2023-06-13 07:05:00 ET
Summary
- Some data says the US might be in a rolling recession already, while other data says a recession is likely weeks away.
- The recent rally in tech stock prices in continued strong economic growth that the data says will not happen. The market is priced for a nearly impossible scenario.
- The REIT sector is the worst performing one of this bear market at the moment, with some of the world's highest quality REITs fully pricing in a recession.
- This article highlights three of the highest quality REIT blue-chips, which are 28% to 35% undervalued and represent coiled springs ready to pop.
- They offer 18% to 27% annual return potential over the next 2.5 years, far more than the S&P 500, while offering generous, very safe, and steadily growing income in all economic conditions.
This article was published on Dividend Kings on Monday, June 12th.
---------------------------------------------------------------------------------------
The most anticipated recession in US history keeps getting pushed back, confusing a lot of investors. After all, the Fed is in the most extreme rate hiking cycle in 42 years, and never in history has the Fed been able to achieve a soft landing (lower inflation without a recession) when inflation began at 5+%.
Daily Shot
So what's going on? Is this time different? Is this the first soft landing in a high-inflation environment ever? Unfortunately, the answer is probably no.
The Key Thing To Know About Rate Hikes And Recessions
According to Pimco, the average lag time for interest rate hikes since 1950 is 15 months. In other words, after a hike, it takes 15 months for the effects of the hike to make their way through the economy fully.
daily Shot
ANZ Research has found the same thing, with peak consumer spending (which drives 65% of GDP) occurring a median of 18 months after the Fed started hiking.
And remember the yield curve which inverted last year? The best recession forecasting tool in history? The median lag from inversion to recession start is 11 months, ranging from 8 to 21 months. Where are we now? 9.5 months.
What does this mean for the economy?
The economic data shows the effects of the March 12th, 2022 rate, which was 0%.
So dreams of an "immaculate disinflation" where inflation falls rapidly, and unemployment doesn't rise significantly, and we thus avoid a recession. The October low is THE final low in this bear market; sadly, the evidence does not support that.
To understand why, let's consider what the Fed does in a rate hiking cycle.
Imagine inflation as a measure of how much money there is in the economy.
We experienced 9.1% inflation in 2022, 60% due to almost $10 trillion in government stimulus, a 40% increase in the money supply, and record government borrowing to fight the Pandemic.
The real fed funds rate is the inflation rate, and that's now 0.23%. Or, to put it another way, all the rate hikes we've had so far have not been restrictive; they've been the Fed taking its foot off the economy's gas pedal.
The Fed's economists estimate that a real Fed rate of 0% to 1% is "neutral," meaning it neither accelerates nor drags on the economy.
This implies that if the inflation rate remains stuck around 5%, the Fed would have to hike above 6% just to become restrictive and start tapping on the brake of the economy.
What about things like QT? Or the regional banking crisis? Or the Treasury planning to sell $1.5 trillion worth of bonds by the end of the year?
Bank of America, JPMorgan, and the San Francisco Fed estimate that all these liquidity headwinds could effectively be adding 1% to 2.5% to the real Fed funds rate.
- So the Fed is effectively at 6% to 7.5%
- though the effects are just starting to show up in the economic data due to the 15 to 18-month lag times
Atlanta Fed
Based on several versions of the Taylor Rule, the Atlanta Fed estimates that even if the Fed's true effective rate is 6% to 7.5%, that's merely appropriate for the state of the economy today.
And possibly, the Fed might have to keep hiking more.
Here's the good news. The reason is that the Fed's dot plots (which get updated this Wednesday at the next meeting) are likely to show a 5.25% peak Fed funds rate is that a slowing economy and falling inflation will do much of the Fed's job for it.
We know the real Fed funds rate is 0.23%, possibly 1% to 2.5% higher.
- we can't be sure because QE and record government stimulus are something we've never experienced before
But as inflation falls, because the Fed and US Treasury are sucking money out of the economy ($2.2 trillion by year-end), even if the Fed doesn't hike rates above 5.25% or just leaves them at 5% for the rest of the year, that will still equal more rate hikes.
CME Group
Think of it this way.
Imagine if inflation remained stuck at 5% and the Fed kept hiking 25 basis points per meeting starting in July. By year-end, the Fed would be at 6%. That's a real rate of 1%.
