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Seeing Red: Opportunity or Warning?

Here is a look at how different investment sectors and styles have been impacted by the sell-off, as well as a few ideas going forward.      

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For starters, year-to-date, the S&P 500 is down only 1.9%, although that encompasses significant gains followed by significant losses as shown in the following chart.

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Why the Sell-Off?

The two most prominent reasons in the news for the sell-off are: (1) A strong jobs report just over 1-week ago spooked the market into believing the Fed will raise rates faster, and that will put the breaks on the economy, and (2) The nine-year raging bull market was simply overheating and needed to blow off some steam.

Regarding reason #1, it’s possible, although the jobs report wasn’t really that much of a surprise. Also, we can argue the merits of reason #2 with metrics such as S&P 500 price-to-earnings ratio and total market cap to GDP ratio, which have some merits.

However, the most important economic point in our view is that the economy is strong and getting stronger, and regardless of short-term noise, the market is still going to go much higher over the long-term. Further, any time the market pulls back 10% from peak to trough (that’s what it’s done over the last two-weeks) on no major news (thank goodness we haven’t had a 9-11 or even just a Brexit), it’s a better time to buy than it was just two weeks ago.

Also critically important, investors must know their personal investment goals (if you’re an income investor, you may not need to have a large allocation to the stock market), and to stick to them (i.e. don’t doing anything silly when the market gets volatile, as it recently has).

The “Safest” US Sectors Have Sold Off the Most

As shown in our earlier performance table, REITs, Utilities and Energy have sold off the most year-to-date, thereby leaving some investors perplexed because those are supposed to be the high-income “safe” sectors…

REITs:

Regarding REITs, the sell-off is due to a combination of rising interest rate fears (REITs rely on borrowing to grow) and stock specific challenges (for example, most retail REITs continue to struggle with growing competition from the Internet, and many healthcare REITs continue to face challenges from struggling operators due to continuing pressure on health insurance reimbursement rates). In our view this is a good time to consider adding shares of high quality retail REITs and high quality healthcare REITs where they’ve sold off with the market, but they’ve also sold off with overblown fears related to their specific industries (i.e. the Internet and troubled operators). We like retail REITs Taubman (TCO) Macerich (MAC) because they’re A-class properties, and we still don’t like B-Class Mall operators like CBL (CBL) no matter how cheap it gets. Regarding Healthcare REITs, some of the more blue chip ones are increasingly attractive such as Ventas (VTR) and Welltower (HCN).

Utilities:

Regarding the utilities sell-off, it makes some sense as investors have piled into this sector in recent years because it offered higher yield relative to artificially low interest rates on bonds thanks to the Fed. However, rates are now starting to rise, and investors who have piled into utilities in recent years are starting to give move serious consideration to moving back to bonds. Utilities are largely still “safe” businesses, but their valuations have gotten frothy in recent years.

Energy:

The energy sector can offer attractive yields because of long-term business/revenue arrangements, but it can also get whipped around in the short-run by volatile energy prices. The entire sector has been extremely interesting in recent years as oil prices went from very high in early 2014, to very low, and now back up toward more reasonable levels. As energy prices have been whipsawed, so too have many energy companies that can only survive with prices above a certain level. As much as we’d love to see only the cleanest safest energy take over the world, oil isn’t going away, and many companies are regaining their footing (in a good way) now that prices have come back up somewhat (though they’re off in the last week). As contrarians, we like this sector, but we also especially like some of the MLPs that have sold off recently, such as Enterprise Product Partners (EPD) and Tallgrass (TEP), and Enbridge Energy Partners (EEP) if you can handle a little more risk/volatility.

The Bottom Line...

The recent market sell-off has created some interesting opportunities (for example, check out this recent article:  ). However, to put things in perspective, the market is still only down about 2% this year (remember--it got off to a great start), and this sell off (as painful and scary as it may seem) is still mainly just normal market “noise.” It’s most important for investors to stick to their long-term plans, and to avoid doing anything silly. Keep calm, and carry on.

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For reference, you can view our current holdings here.

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