VONOY - A Serious Warning To All Investors

Summary

• The market crashed because the high inflation forced the Fed to hike rates.
• But now inflation is coming back down, and a pivot is coming.
• If you are still sitting in cash, take this as a serious warning.

It appears that the period of high inflation is finally coming to an end.

The year-over-year CPI figure is still high because there is a time lag, but the month-over-month CPI, which is a more real-time measurement of inflation, is now back to where it was in early 2021:

As we explain in a recent market update , we think that the inflation will only continue to moderate from here because:

• Labor shortage issues are moderating
• The impact of the pandemic-era stimulus is fizzling
• Wage growth has not kept up with inflation
• Saving rates are down significantly
• Credit card debt is up a lot
• Durable goods inflation is cooling
• Import prices are declining - i.e. deflation
• Input prices are moderating
• US goods production is rising

So we are having significant relief on both, the demand and the supply side, and the impact of the pandemic and war in Ukraine are now moderating, which logically then should lead to lower inflation.

What does this mean for investors?

Well... trying to predict the short term is near-impossible because there can always be some exogenous event like say Russia invading a neighboring country... that throws off a forecast.

But excluding another black swan event, we think that it is only a question of time before interest rate hikes turn to interest rate cuts and this could lead to an epic market recovery.

So my warning to you is that this may be your last chance to buy the dips and if you are still sitting in cash on the sidelines, now is the time to reconsider your cash allocation.

I am only keeping enough cash to sleep well at night, but beyond that, I stay fully invested and continue to buy more whenever new cash becomes available because I think that the days of this bear market are counted.

And the logic for this is simple: the market crashed because the high inflation caused interest rates to rise, but now as inflation returns to normal, we expect interest rates also to drop back to lower levels shortly after, and the market to recover.

The Fed probably won't cut rates immediately because it needs to be 110% sure that we have inflation under control, but if history can serve as a guide, interest rates will be cut again within a year or two from now.

As you see above, the Fed has tried to normalize interest rates for decades without success, and this is largely because of the high debt load, aging demographics, technological innovations, and growing income inequality.

Today, these deflationary forces still exist and in fact, they are much stronger than ever before.

The debt load has gotten a lot larger due to the pandemic stimulus and we simply cannot afford to make so much interest.

We have also made huge technological advancements, which will among other things allow people to work from home and travel less for business meetings, both of which are very deflationary.

Income inequalities have also grown a lot further due to the appreciation of home prices.

But perhaps the most deflationary force of all in the near term is the recession that we are facing. The yield curve is today very steeply inverted and historically, we have never escaped a recession when the yield curve was so inverted:

As the economy dips into a recession, and inflation returns to low levels, the Fed will shift to stimulating the economy, lowering interest rates, potentially quite significantly, and this will serve as a big catalyst for the market.

In fact, we have already gotten the first taste of that in the REIT sector ( VNQ ):

What's my favorite sector to profit?

Not all stocks are equally opportunistic.

Some businesses have suffered from high inflation, lowering their profits. Others will suffer from a recession. And many didn't drop enough in 2022 to offer a sufficient margin of safety or upside potential in the recovery.

My favorite opportunities are REITs and that's where I invest about half of my portfolio at the moment:

I think that they are more opportunistic than the rest of the market because they greatly benefited from the high inflation, which led to materially higher rents and property replacement costs.

But despite that, REITs dropped a lot more than other stocks ( SPY ) due to fears of rising interest rates, which were largely misplaced since REITs use little debt and most of that debt is fixed rate and long term.

Now, as interest rates return to lower levels, the worry of higher interest expenses will dissipate, but the higher rents won't go anywhere, making REITs more valuable than ever before.

A number of REITs have grown their cash flow by 10-20% in 2022, but they are down by ~30%. This essentially means that their valuations have been cut in half and they now offer 50-100% upside potential as the market recovers and you earn 4-6% dividend yields while you wait in most cases.

Lastly, and importantly in today's environment, most REITs are recession-resistant because they earn cash flow from long-term leases. Historically, REITs have strongly outperformed in recessions and early cycles for this reason.

Here are a few examples of REITs that I am buying:

STAG Industrial ( STAG ) owns industrial property that greatly benefited from the growth of e-commerce companies like Amazon ( AMZN ). Its rents are deeply below market, providing margin of safety, but also upside potential as it is hiking rents by ~20% on expiring leases at the moment. Despite that, its share price is down 30% year-to-date, and the company is priced at an estimated 25% discount to NAV. As it recovers, it offers at least 40% upside potential, and you earn a safe 4.7% dividend yield while you wait:

Vonovia ( OTCPK:VONOY / VNA) owns affordable apartment communities in Germany. Its rents are highly resilient because of how rents are regulated in Germany and are expected to keep rising steadily, even if we go into a recession (Note that rents did not drop even during the great financial crisis in Germany). Tenants are also responsible for utility costs, protecting the landlord from rising energy costs. Despite that, VNA has seen its share price drop by 60% in 2022 and it now trades at a 70% discount to NAV. Put differently, it trades at just 30 cents on the dollar, which signals that the company is facing severe distress, but that's not the case. The share price could double and it would still be discounted relative to the asset value. While you wait, you also earn a 7% dividend yield.

A last one: Whitestone REIT ( WSR ) owns defensive, service-oriented strip centers in rapidly growing sunbelt markets like Austin and Phoenix. Its rents are again below market, but its leases are now short at 3.5 years on average, and as they expire, WSR has been able to hike rents by 15-20%. Even then, it is today priced at a 35% discount to NAV after dropping by 30% over the past year. Just to recover to its NAV, it would need to rise by about 50% and you earn a 4.8% dividend yield in the meantime.

These are just 3 examples of undervalued REITs, but as you can see here, these are companies that are heavily discounted, despite doing well fundamentally and being resilient to recessions. They offer margin of safety, upside potential, and pay you while you wait. This is why I am investing most of my portfolio in these opportunities at the moment.

Bottom Line

The market dropped in 2022 because the high inflation caused interest rates to rise. But now inflation is returning back to normal and it seems that it is only a question of time before interest rates are cut again.

If rising rates caused the market to drop, then it would be logical that declining rates would cause the market to rise.

We have already had the first taste of this over the past months, but this is still just the beginning. We are approaching a pivot and while we cannot predict its exact timing, we know that it is coming and it will likely lead to materially higher prices.

Sitting in cash on the sidelines is becoming increasingly risky as you might risk the recovery. We continue to buy the dips, week after week, in many phases at High Yield Landlord.

For further details see: