It’s been a little more than two years since stocks kicked off the most extended bear market since the Great Financial Crisis. Today, 7 of the 11 S&P 500 sectors are higher than they were back at those January 2022 highs, and the index itself has been setting new highs for most of the last 3 months.
Not every area of the market is feeling the love - Real Estate is still down in the dumps. From the start of the 2022 bear market to today, the S&P 500 Real Estate sector has fallen 22%. The next worst sector is Consumer Discretionary, down just 8% from its highs by comparison.
If you’re looking for a reason for Real Estate’s troubles, blame the rise in interest rates. Take the trend of the sector vs. the rest of the market, then overlay that with Treasurys. The relationship speaks for itself.
When interest rates go up, Real Estate underperforms.
Higher interest rates are a two-fold headwind. One, they make fixed income more attractive to investors and lower the relative appeal of stocks with high dividend yields. Consider this: Two years ago, 10- year Treasury rates were just 1.5%, while the dividend yield on Real Estate stocks was among the highest in the S&P 500 at about 3%. Today, the risk-free Treasury yield is about 4.4%, while Real Estate pays the highest dividend yield of any sector at just 3.5%. For income-focused investors, there’s little comparison.
Second, rates are a problem for the business activities of real estate stocks, which tend to have high debt loads. Real Estate has just a 2% market cap share of the S&P 500, but it has a 6% share of net interest expense. By that measure, Real Estate stocks are already paying 3x more interest than the average S&P 500 company. Only the Utilities compare, and they’re even worse, with a ratio of interest expense to market cap share of 8x.
The Utilities have one distinct advantage, though. The average maturity of debt for Utilities stocks is more than 10 years - double that of Real Estate at about 5 years. That means Real Estate companies will be repricing their high debt loads at higher interest rates at a much faster pace.
Underperformance is different from falling outright, though. Taken on its own, the Real Estate sector isn’t so bad. Even though they were among the worst performers in 2022 and failed to participate during most of the 2023 rally, Real Estate is making progress on reversing this multi-year downtrend. Last fall’s failed breakdown below the October ‘22 lows was a start, but now we’re waiting to see some incremental new highs.
Unfortunately, waiting around for new highs while the rest of the market is screaming higher doesn’t make for a compelling investment opportunity. Compared to the S&P 500, the Real Estate sector has been trending steadily lower throughout this bull market.
And even though more than half of S&P 500 Real Estate stocks are in long-term uptrends (if you define an uptrend as a stock trading above its 200-day moving average), Real Estate still has the weakest breadth characteristics of any sector in the market. That’s true whether you’re looking at the short, intermediate, or long-term.
Relative weakness and poor breadth makes the Real Estate sector a place we’d rather not visit - at least not until we see clear and convincing evidence of a change in the trend.
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