Is The Bull Market In REITs And MLPs Over?

Over the past 10 days, a period where the S&P 500 has traded sideways, REITs and MLPs are down 8% and 6%, respectively, as measured by the Vanguard REIT ETF (VNQ) and the JP Morgan Alerian MLP ETN (AMJ).


Individual REITs and MLPs got hit harder. The popular Realty Income (O) and Martin Midstream (MMLP) were down 15% and 10%, respectively.

Ouch.
All of these securities have one thing in common: they have become extremely popular with yield-starved income investors in recent years. And the Fed’s recent pronouncements—which indicate that quantitative easing may be ending sooner than expected—slammed them in response.

So is that it? With rates now destined to rise, is the bull market in income-focused securities over?

Not so fast. To start, it is not entirely certain that interest rates will materially rise. Sure, we probably won’t see the 10-year note at 1.5% again (or mortgages at 3.3%). But as the experience of Japan has proven, rates can stay much lower for much longer than anyone expects during a prolonged period of deleveraging and aging demographics.

The U.S. is not Japan, of course. But we have a supply/demand mismatch in the fixed income market. Supply of fixed income from government and private-sector borrowers has not kept up with demand for fixed income by retiring Baby Boomers. Putting it another way, there is a surplus of investable funds out there, and that surplus means that the price of money—i.e. interest rates—will likely stay low irrespective of what the Fed does.

In other words, don’t expect to see 4-5% Treasury note yields any time soon.

But beyond this, even if yields do rise modestly, a well-bought portfolio of REITs and MLPs can offer something that a standard bond portfolio cannot: an income stream that rises over time. With demand for pipeline infrastructure charging ahead and with the U.S. commercial real estate markets continuing to improve, the fundamentals of REITs and MLPs as a group are strong and looking to get stronger.

That said, investors had gotten a little carried away this year. Realty Income and Martin Midstream had been up by as much as 35% and 45%, respectively, since January 1. They needed a correction…and they got it.

Where do we go from here?

I continue to like both REITs and MLPs as asset classes for the next 5-7 years. But it’s never good trading advice to try to catch a falling knife. I would recommend averaging into your favorite REIT and MLP shares on any additional weakness. You don’t have to buy your entire target allocation in one trade; buy on dips to enjoy a lower cost basis and plan on holding for a while.

If I’m wrong—very wrong—and inflation goes through the roof in the years ahead, REITs and MLPs will take a hit, at least initially. But both also have a degree of built-in inflation protection in that real estate and pipeline assets should hold their value in real terms even while the debts used to finance them get inflated away.

Disclosures: Sizemore Capital is long O, MMLP, AMJ and VNQ.