Stock markets were giddy with excitement after the U.S. Federal Reserve Board cut interest rates by half a point on Sept. 18. The larger-than-expected move was intended to buoy the weakening U.S. jobs market and was the first interest-rate reduction since March 2020 when COVID struck.
The cut was a dramatic end to two years of higher rates introduced to fight inflation. The Fed also suggested an additional half-point cut is likely later this year, with more cuts expected in 2025 and 2026.
Crafting a portfolio for declining rates
The Fed’s surprise cut left many investors wondering how to reposition their portfolios for a world of declining interest rates. Wouldn’t real estate, for one, be a big beneficiary of falling borrowing costs?
The answer is they’re about a year too late. The markets long ago started to anticipate last month’s move by the Fed. In fact, major North American stock indexes have been in a remarkable bull market for the last year. The S&P 500 has shot up 35% in the past 12 months (as of Oct. 1), while the TSX Index has soared 26.4%.
Real estate stocks, in particular, have been among of the most stellar performers of late. Among the 11 U.S. sector exchange-traded funds in the SPDRs family, the real estate SPDR fund was the second biggest gainer during the past three months. It rose 16.7% versus 4.3% for the S&P 500 as a whole.
Markets are quick to price in events
We see this time and again in investing. Markets usually price in events long before they take place. Trends can start changing direction well before most investors see any good reason to jump aboard.
Conditions don’t need to be perfect to spark a turnaround. All that’s often needed is for news to become a little less bad or a tad less good.
We saw a vivid example of this when the COVID pandemic struck in March 2020. Markets at first panicked and crashed. But strong government intervention to support the economy in mid-March 2020 was enough to stop the rout in its tracks. A powerful 20-month bull market took shape even as the health crisis and economic disruption continued.
Real estate is a core holding
All this isn’t to say that you should ignore the rebound in real estate. At PWL, our clients already own it as a core part of their portfolio. They benefited from the real estate gains without having to do any rebalancing.
We believe real estate is a valuable element in a broadly diversified portfolio to maximize returns, minimize risk and meet investor goals, such as generating income or leaving a legacy.
For these reasons, we also favour publicly traded real estate funds over private real estate holdings. Public funds tend to be more efficient, as they price in conditions more quickly. They’re also generally more transparent, cost less and are more liquid.
Public vs private real estate funds
These advantages are important. Due to their broader, more diversified holdings, public real estate funds tend to enjoy a lower risk of major losses.
Some private real estate investors faced significant challenges in the past year or had to sell holdings at substantial discounts.
Meanwhile, public real estate funds can still offer impressive gains as we saw in their outperformance in recent months. We believe their returns are similar or better than those offered by private real estate opportunities over the long run.
Stick to your plan
The strong recent gains show why we consider real estate to be a core holding in our clients’ portfolios. During the earlier period when real estate was underperforming, some investors wondered if it was a good idea to continue holding on to this laggard asset.
A spell of poor returns isn’t a reason to toss your investing strategy out the window. No one can predict what markets will do. This is one of the reasons it’s so important to use diversification to craft a well-balanced portfolio, and then to follow your investing strategy with discipline.
Fads come and go. But by the time most of us hear about the latest one, the bulk of the gains have already been made. Investors who jump in at that point are often the ones holding the bag when the happy times end.
You can avoid such a fate by keeping the long-term horizon in mind and ignoring the day-to-day noise.