigger slice of America’s and the World market. In the first ten months of 2009 America imported 15% less from China than in the same period of 2008, but its imports from the rest of the world fell by 33%, lifting China’s market share to a record 19%. So although America’s trade deficit with China narrowed, China now accounts for almost half of America’s total deficit, up from less than one-third in 2008. Over the ten years to 2008 China’s exports grew by an annual average of 23% in dollar terms, more than twice as fast as world trade. If it continued to expand at this pace, China might grab around one-quarter of world exports within ten years. That would beat America’s 18% share of world exports in the early 1950s, a figure that has since dropped to 8%. China’s exports are likely to grow more slowly over the next decade, as demand in rich economies remains subdued, but its market share will probably continue to creep up. Projections in the IMF’s World Economic Outlook imply that China’s exports will account for 12% of world trade by 2014. In addition, The Economist reported imports have been stronger than its exports, rebounding by 27% in the year to November, when its exports were still falling. America’s exports to China (its third-largest export market) rose by 13% in the year to October, at the same time as its exports to Canada and Mexico (the two countries above China) fell by 14%.
The challenges to China are that Foreigners insist that the main reason for China’s growing market share is that the government in Beijing has kept its currency weak. Foreign hostility to China’s export dominance is growing. Paul Krugman, the winner of the 2008 Nobel economics prize, wrote recently in the New York Times that by holding down its currency to support exports, China “drains much-needed demand away from a depressed world economy”. He argued that countries that are victims of Chinese mercantilism may be right to take protectionist action. The other issues include the challenges of doing business in China due to language barriers, laws and growing pains.
All said, I would want the Dragon on my side in the long run.

As the US Turns the Decade

Looking back over the last decade in the US you would have been better to put your money under the mattress than invest in the S&P 500. The S&P 500 closed over 20% below where it started the decade in 2000. Although, if you got your timing right, you could have done extremely well. For example, in the last year, the S&P 500 was up nearly 25%, albeit significantly less if you took into account currency.

If we look at the chart on XSP, a representation of the S&P 500 hedged back into Canadian dollars, we can see that the price of XSP started the decade at about $20 and finished the decade at about $13. That is over 30% drop. Currency movements could possibly explain the additional loss, as the Canadian dollar has been on a steady rise since the beginning of the decade. Over the last year XSP has increased from $10.50 at the start of 2009 to about $13 at the end. From a technical perspective the signs are all positive, although, if we look at moving average convergence divergence, MACD, the signal line is starting to level off and could potentially fall if we have any bad news.

The messages are mixed in the fundamental camp. In an article in the New York Times, “Heart-Stopping Fall, Breathtaking Rally”, by Vikas Bajaj, he warns, “But whether investors continue to see gains will depend on more that an economic recovery. As the recession ebbs, interest rates are expected to rise in 2010, weakening the fragile rebound that is emerging in corners of the housing market. Unemployment may be peaking, but many Americans are still struggling to pay bills, or even avoid foreclosure. And the government is starting to pull back on cheap financing it used to stimulate the economy and nurse the industry back to health”. Mr. Bajaj references Barry Ritholz, author of Bailout Nation who says, ”There are long, long periods of time when the market and the economy go two different ways. A rallying market doesn’t necessarily mean the economy is healing.”

We just finished a dismal 10 years for the S&P 500. According to Robert Shiller, a Yale economist, the average P/E ratio for the S&P 500 over the last 130 years is 16.4X. In March when things were at the height of pessimism the S&P 500 P/E ratio 13.3X and now the 10-year P/E ratio is more than 20.3X. After such a huge rally since March, let’s hope future earnings prove the price is right.