The REIT Stuff

So much for AI, I'm buying RE.

Now that the Artificial Intelligence sector is looking ever more artificial, where do you put your money?

Of all the left-for-dead sectors in the market, none are more ignored than REITs. Rising interest rates and a moribund housing market have taken the steam out of these defensive stocks. But they are ripe for the picking in my view.

The self-fulfilling prophecy that drove the mother-of-all concentration effects on the S&P 500 is nearing an end. Cracks such as failed/canceled IPOs and CDS blow-outs reflect a sharp downshift in AI bullishness. The expectations of unlimited growth in data center-fuelled economic growth are undergoing a serious reset. That may call into question the AI bull market's future, but the silver lining is lower interest rates, which should allow a leadership rotation to develop.

The three inflation shocks of the past year - tariffs, oil, and AI capex - have converged to perpetuate the persistent inflation created by COVID-19 stimulus. Of the three, only AI remains a threat, as the former two are cost-push inflation impulses and should lap easy comps in the year ahead. That will mechanically lower realized inflation over the next year. Only the huge surge in capital spending from the Hyperscalers has the power to generate inflationary forces going forward.

If capex slows due to data center buildout pushback or slower AI acceptance by consuming enterprises, expect further downside in the tech-heavy broad market averages. But that correction phase is more likely a pause that refreshes many of the Defensive and Quality stocks left behind during the AI froth. Real Estate Investment Trusts fall into that category.

The BMO ZRE is a good choice here. It has outperformed XRE over the long term and is equal-weighted. The only flaw is its high expense ratio. A perfect entry point has shaped up, as money flows have bottomed out and the trendline has held.

BMO REIT ETF

Vanguard's version, although lower-yielding and less liquid, has a much lower MRE and focuses on lower-cap issues.

Vanguard REIT ETF

So, slow and steady can win the race now. Any further market risk from the known unknowns in a volatile geopolitical world should further damage the broader market. But there are hiding places in plain sight.

If you have the REIT stuff.

Risk Model: 4/5 - Risk On

A sluggish tape, combined with a lack of follow-through from U.S. banks, has me a bit worried. I looked for a positive follow-through, and I didn't get it. No banks, no thanks.

Although the Model is positive, AAII Sentiment is vulnerable to the downside, and the sudden jump in VIX-related measures of implied volatility is a warning sign. It only reinforces my belief that the market's narrative is about to change. Hence my love for bonds and the more defensive themes like REITS, Quality, Low-Vol, and Staples.

Warsh's rearview mirror is filled with oil prices and AI capex surges, while the bottom half of the 'K'-shaped economy is on its affordability knees. Housing starts are still falling despite low unemployment. Could the Fed's hikes be so late to the party that the housing market collapses?

I can see them being forced to ease next year if that happens. Sort of the opposite of this time last year, when easing was the popular narrative. That's why I like it.

3-MO Volatility Index