REIT Strength Means Weakness For Stocks?

I saw this chart on the Humble Student Of The Markets blog, which is one of my favorite blogs for a quick and thoughtful market perspective:

Source: 10 or more technical reasons to be cautious on stocks

The corresponding analysis is the following:

On an absolute basis, this chart of VNQ, which represents REITs, is undergoing a bullish cup and handle upside breakout. Leadership from such a defensive sector is another technical warning of a potential market top. Source: 10 or more technical reasons to be cautious on stocks

While I agree with most of the things written in the article, I have to add that the behavior of REITs at significant market tops is not as clear cut as it seems. Sometimes they outperform, sometimes they underperform the market. What is more important for REIT outperformance is the rates environment, i.e. whether rates are falling or rising. I tried to capture this with the simplest of all, the 10y US Treasury yield vs REITs:

Source: Bloomberg

First of all, during the past 10 years, we can see outperformance and underperformance as well (rising and falling white line), while the S&P 500 has been steadily rising. What is more important, is that the white line (VNQ relative to the S&P 500 index) seems to be negatively correlated with the green line (10y US Treasury), aka they move inversely. The latest period of outperformance (circled) has been coincident with the rise of the stock market from its lows in March, however if you look at the green line, it seems that it has been likely driven by the consolidation of the 10y Treasury yield. Since REITs are more rate-sensitive, this might have warranted some sort of outperformance, however its extent is quite muted.

It is not to say that the outperformance of defensive sectors is something not to worry about, but in the case of REITs there might be other factors in the background, other that a recession on the horizon. But in the past 10 years, corrections in the market have not always been preceded by the outperformance of REITs.

 

Disclosure: We are long VNQ.

REITs vs Banks

This is my favorite chart from Friday’s links:

Source: Bonds Could Be The Catalyst To Take Stocks Much Higher

While REITs have held up pretty well recently, the 10y yield recently broke out of the triangle pictured above and is now above 3%.

Will this be a game changer for REITs? I have no idea, but the 10y yield is definitely an important indicator to watch.

 

Disclosure: We have no positions in KRE or IYR. We are long VNQ.