The economy is driven primarily by real rates, not the headline rate.
Going from 0.23% to 1% would obviously drag on the economy.
But now imagine the Fed holds at 5% and inflation falls to 4% by year-end. That's also a 1% real rate and effectively has the same economic effect.
Jerome Powell has said that we shouldn't expect any rate cuts until the real rate on core PCE (the Fed's official inflation metric) is at least 1.5%. That's because the Fed wants to keep the real rate restrictive, meaning at least 1.25% until inflation is beaten.
Currently, core PCE is 4.7%, meaning that when it falls to 3.6%, the Fed would consider "maintenance cuts."
Cleveland Fed
The Cleveland Fed expects core PCE to remain at 4.7% at the end of June and fall to 4.5% by the end of July.
The Fed thinks 3.6% by the end of the year is most likely, and the FactSet consensus is 3.2%.
Or, to put it another way, the reason the Fed says not to expect any rate cuts this year is because the Fed is now in stage 2 of its war on inflation.
- stage 1: hike rates aggressively to stop stimulating the economy with negative real rates
- stage 2: once Fed rate is above inflation, hold rates high so falling inflation can act like effective rate hikes and further slow the economy through rising real rates
- stage 3: maintenance cuts to keep real Fed rate at least 1.25% "restrictive" until inflation is beaten
So why is the recession taking so much longer to arrive than economists and most people initially estimated? Because we flooded the economy with so much more money, it's now starting to work out of the financial system.
Want proof of that? I know I do.
With the sad death of Jeff Miller, NDD is the best economic guru on Seeking Alpha, providing detailed weekly real-time economic updates using the best objective data, including continuing Miller's proprietary recession warning system.
The “Recession Warning,” which began at the end of November this year remains, as all three of my primary systems remain consistent with a near-term recession." - NDD
According to the real-time weekly data, a recession is likely to begin by the end of November 2023.
David Rice
Based on 18 monthly economic indicators, David Rice at BaR (baseline and rate of change) agrees that a recession is historically likely coming soon.
The red dot (mean of coordinates) is now contracting at about 7% per month, and the green dot (leading indicators) is contracting twice as fast and below the historical 30-year baseline.
David Rice
Based on the last three recessions, the average of all 18 economic indicators now indicates we could be about two weeks from the start of a recession.
That means Q3, July, just like the Bloomberg and FactSet consensus among economists.
Daily Shot
The actual recession is expected to be from a -0.2% GDP contraction (mildest in history) to a 6% GDP contraction (50% worse than the Great Recession).
So why does it seem like this recession is taking longer than expected? It's actually not.
- The yield curve was predicting a recession would begin between March 31st, 2023, and July 31st, 2024
- Consumer spending was expected to peak around September 2023
It only seems like this recession is taking so much longer because everything has moved faster in our zero-rates world since 2009.
Every correction was a V-shaped recovery.
The Pandemic was a 2-month recession that was over in a flash, and the market was at new highs within five months of bottoming.
Everyone, including most economists, was expecting that the Fed hiking 4.75% in 2022 would cause a recession relatively quickly. It turns out that the timing of the recession is exactly historically normal.
So what does this mean for investors?
REITs: The Best Sector For Bargains Right Now
Charlie Bilello
The AI tech bubble is a function of several things.
Yes, AI is the future, with Goldman estimating it will boost long-term productivity and economic growth by 0.3% to 2.9%.
Goldman Sachs
However, that's not going to show up in the productivity data anytime soon.
WSJ
In fact, the current negative productivity data says we might potentially have been in a stealth "rolling recession" for the last six months.
WSJ
Gross Domestic Income or GDI, which normally closely tracks GDP, also indicates that we might already be in recession.
How is it possible that we're creating so many jobs if we're already in a recession?
Charlie Bilello
It can happen in a period of high inflation. In the 1973 recession, job growth was positive for eight consecutive quarters before job losses suddenly showed up out of the blue.
High inflation means revenues are rising, allowing companies to keep hiring in a tight job market to "hoard labor" to prepare for the end of a mild recession.
However, eventually falling margins force companies to start laying off workers, and that's what triggers a surge in unemployment and a contraction in consumer spending.
