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Feb 06 2024

Research Preview: REIT Rebound?

  • Feb 6, 2024

Since the pandemic, investors have been leery of adding REITs to their asset mix due to fears that flexible scheduling and work-from-home will permanently diminish the demand for office space. While that view may prove correct, the magnitude of such a change is much less significant than some might suspect.

Read this week's MTI update.

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Real Estate was the top performing sector in the final quarter of 2023, climbing an impressive 18.8% against the market’s 11.7% gain.  Signs of enthusiasm for the REIT industry have been rare in recent times.  While the S&P 500 gained 96% over the last five years, REITs returned a paltry 31% over that time.  We wondered if last quarter’s success signaled that it was time to take a fresh look at the group.  This report examines the investment merits of REITs as an asset class, using the mental model of evaluating “what you pay vs. what you get.”

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Read this week's Major Trend. 

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CPI readings were a tad hotter than estimates again in January. Given the speed of disinflation that’s currently priced in by the market, we are probably headed toward a period of expectation adjustment.

 

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It’s too soon to know if the October low for small caps will stand, but it would have been a better, more buyable low if it had been accompanied by a recession. It’s all about “initial conditions.” Russell 2000 lows associated with recessions bottomed with a normalized P/E multiple nearly five points below that of the median multiple for non-recessionary lows—and subsequently gained an average of 185% versus +75%.

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The stock market remains “externally” strong, with the S&P 500 and DJIA at new all-time highs on February 2nd.  However, the YTD performance gap between the S&P 500 and the Russell 2000 is already 8%—the worst five-week start ever for Small Caps on a relative basis. And, on a trailing 12-month basis, the percentage of S&P 500 stocks outperforming the index, itself, is the lowest on record at just 25.6%. That’s made it a challenging time for active managers and dart-throwers alike.

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The probability of a soft landing has materially increased, while stronger than expected growth is likely to put a floor on inflation, which challenges the consensus disinflation view. A refresh of our Dollar Monitor suggests a weaker dollar going forward.

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While mid- and small caps notably underperformed, large growth results were freakish. Measured against the S&P 500 Growth index, an implausible 96% of active large growth funds beat that benchmark—a result that stands as one of the most extreme win rates ever seen for a style box.

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Read this week's Major Trend.

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Well, it’s Groundhog’s Day Earnings Season… again. With the first month of results for Q4, operating earnings estimates for the S&P 500 continued their long slide from their optimistic highs set back in June of 2022 (Chart 1). The 20% drop in projected EPS didn’t stop the index from rallying +30% over those 19 months. Full-year 2023 operating EPS is now crystallizing around $210—a 7% gain from 2022’s results.

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Read this week's Major Trend. 

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The Magnificent Seven’s remarkable performance defines the stock market in 2023. This basket of the seven largest companies in the S&P 500 index gained an average of 111% vs. an average gain of 9% for the other 493 companies. The combined impact of huge index weights and outsized performance made 2023 one of the most top-heavy markets in history. Whenever assets outperform to this degree over just a few quarters, the valuation alarm bells start clanging. Could the fundamentals possibly justify such a massive advance, or is AI mania responsible for the outperformance?

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Read this week's Major Trend. 

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Read this week's Major Trend.

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CPI readings for December were a tad hotter than estimates. The path forward is unlikely to be a straight line down. Watch geopolitics closely, as it could drive prices in either direction very quickly.

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Read this week's Major Trend. 

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Over the entire history of this study, the momentum plays of our “Dreams” and “Nightmares” have worked both ways. This was not the case in 2023, however, as the fortunes for both groups (based on 2022 performance) U-turned in a considerable way.

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Given how many potential political and geopolitical hotspots there are at present, it might be a bit presumptuous to think 2024 will be a typical year. Politics and geopolitics are the most underpriced risk for 2024.

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In the theme that’s reminiscent of all but a couple of the last 15 years, the optimal strategy for equity managers and asset allocators in 2023 was the same: Buy the S&P 500, and then hit the links.

