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Defensive Stocks And REITs Look Overpriced

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Thus, investors in need of income continue to look for alternatives. One manifestation of this is a strong bid for so-called “defensive” equities, or stocks with low volatility and a high dividend yield. Real Estate Investment Trusts (or REITs) are one example of this trend. The search for yield has pushed the Dow Jones Select REIT Index up about 20% year-to-date, roughly twice the return of the S&P 500.

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Market Realist – The search for yield is forcing investors to look for opportunities beyond the traditional investments. Defensive stocks are fast becoming the top choice of investors. Because defensive stocks usually give high dividend yields and are relatively less volatile (VXX), investors are climbing into asset classes such as real estate investment trusts, or REITs, which makes REITs look overpriced.

REITs look overpriced

REITs (VNQ) outperformed the broader markets in 2014, as you can see in the above graph. The MSCI US REIT Index is giving year-to-date returns of 27.7% versus year-to-date returns of 11.1% from the S&P 500 (SPY).

Search for income is becoming increasingly tougher with low Treasury (TLT)(IEF) yields as a backdrop. Because REITs are providing an average dividend yield of 3.5%, higher than ten-year Treasuries (IEF), investors are being drawn to the asset class.

The heightened interest in REITs is evidenced by the IPO (initial public offering) issued by the Paramount Group Inc. (PGRE) in November. The $2.29 billion IPO is the largest ever for a US REIT.

Sears Holdings Corp. (SHLD), too, is contemplating converting around 200 to 300 of its stores into a REIT. But considering the problems facing Sears, including the company’s junk credit rating, the fall in sales, and consistent losses, the appeal of this idea remains to be seen.

REITs look overpriced valuation

The increased interest in REITs is causing rich valuations and making REITs look overpriced. The graph above shows MSCI’s estimated earnings multiples for REITs, global equities (QWLD), and US equities (SPY).

In the next part of this series, you’ll learn how the search for income is affecting other defensive sectors such as utilities and consumer staples.

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