Bonds sell off despite weaker releases as emerging markets improve

Part 5

Why retail sales and Janet Yellen’s speech are major REIT drivers

The ten-year bond is the basic driver of REITs and homebuilders

Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as “quantitative easing” (or QE). As a general rule, economic data that shows weakness is bond bullish (positive). However, data that shows strength isn’t necessarily bond bearish (negative).

Retail SalesEnlarge Graph

Some weaker-than-expected economic data

Retail sales fell in January, although that was largely attributed to bad weather in the Northeast. Industrial production came in light, and capacity utilization was lower than expected. The highlight of the week was Janet Yellen’s testimony in front of Congress, where she pretty much endorsed the policies that the Bernanke Fed was following.

Homebuilder earnings and M&A

We had earnings from Lennar (LEN) and KB Home (KBH) recently. Lennar’s numbers were strong, while KB Home missed. Toll Brothers (TOL) reported good numbers the week before. The homebuilding segment has definitely been a case of two sectors—the luxury sector, which is doing extremely well, and the first-time homebuyer sector, which is getting bombarded by increasing real estate prices, increasing interest rates, and a lousy job market.

We’re starting to see mergers and acquisitions (M&A) activity in the homebuilding space, with two deals. First, Tri Pointe Homes (TPH) is buying Weyerhaeuser’s homebuilding unit, and second, Toll Brothers is buying Shapell. We can attribute much of this to the two-tiered financing market in general. Large companies like those in the homebuilder ETF (XHB) are able to borrow at exceptionally low interest rates and almost have money thrown at them by the Street. Smaller builders, however, are stuck dealing with the banks, and credit is much tighter for them.

Commercial REIT earnings

Recently, we heard from mall REIT heavyweights Simon Property Group (SPG) and General Growth Properties (GGP). Overall, retail sales may have been slightly disappointing, but these mall REITs are reporting strong numbers.

Implications for mortgage REITs

Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. AGNC reported earnings and said that it was investing some of its portfolio in the stocks of its competitors. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE (quantitative easing). In his post-FOMC press conference, Ben Bernanke told the market to expect a reduction in pretty much every FOMC meeting, with the normal caveats that everything is data-dependent.

Implications for homebuilders

We heard recently from D.R. Horton (DHI) and PulteGroup (PHM). Both are diversified homebuilders that cater to the first-time and move-up buyer. While the first-time homebuyer remains on the sidelines, the move-up buyer has been active, and has been driving price increases. Both companies noted that traffic increased in January, which bodes well for the spring selling season.

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