ChatGPT is amazing, but it isn't going to prevent this recession, nor the likely decline in earnings that Bank of America, Morgan Stanley, or the banking data says is coming.
Daily Shot
Bank lending standard data points to an 11% EPS contraction, about average since WWII.
Daily Shot
Bank of America estimates a 16% EPS contraction is coming.
Morgan Stanley doesn't expect a recession, just a single quarter of negative growth and then weak growth next year.
Daily Shot
But they expect a 20% EPS contraction, and thus the reason for their expected market bottom of 3,000 to 3,300 on the S&P (by year-end).
So what's a smart income investor do too? First, stay calm, and avoid the dangerous temptation to time the market based on economic data.
Charlie Bilello
Timing the market is impossible even if you could predict the economy perfectly, which no one can.
But here's what you can do. Consider buying undervalued blue-chips in sectors that aren't priced as if AI is going to overturn all the laws of economics suddenly.
Daily Shot
REITs are the worst-performing sector so far in this bear market, mostly because of the office industry.
Daily Shot
So don't buy Office REITs with the exception of the name I'll show you in a moment.
Focus on the highest quality and strongest investment grade REITs that are trading at some of the best valuations in years. These are "pre-crashed" sweet REIT blue-chip bargains that are likely pricing in a mild or even average recession already.
In other words, they have the most coiled-spring upside if the economic downturn turns out to be mild.
In contrast, the red hot tech stocks? They are mostly priced for not just a soft landing but a no-landing scenario, in which economic growth doesn't even slow down.
Big Tech: Priced For No Landing Scenario While Everything Else Is Pricing In Recession
Wide Moat Research
So let me show you three of my favorite sweet REIT blue-chip bargains that you can safely buy today, ahead of what's likely to be an average recession beginning in the next few weeks.
Dividend Kings Zen Research Terminal
I screened for non-speculative REITs with 81+% dividend safety (very safe) and then sorted by highest discount to fair value.
Here are three sweet REIT bargains to consider today.
Alexandria Real Estate ( ARE ): The Best Office REIT Isn't An Office REIT
Further Reading
Why ARE Is A Great Buy Today
ARE is suffering because it's classified as an "office REIT" when it's not.
ARE IR
It's actually the king of biolab REITs renting out state-of-the-art research labs to the world's strongest drug makers.
That's why its fundamentals have proven immune from the meltdown in office properties during the Pandemic and are expected to remain solidly growing in this recession.
FAST Graphs, FactSet
During the Pandemic, ARE grew at 5%, and in the 2023 recession, it's expected to grow at 6%, with 9% and 5% growth in 2024 and 2025.
Where is the recession in this data? There is no recession for the king of Biolabs because the secular growth tailwinds for big pharma are so strong.
Fundamental Summary
- DK quality score: 99% low risk 13/13 Ultra SWAN biolab REITs
- DK safety score: 99% very safe dividend (1.05% dividend cut risk in severe recession)
- Historical fair value: $182.11
- Current price: $120.55
- Discount to fair value: 34%
- DK rating: potential very strong buy
- Yield: 4.1%
- Long-term growth consensus: 9.7%
- Consensus long-term return potential: 13.8%
ARE offers 27% annual return potential through 2025 as well as an incredible 14% long-term return potential, better than the Nasdaq.
Federal Realty ( FRT ): The Only Dividend King REIT Is On Sale
Further Reading
Why FRT Is A Great Buy Today
FRT is a recession-resistant REIT, so it's managed to deliver a 55-year dividend growth streak, the longest of any REIT.
Metric | 2022 Growth | 2023 Growth Consensus (recession year) | 2024 Growth Consensus | 2025 Growth Consensus |
Sales | 9% | 5% | 5% | 5% |
Dividend | 1% | 1% (Official) | 2% | 2% |
FFO | 13% | 2% | 4% | 6% |
AFFO | 7% | 4% | 6% | 5% |
EBITDA | 9% | 5% | 7% | 6% |
EBIT (operating income) | 14% | 3% | 9% | 12% |
(Source: FAST Graphs, FactSet)
Yes, growth is expected to slow in the recession, but it's expected to remain positive, and the dividend growth streak is expected to hit 57 years by 2025.
