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.

I’m seeing a lot of attention directed towards the weakness ni the US REIT sector:

• the CBOE Dow Jones REIT Index (DJR) weak relative strength
• DJR formed a clear “head and shoulders” pattern
• the weakness in the real estate market in the US
• DJR just fell through long term support at the 200 day moving average

So the REITs are finished at this point, right?

Not quite.

At the bottom of the March 2007 low, I shared a study by Lowry’s which looked at percentage of stocks above their 10 day moving average. It was wildly bullish at a time when others were panicky and fearful. Like everything I’ve come to expect from Lowry’s, it was top notch analysis.

So lets take a page from their playbook and look at the REIT sector as defined by the CBOE Dow Jones REIT Index and see how many are above their 50 day and 200 day moving averages.

As of Friday last week, only 21% closed above its 50 day moving average and 45% above its 200 day moving average. That tells you things are very oversold in the short term and will probably bounce rather than keep going down.

Keep in mind that quite a few REITs in the index are only above their 50 day and 200 day moving averages because they are being bought out. For an example, see Eagle Hospitality Properties Trust Inc. (EHP). So realistically we are even more oversold than that measure shows.

The REIT sector broke out in the summer of 2003 and entered into an uptrending channel. It has stayed within that channel and everytime it has dipped below, it has been to trap more shorts and zoom higher (the yellow line is the 50 week moving average):

And about that ominous technical formation: when something is obvious to everyone, especially a well known pattern such as a “head and shoulders”, then it probably will not complete as expected. This reminds me of the massive head and shoulders formation on the S&P 500 index which formed in the summer of 2002 at the 950 area (neckline). Everyone and their uncle was expecting it to complete. Had it done so, it would have meant a measured move to 400 on the S&P 500 !!

Obviously, it didn’t. Instead, the market bottomed towards the end of that year and then started on its bull run, which is still ongoing. The market has a tendency to make mincemeat of those who think they’ve “figured it out”. Especially when what they’ve firgured out is blatantly obvious.

Finally, take a look at the 90 day T-Bill rate:

As I mentioned when I wrote about the yield curve flattening, we are seeing a topping formation which may be presaging a cut in Fed funds rates. If we do see a rate cut, that would, once again, breathe new life into the REITs bullish run.

Here are the top 10 REITs in the US - representing more than $136 Billion in capitalization:

Simon Property Group Inc. (SPG)
Vornado Realty Trust (VNO)
ProLogis (PLD)
Equity Residential (EQR)
General Growth Properties Inc. (GGP)
Boston Properties Inc. (BXP)
Host Hotels & Resorts Inc. (HST)
Archstone-Smith Trust (ASN)
Public Storage Inc. (PSA)
Kimco Realty Corp. (KIM)

There are also a few ETFs:

Real Estate iShares (IYR)
Vanguard REIT VIPERs (VNQ)
streetTRACKS Dow Jones Wilshire REIT Fund (RWR)