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Real estate trusts sell-off looks overdone

US Federal Reserve: expected to raise rates in December

Week ending November 6, 2015

Our strategy worked really well last week with the performance on the Global Equities fund about 150 basis points ahead of the S&P 1200 Global Index and the Dividend Income approximately 100 basis points ahead of the same index. Global markets were generally flat although the US markets as indicated by the S&P 500 were up 95 basis points.

Our strategy worked from several perspectives. Firstly although we are managing equities against a global index, we were very much overweight in US dollar terms (83.3 per cent US dollars in the Global Equities fund and 81.7 per cent in the Dividend Income fund). At the same time we were underweight euros and Japanese yen which fell against the US dollar during the week. This really gave a boost to our performance.

US non-farm payrolls came in higher than expected at 271,000 and boosted US stocks and the currency. This reinforced our expectation that the Federal Reserve will hike the Fed funds rate in December although likely to be less than the quarter point suggested by most market pundits.

The hike in interest rates drives dollar strength, benefiting our portfolios. Further the good employment number underscores optimism for the outlook for the US economy despite jittery markets.

The two big questions in the market today are:

• Will the hike in the Fed funds rate put a damper on stock market performance?

• Will the sharp sell-off of stocks in the third quarter generate greater than usual tax-loss selling ahead of the year-end?

We think the latter is more likely than the former. We will have a difficult time letting go of our positions at these valuations and dividend yields. US markets are down about 1 per cent today.

Most interesting to us has been the fall in value last week of high-yielding real estate investment trusts. These are yielding between 6 and 11 per cent which in our view over-anticipates the magnitude and pace of hikes in interest rates. We are of the firm belief that although the Fed is about to raise rates, the pace of interest-rate hikes will be very much measured. These dividend payers are generating tremendous income that fixed-income securities are yet to produce. Not until fixed-income securities are yielding in excess of 3 per cent will we see them as being a worthwhile hold instead of dividend-paying stocks.

Yes, fundamentals rule but we are likely to see volatility in the future — although not to the same degree as we saw in the third quarter.

Robert Pires is the chief executive officer of Bermuda Investment Advisory Services Ltd.