So, the Federal Reserve just told us that it has decided it could start “tapering” its bond buying purchases later this year. And while I didn’t think that was much of a surprise, what was a surprise was Chairman Ben Bernanke telling the world during his press conference that quantitative easing could end by mid-2014.
That potential chock-off of the printing presses during the next 12 months has traders running for cover, and indiscriminately selling just about every asset class. Stocks, of course, are getting slammed, but so are bonds and so is gold.
I suspect the current selling across the board is basically a “risk-off” overreaction trade caused by everyone trying to grapple with the potential aftereffects of a zero-QE vista.
Now, I actually think the Fed will continue its bond-buying program well past mid-2014, as I don’t think the economic data is going to be good enough to justify the Fed’s absence. Having said this, we cannot deny the reality that QE is going to be tapered, and that this likely will cause a drop in bond prices and a concomitant spike in bond yields — particularly in the benchmark 10-year Treasury note.
Of course, when bond yields spike, it also means interest rates spike, and that condition places interest-rate-sensitive sectors at particular risk for decline.
For dividend stock investors, the current market milieu means it’s time to treat the sectors and the companies with the greatest exposure to interest-rate risk as an impediment to continued portfolio performance. More specifically, dividend investors will really want to shun sectors that don’t have the ability to raise dividends because of either A) market conditions or B) regulatory constraints.
Two sectors that resemble this aesthetic perfectly are real estate investment trusts and utilities.
The color in the REIT space right now is such that even the best REITs would have a hard time raising rents in a rising-interest-rate environment. The logic here is that if the cost of capital is going up, this presumably would put pressure on the economy, thereby constraining REIT operators from hiking customer rents.
As for utilities, these stocks generally rely on the good graces of state regulators to allow them to increase payouts. Well, with many states around the country facing fiscal hardships, combined with the pressure of added borrowing costs, the last thing state utility commissioners are going to want to do is allow utility companies to boost dividend payouts.
Now, practically speaking, the two biggest exchange-traded funds to avoid here are the Vanguard REIT Index ETF (VNQ) and the Utilities Select Sector SPDR (XLU). These funds contain the biggest — and arguably the strongest — companies in their respective sectors.
Not surprisingly, both VNQ and XLU have seen significant selling since late May, when Bernanke first introduced the “tapering” meme into Wall Street’s collective cortex. The charts here of VNQ and XLU show the breakdown in each sector — a breakdown that has sent both funds cascading through support ledges at their respective 50- and 200-day moving averages.
If you own these funds, or if you are thinking about nibbling on them as a sort of contrarian value meal, I strongly recommend you rethink your position and either sell or avoid them, whichever course of action applies to you.
As for individual dividend stocks, here I would avoid marquee REIT names such as Simon Property Group (SPG), HCP, Inc. (HCP) and Avalonbay Communities (AVB) to name only a representative trio. In the utility space, it might be wise to avoid widely held stocks such as Duke Energy (DUK), American Electric Power (AEP) and Sempra Energy (SRE).
Bottom line: The time is right to treat both REITs and utilities as a pariah in your quest for profits … despite their outsized yields.
As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.