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There are reports that 40% with student loans did not make an initial payment when installments resumed in October. Meanwhile, among seniors aged 65-79, the share with a mortgage rose to 41% in 2022, up from 24% in 1989, while the percentage of those aged 80+ with a mortgage increased from 3% to 31% during the same time! 

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Remember the nickname for retired San Antonio Spurs star Tim Duncan? “The Big Fundamental.” The stock market itself is a big fundamental—and that’s probably truer now than in past cycles, since market capitalization relative to U.S. GDP is larger today—with the exception being the most extreme phase of the post-COVID mania.

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Speculating on the link between style performance and interest rates is a favorite pastime of factor aficionados, but 2023 provided a real-time laboratory to evaluate those ideas. We examined factor returns during the interest rate swings to uncover some empirical insights into this important relationship.

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Whenever a basket of stocks with the market heft of the Magnificent 7 shows a price gain of 111% in a single year, the valuation alarm-bells ring loud. Is this gain the result of a mania for all things AI, or could the move be justified by equally magnificent fundamentals? 

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Read this week's Major Trend.

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Read this week's Major Trend.

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Depending on how you measure it, with a few days to go, it’s either been a superbly profitable 2023 or a year that barely crept above the 30-year average.

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This looks like a market that has made up its mind about inflation and a coming soft landing. Inflation and Economic Surprises in 2023 have helped form this rosy outlook.

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The S&P 500’s 8.9% November gain ranks as the 18th largest over the 800 months since the index’s inception in March 1957. Are such short-term market spikes typically followed by additional upside? The evidence is not quite as compelling as the data-mined analysis we found on X (formerly Twitter) initially had us believing. 

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It would take a solid December gain of about 5% to bring the S&P 500 back to its all-time high of 4,796.56—printed on January 3, 2022. Well then, what’s been accomplished in the nearly two-year trip to nowhere? For one, valuations for the cap-weighted S&P 500 have receded from truly bubbly readings to levels we’d merely consider “pretty damn high.” 

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The retail investor is warming up to the stock market. We also see the “smart money” is also taking a shine to stocks. It’s rare to see these two classes in agreement. Usually when the retail public becomes euphoric, insiders become fearful.

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Will 2023 be remembered as a delightful year with +20% returns, or might it go down as a time when stocks lagged even a risk-free money market fund? We introduce this month’s research topic: The huge return disparity between the capitalization weighted S&P 500 and the equal weighted version.

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Value has worked much better within small caps compared to large caps for three of the last four years. This is nothing new, though, as value is historically a much better factor within the less efficient smaller-cap universe.

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With the market penciling in four rate cuts in 2024, the consensus appears to have accepted the idea that the last rate hike of the series was in July. We look at various market indicators around the end of previous hiking cycles and compare the historical pattern with today’s episode.

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Read this week's Major Trend. 

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As we put a fork in the S&P 500’s Q3 earnings, our snail trail is now decidedly pointing south. However, the kink you see in Chart 1 should not be viewed as an EPS collapse. An accounting sleight of hand from Berkshire Hathaway—R.I.P. Charlie Munger—shaved off just under $3/share in EPS for the index. If that were added back, the quarterly estimate of $55 would be pretty much unchanged since the start of the summer.

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Read this week's Major Trend. 

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Performance chasing is one of the most common behavioral errors made by mutual fund investors and represents one of the most heavily traveled roads to poor investment results.  Now, when we use the phrase performance chasing it is universally understood that we are talking about chasing good performance. That is why we are so intrigued with TLT, this year’s fund flow leader among bond ETFs. The iShares 20+ Year Treasury Bond ETF has raked in over $20 billion in new assets this year, but not by posting strong results. Rather, inflows have surged despite returns that are frankly terrible. Such an incongruity deserves a closer look, and this study lays out some of the key storylines behind this surprising development. 

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