Our largest exposures in the Dividend Growth portfolio as of this writing are in midstream oil and gas pipelines, automakers, alternative asset managers and REITs.
After a mixed year in 2017, pipeline stocks, automakers and alternative asset managers have all enjoyed a very strong start to 2018.
In my opinion, these sectors may be very strong drivers of our returns this year.
REITs, however, have had a rough start this year. And while it’s impossible to ever truly know “why” a sector falls out of favor, it appears that worries over rising bond yields is what is depressing REITs at the moment.
Rising bond yields affect REITs in two ways. To start, REITs tend to borrow a lot of money, so every additional dollar paid out in interest due to rising yields is a dollar that comes out of profit.
But secondly, REITs, as high-yield investments, are also priced relative to bonds. So, rising bond yields (and falling bond prices) mean rising REIT yields (and falling REIT prices), all else equal.
With U.S. economic growth picking up, there is widespread belief that inflation is just around the corner. And higher inflation, were it to happen, would almost certainly mean higher yields.
I’m not convinced that higher inflation rates are imminent, however. Inflation remains very subdued globally, and this is reinforced by the aging of the baby boomers and by technology trends.
In my view, older consumers borrow and spend less than younger consumers. So, the aging of the baby boomers may create a deflationary anchor that should keep inflation rates low for a long time to come.
Furthermore, the wage inflation that has been so hard to come by over the past 10 years isn’t likely to come roaring back, even with a strong economy.
In virtually every customer facing industry, kiosks and smartphone apps have effectively replaced human labor.
As soon as higher labor costs start to cut into profits, companies react by replacing expendable labor with cheaper technology.
And while this trend has been with us since the dawn of human history, today it is accelerating at the fasted rate since the Industrial Revolution.
So again, inflation is not something I’m particularly concerned about, and I believe that the current spike in yields will recede within a few months.
I may prune our REIT portfolio slightly in the first quarter, but in my opinion the overall bearishness towards the sector is unwarranted, and I continue to view the sector as a good “fishing pond” for stable, dividend-paying stocks.