V-Shaped Real Estate Can Fly as a Recovery Bet

This raises the interesting question of whether real assets will have a chance to blossom after this crisis. Perhaps surprisingly, listed real estate in the U.S. has outperformed the S&P 500 over the last three decades, on a total return basis — which allows for the reinvestment of the high rental yields generated by real estate investment trusts, or REITs.

There is now the possibility of a shakeup within the sector, in both the residential and commercial segments, and across the world. Home builders in the U.S. are positive because the demand for their services in the suburbs is rising as a result of the virus. The NAHBs chief economist, Robert Dietz said:

Is it reasonable to hope for a recovery from here？ It might well be. Bond yields have dipped, as we are all aware. This makes the dividend yield that REITs are able to pay out of their rental income that much more attractive. In this chart, Capital Economics Ltd. of London shows the REIT dividend yield compared to the earnings yield (the inverse of the price-earnings ratio) of the S&P 500. This exercise suggests that REITs are at last attractively priced after years of looking expensive:

Trying the same exercise for FTSEs global REIT index compared to the MSCI World index, and using dividend yields in both cases, we see that the spread in favor of REITs rose sharply with the beginning of the Covid crisis, and remains at roughly the same level.

Naturally, dividend yields are high for a reason. In the grips of recession, the fear is that a lot of rents will go unpaid. But this still creates possibilities.

One is at the level of what might be called stock selection. In the confusion following a serious economic shock, it remains unclear who will benefit and who will lose. According to President Trump, there is a risk that a newly elected President Biden would attempt to abolish the suburbs. That appears unlikely. But if some areas grow less popular, former tenants and owners will relocate. Working out the winners could be very profitable.

Secondly, at a macro level, real estate is still priced on the assumption of a major and enduring economic downturn. Data centers are the only commercial real estate sector to have gained since the pre-Covid peak on Feb. 19. Meanwhile, as the chart from Capital Economics shows, REITs as a whole are performing very much in line with airline stocks, which are an obvious play on the duration of the pandemic and its impact on economic activity:

For those who want to bet that the economy will do better than many now expect, and that there will be a shorter Covid interruption than we believe, real estate looks like a good way to make that bet. It behaves like airlines, only with extra yield.

Netflix

After the close, Netflix Inc., the dominant company in video streaming and a critical member of the mega-cap acronym stocks, provided us with the most important announcement of the earnings season so far. To a greater extent than virtually any other large company, Netflix actually had lofty expectations to meet. And even though its number of subscribers bulged as many had hoped in the stultifying conditions of the second quarter, it still fell short of expectations.

That meant quite a punishment in after-hours trading:

As the spikes show, there are plenty of people keen to “buy the dip.” Netflix stock might easily rise again. But the extent of disappointment is telling. It isn‘t as though there was anything wrong with subscriber growth, which for the second quarter in a row was massive. Netflix’s sin in the eyes of its investors was to forecast that the pandemic had merely allowed it to rob Peter to pay Paul — it brought forward subscriptions that would otherwise have shown up later, and it is estimating slower growth ahead:

Netflix matters because it is a “Fang” stock, though it differs in being much smaller (only the 20th largest company by market cap in the S&P 500, while other Fangs occupy all the top five positions). It has arguably greater potential to grow in the future, but it may be beginning to dawn on investors that it has other crucial differences. Unlike the others, it does not have a protected monopoly position. Any number of deep-pocketed competitors — other Fangs among them — are now offering Netflix a credible contest.

Also, unlike most of the other Fangs, it has a valuation that offers almost no margin for error. The S&P 500 trades for twice its sales; Netflix trades at more than 10 times sales. This is still below Netflixs previous peak in the summer of 2018, and it is notable that the sales multiples of other much more mature Fang stocks, such as Apple Inc. and Amazon.com Inc., are also rising to what look like infeasible levels. But Netflix remains indubitably expensive. It has to grow a lot to justify its multiple:

Netflix has another problem as a result of the shutdown: content. Particularly if the lockdown conditions persist for a few months longer, many of us will have exhausted our appetite for classic TV series and movies that we want to see again, or missed the first time. Original content will matter ever more. Netflix grasped this earlier than competitors, splurged on gems like “House of Cards” and “The Crown,” and reaped the rewards. But current conditions don‘t permit putting together content with high production values (although cheerfully cheap pandemic editions of shows like Hasan Minhaj’s “Patriot Act” have been fun to watch). As long as Netflix remains stymied in its desire to make new Crowns, it may lose subscribers to rival services with back catalogs as yet unexplored.

The ramifications could be interesting, as the NYSE Fang+ index, which includes Tesla Inc., often trades as something of a unit. Since Tesla‘s sudden reverse Monday, that index has dipped uncharacteristically, and leadership this week has shifted to previously derided value stocks. As this chart should make clear, it is way too soon to call an end to this trend, because the Fangs’ outperformance since the beginning of this year has been truly remarkable:

Could this be a “Wile E. Coyote moment” when the coyote, who has been chasing the roadrunner, runs over the side of a cliff — but doesn‘t fall until he looks down？ With the significant exception of Tesla, none of the other Fang stocks have Netflix’s extreme valuation, and so they should have less far to fall. But almost all of them have benefited from a perception that they will do well from the lockdown. Investors might now begin to grasp that they have somehow slipped into the assumption that the Fang-friendly lockdown conditions will continue forever. We all fervently hope and trust that they wont.

There is another flaw, which is that the Fangs are all priced as though they will be dominant, but in many cases they are competing against each other. If this really is a Wile E. Coyote moment, you won‘t be able to stream the roadrunner cartoons on Netflix — they’re on Amazon.

Survival Tips

Having just been so rude about Netflix, this is a good opportunity to remind everyone of the movie that is still the most uplifting and memorable I have watched since March — “Searching for Sugar Man.” It‘s an extraordinary documentary about a forgotten Mexican-American singer from the 1970s called Rodriguez, and it is wonderfully uplifting. So is his music. I recommended it months ago in the first Survival Tips and it stands up. And it’s on Netflix.

Have a good weekend everyone.