FRT was founded in 1962 and is one of the oldest REITs in the country.
-
Congress created REITs in 1960.
Over the last 61 years, FRT has survived and thrived through the following:
-
nine recessions
-
the Great Financial Crisis
-
the Pandemic lockdown
-
inflation as high as 15%
-
interest rates as high as 20%
-
10-year treasury yields as high as 16%
-
15 bear markets.
FRT has been raising its dividend every year since 1967, including through stagflation hell. Its 55-year growth rate is 7%.
FRT owns 103 open-air shopping centers, mixed-use properties, and 3,000 apartments.
Its occupancy at the end of 2022 was 94.5%, including 96.1% for its apartments.
Its properties are in rich and thriving cities, including San Francisco, LA, Phoenix, Chicago, Boston, New York, Philadelphia, Washington, DC, and Miami.
FRT's properties have the best demographic profile of any shopping center REIT, with 90% of properties surrounded by high-income residents.
Its average population density, within three miles of a center, is 177,000, 45% more than its second closest rival.
The median household income of people living within three miles of its centers is about $110,000.
In an industry where "location, location, location" is everything, no shopping center REIT has better locations than FRT.
Fundamental Summary
- DK quality score: 89% low risk 13/13 Ultra SWAN dividend king
- DK safety score: 89% very safe dividend (1.55% dividend cut risk in severe recession)
- Historical fair value: $137.08
- Current price: $95.92
- Discount to fair value: 30%
- DK rating: potential very strong buy
- Yield: 4.5%
- Long-term growth consensus: 5.5%
- Consensus long-term return potential: 10.0%
FAST Graphs, FactSet
The king of reliable REIT dividends is so undervalued that it offers a 25% annual return potential through 2025.
Essex Property Trust ( ESS ): A Great Recession-Resistant REIT Aristocrat
Further Reading
Why ESS Is A Great Buy Today
ESS is a wonderful company at a wonderful price.
ESS IR
It owns some of the best apartment complexes in the richest cities in America, Where NIMBYism means that building new homes is very difficult.
ESS IR
Management is battle-tested with an average of 17 years experience (2007, right before the Financial Crisis) and is guiding for 3% growth in 2023 and 2024. Modest growth in a recession is much better than most companies will be able to deliver.
And you have the peace of mind of a 29-year dividend growth streak to help you SWAN during the coming economic pain.
Fundamental Summary
- DK quality score: 95% very low risk 13/13 Ultra SWAN dividend aristocrat
- DK safety score: 95% very safe dividend (1.25% dividend cut risk in severe recession)
- Historical fair value: $322.13
- Current price: $233.30
- Discount to fair value: 28%
- DK rating: potential very strong buy
- Yield: 4.0%
- Long-term growth consensus: 6.2%
- Consensus long-term return potential: 10.2%
FAST Graphs, FactSet
Buffett-like return potential from a recession-resistant aristocrat REIT that's literally pricing in a recession already.
Bottom Line: Recession Is Still Likely, So Buy These 3 Sweet REIT Bargains Today
The recession that we've been expecting for over a year is still likely, and it could be weeks away from the beginning. In fact, some compelling evidence points to the US being in a rolling recession right now.
The most aggressive Fed hiking cycle in 42 years is just starting to bite into the economy now, and with the Fed planning to hold rates at current levels or even raise them one more time in July, the current hopium rally in big tech is irrational.
CNN
The recession likely hasn't started yet, but it's coming, yet investors are partying like it's 1999.
At least index fund investors are. It's always a market of stocks, not a stock market, and ARE, ESS, and FRT are three 30+% undervalued REIT blue-chip bargains you can safely buy today.
These are rock-solid REITs with strong balance sheets and battle-tested management; two are dividend aristocrats. In fact, FRT is the only dividend king in REITdom.
Wall Street doesn't run on certainty; it runs on probabilities. I can't tell you that NVDA is about to crash, and ARE is about to take off like a rocket.
But I can tell you that for anyone comfortable with their risk profiles, buying ARE, FRT, and ESS today will likely make you very happy in 5+ years.
Because when you focus on safety and quality first, and prudent valuation and sound risk management always, you never have to pray for luck on Wall Street; you make your own.
For further details see:
3 Sweet REIT Blue-Chip Bargains