The best returns from any asset class last financial year came from listed property trusts (AREITs), with the S&P/ASX 300 A-REIT Total Return Index up 19.4 per cent over the year to June. A leading equity research house has warned that the good times in the AREIT market may not last.
AREITs, along with infrastructure and utility companies, are classified as “bond proxies”, which means they have some of the characteristics of government debt securities and will increase in value when the yields on bonds are low.
Macquarie Securities says more than two-thirds of the total return from bond proxies last financial year was due to “yield compression” – revaluation in the face of falling bond yields.
Macquarie’s view is that “momentum in bond proxies is extended” and the growth that we have seen over the past year may not be sustained. “We expect bond proxies to lag as the cycle improves,” it says in a report issued last week.
In 2018/19 most sectors relied on yield compression to outperform. Actual yield from REITs was only 4.9 per cent of the total return., and dividends did not increase that much. Valuation change was the big driver.
This yield driven price momentum has gonetoo far.
“With the second RBA cut in as many months, the search for yield may continue in the near term but we think the spread of dividend yields relative to bonds will contract in the next year. We think it will be driven by an improving cycle and rising bond yields,” the report says.
The case for an “improving cycle” is based on the likley positive impact of two Reserve Bank interest rate cuts, the likelihood that the US Federal Reserve will follow the same course of action, the begging of a pick-up in the domestic housing market and the OECD signaling an improving US cycle.
“A year from now we expect to be in the expansion phase of the OECD leading indicator mini-cycle,” Macquarie says.
The last time there was an expansion in the US, ASX bond proxies took a hit.
Macquarie says growth opportunities are in offshore earners with rising dividends. These include Fortescue, BHP, Rio, CSL, Aristocrat Leisure, Oil Search and Origin Energy. All are rated ‘outperform’ by Macquarie.
Macquarie continues to hold a couple of REITs in its Macquarie Equity Strategy Portfolio: Goodman Group, “as it continues to generate earnings growth”; and Stockland for its exposure to the housing recovery.
Macquarie also recommends “buying the dip in housing related stocks”. In April it added REA Group to its portfolio on the view that the domestic housing market would “get less bad” over the course of 2019. In May it added more domestic housing exposure in the form of Stockland and building products company CSR Ltd.
Macquarie says a key takeaway is to continue positioning for an improving housing market. Other stocks it likes include Nine Entertainment, which owns 60 per cent of Domain Holdings, a couple of banks (NAB and Westpac) and construction materials companies CSR and James Hardie.