2017 Review

Having finished compliance stuff for MiFidII and PRIIPs, let’s take a review of the year that passed.

I couldn’t have written a better memo myself than the guys at Hoya Capital: REITs End 2017 On High Note

What’s more, they have also collected the 2017 returns for the most important US real estate sectors and ETFs:

Source: REITs End 2017 On High Note 

So I’m just going to present some charts here that are worth watching in 2018…

  • VNQ, alias Vanguard REIT ETF which covers the US REIT sector without cell towers was rangebound all year swinging between 80 and 86 and closing almost where it started the year:

Source: Bloomberg

I’ve plotted two indicators on the chart as a textbook example of the usage of the oscillators and the Bollinger Bands. Oscillators (here the Stochastic) can best be used in trading ranges, where one sells when the indicator line closes below a standard reading (say 70 or 80), and buys when crosses above a certain level (30 or 20). So when the oscillator has a high reading one should look for the exit, and when it is low one should look for an entry. In trending markets the reverse is usually true: high readings (or closing above a certain level) are signs of strength, while low readings are signs of weakness.

The same is true for Bollinger Bands: in rangebound markets, one sells when price closes above the upper band, and buys when price closes below the lower band, basically a mean-reverting strategy. In trending markets the reverse is true: in a strong trend price usually “hugs” the lower/upper band, and travels in the same direction for an extended period.

In this case, out of several technical trading strategies, the one using Bollinger Bands generated the highest total return (almost 43%), while buy-and-hold was essentially 0. The popular MACD and various moving average strategies (50 and 20 days) generated negative returns.

This is from Bloomberg’s backtesting functionality for VNQ and 2017:

Source: Bloomberg

The lower panel shows the cumulative PnLs for different strategies, where the one using Bollinger Bands stands out as a clear outperformer.

And this is how the various real estate sector ETFs’ 2017 performance looks like:

Source: Bloomberg

The performance differences (which are huge) can be traced back to the inclusion of the cell tower segment (see this post for further details).

  • XHB (Homebuilders ETF) and ITB (Home Construction ETF) were the stars of the year, easily leaving behind every other vehicle in 2017. They have correlated better with the rising large-cap equities, while REITs acted like a bond proxy.

Source: Bloomberg

Source: Bloomberg

What a year this was for this sector! I’ve added the same two indicators to stress the point of using the proper indicator for a given market environment. For these trending ETFs, one would have sold early and never would have gotten back in time to profit from this trend. In other words, the previous strategies (oscillators and Bollinger Bands) were not successful in this trending environment. So what was successful? The easiest strategy:

Source: Bloomberg

In the lower panel of the above chart, you can see that those strategies that worked for VNQ didn’t work here, and those that generated losses there made outsized gains here.

The upshot is that you should apply your trading/investing strategy to the appropriate market environment.

  • Finally, let’s look at the performance of the mortgage-backed bonds market represented by REM, iShares Mortgage Real Estate Capped ETF:

Source: Bloomberg

This chart shows us a trending move until mid-year, when it started a lengthy consolidation. Being composed of mortgage-backed bonds, it is more or less the mirror image of the 10 year Treasury bond’s yield:

Source: Bloomberg

This is for the US market regarding the past, I’ll come back shortly with a review of international real estate.


Disclosure: We are long VNQ, IYR, XHB and ITB.