Mar

25

I was glancing at the performance of the Vanguard family of funds today. Their REIT index fund is down about 26% YTD through March 23, 2009. According to Practical Speculation by our own Niederhoffer and Kenner there is a 50% correlation between REITs in one quarter and stocks in the next quarter. A quick eyeball check of the regression scatter plot in the book shows that this performance predicts something like a 12% move in stocks next quarter. Whether the move is up or down is left as an exercise for the reader. But pages 253-259 would be a good place to start.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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  1. Rocky Humbert on March 25, 2009 4:09 pm

    Being mindful of the fact that several REITs have been added to the S&P500 over the past few years, here are the "live" data:

    QUARTER REIT %chng SPX %chng

    Q1 06 14.7 3.7

    Q2 06 -1.33 -1.9

    Q3 06 9.2 5.2

    Q4 06 9.5 6.1

    Q1 07 3.4 0.18

    Q2 07 8.9 5.8

    Q3 07 2.5 1.5

    Q4 07 -12.6 -3.8

    Q1 08 1.4 -9.9

    Q2 08 -4.9 -3.2

    Q3 08 5.4 -8.9

    Q4 08 -39 -22.5

    Q1 09 -31 -9 13

    Observations. The REIT direction correctly predicted the following quarter's S&P direction in seven quarters. And was wrong in six quarters. This is without regard to the magnitude of errors. If one only considers quarters where the REIT change was > +/- 5%, the results are the same. A very quick and dirty correlation between these times series results in a 0.8 correlation. If you lag the S&P, the correlation goes down to 0.7. [Interested readers should check my work, as I have been known to make mistakes.] A perhaps more useful exercise for the reader would be to examine the net asset value of REITs; their market capitalization; and the historical relationship between their cap rates and both their cost of financing and the riskless interest rate, and also considering their ability to service debt during a recession. One should also remember that REITs pay no corporate taxes or retain earnings. By these measures, some readers may conclude REITs are interesting investments at their current valuations.

  2. James Starr on March 25, 2009 7:08 pm

    I have just re-read the pages cited and as usual am very impressed and entertained. However, my usual problem is in trying to discern the correct time to enter such trades. It seems the easy part is identifying an obvious overvaluation or otherwise.

  3. David Riffer on March 29, 2009 12:05 pm

    REITs employ substantial leverage, and given that we are going through a relatively unique time for both their assets and liabilities, it’s tough to believe that this sort of statistical relationship has much predictive power. I certainly wouldn’t want to risk much money on it.

    Are there any periods where REITs were down more than 30% in two consecutive quarters? And - mindful of the extremely small sample size - what happened to stocks in the ensuing quarters? For that matter, what happened to the REITs?

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