Trader’s Narrative

Almost a year ago I asked rhetorically, is the REIT bull market over? My own take on it at the time was that what we were seeing was yet another correction and not a top, as it actually turned out to be - in hindsight.

So where did I go wrong?

For starters, unlike the Canadian REITs (which I was also wrong on by the way) the US REIT index had an ominous head and shoulder formation. I downplayed this because of its “obviousness”.

But the head and shoulder pattern completed and price broke through the neckline. This same level corresponded to the bull market trendline. So because of this multiple significance it was important what price did near this level.

Back when I wrote about US REITs last, the breadth in the sector was really bad with only 20% or so above their 50 day moving average. This is a short term metric however and does not provide signposts for a longer term outlook. The REIT index did snap back sharply into June 2007. But from then on it was on a continuous and relentless decline.

The next rally created a lower high and the subsequent reaction a lower low. REITs were now in a clearly new market condition. As you can see from the chart, a bull market means that price stays well above its long term moving average. It only sporadically comes back to meet or pierce the 200 day moving average. The previous time that the REIT Index was “under water” this long was prior to the final base building in 2002-2003.

Trend Change or Correction
It is extremely difficult to pinpoint a major change in trend - at least I almost always find it extremely challenging. I have enough trouble with short to medium term inflection points. So I prefer to assume that there isn’t a major trend in store unless I’m proven wrong.

I prefer this not only because of the difficulty in separating a major trend change from a normal run of the mill correction but because the former only happens once in a blue moon while the latter occurs much more frequently. So I’m more than happy to take my chances because probability is on my side.

Powerless Fed
My other mistake was in attributing too much power to the Fed. I correctly thought they would soon start to lower interest rates. But my mistake was in thinking that this would be able to halt or reverse any weakness in the housing market. The rot in this sector was beyond the imagination of even the most die hard shorts.

What Now?
The only positive “spin” I can put on the abysmal REIT performance is that unlike most investments in the stock market, REITs are specifically built to be income vehicles. So while your holdings may be underwater, as an investor you are continuing to earn monthly or quarterly income from holding them. And depending on the particular REIT in question this can be a substantial amount. But this is only consolation for the long term investors, not the nimble short term traders.

Until we see the REIT Index (DJR) or the REIT iShares (IYR) or similar proxy carve out higher highs and higher lows, I can’t say it has flipped into bull mode. The disadvantage is that while by that time we may be confident, the inflection point will be far gone and with it, a good chunk of price performance.