With stocks continuing to climb higher I’ve been a lot less active in terms of buying, especially on the Growth side of portfolios. However, there are some attractive opportunities popping up in the Income arena due to rising short and intermediate term bond yields.
The yield curve is a line that measures yields at each maturity from short-term T-bills out to the long-term 30 year T-bond. We typically have an upward sloping yield curve meaning the longer an investor is willing to lend money, the higher the interest rate they demand. Lately, short and intermediate term rates (90 days to 5 year) have been rising quite a bit while the long end (10 and 30 year) has been relatively steady, creating a flatter yield curve. This is pretty typical for what you see in the later stages of an economic cycle. It’s even possible to see the curve invert where short-term rates are higher than long-term rates. This is the bond markets way of telling the Federal Reserve they’ve gone too far with rate increases and are falling behind. We’re not there yet but could easily see it happen later this year at the pace we’re on unless the 30-year yield starts moving higher.
Here’s a chart of the US Treasury 2-year to 30-year yield curve today (green line) vs. where it was 1 year ago (blue line). As you can see, the slope is much flatter because short-term rates have risen more than long-term. In fact, the 30-year is currently yielding less than it did 1 year ago which says a lot about long-term growth and inflation expectations and is going to make it difficult for the Fed to engage in a long hiking cycle.
2-year to 30-year Treasury Yield Curve
source: St Louis Federal Reserve (FRED)
The increase in yields has been putting pressure on yield sensitive equities over the past couple of months, namely Utilities and Real Estate Investment Trusts (REITs), which is creating a nice opportunity for investors looking to generate income in their portfolios.
Divergence between S&P 500 vs 10-year Treasury, Utilities and REITs
This is the natural reaction one would expect when yields rise but I think the market is getting a bit overdone and starting to miss the forest for the trees. Cash flow producing real assets is exactly what you want to own in an environment like this, meaning the short-term dip is a great long-term investment opportunity. And the 30-year Treasury bond is confirming it.
It’s REITs in particular that I’m liking right here, with the caveat of noting that one needs to be company specific. Prices haven’t come down enough to get aggressive with the entire sector yet. There are too many bad apples in a broad based REIT fund with either too much debt or operating in an unattractive industry. REITs should also be beneficiaries of the new tax bill whereas regulated utilities could be forced to pass on a lot of the savings to their customers via lower rates.
I’ve purchased one new position in Ventas (VTR), have added to a couple existing positions, and have one more I’m close to buying.
Ventas is the second largest healthcare REIT in the country, right behind Welltower which we invested in last year. Both companies are top-notch with slightly different strategies. Ventas is more diversified with exposure to life science research facilities and medical office buildings in addition to senior living facilities. This has generated a higher growth rate in Funds for Operation (FFO) and the dividend so VTR has been trading at a slightly lower yield than Welltower. With the recent drop though and the stock now trading at a 5.5% yield, I’m a willing buyer. Given the demographic outlook of aging baby boomers, I view both of these healthcare REITs as very high quality income investments that you can likely hold for the next 10 to 20 years.
Long Term Market Opportunity
Ventas Financial Stats
Ventas Diversified Portfolio
Source: Ventas Investor Presentation
Thanks for following!
-Nick