Interest rates and Real Estate Investment Trusts

Bond yields are hitting chart resistance levels with a fair bit of momentum. Investors and traders are thinking about how likely they are to get back to last year’s levels. The answer will have significant implications for stocks seen as “yield proxies”. Real estate investment trusts like Goodman Group are a case in point.

Bond yields are hitting chart resistance levels with a fair bit of momentum. Investors and traders are thinking about how likely they are to get back to last year’s levels. The answer will have significant implications for stocks seen as “yield proxies”. Real estate investment trusts like Goodman Group are a case in point.

At the end of the day, bond yields and stock prices are linked. When bond yields rise, the yield required on stocks ultimately rises as well. Higher earnings yields on stocks means lower prices or, at best, steady prices supported by earnings growth.

Bond yields have been rising over the past couple of months driven by expectations that central bank stimulus is gradually drawing to a close and that firmer commodity prices will lead to higher inflation.

This has brought bond charts to interesting levels. The chart of Australian 10 year bond yields is a case in point. It’s just hit the bottom end of a resistance zone with the 200 day moving average at around 2.27%. This is also the point where the latest CD swing is the same size as the AB swing which preceded it.

The question now is whether this will be the end of it. Despite hitting the bottom end of resistance, it wouldn’t surprise to see yields get closer to last year’s levels over coming months. Just after the  Fed's last rate hike in December 2015, the Australian bond yield was at 2.85% compared to 2.27% today.

However, for Aussie bonds, there are some key differences between December 2015 and now. The RBA cash rate is 0.5% lower, $A is .758 compared to .716 and the CPI excluding volatile items is 1.6% compared to 2.1%. All these things suggest that our bonds may take a while to get back all the way back to the levels seen last time the Fed hiked.

Even so, the current upward momentum in bond yields is strong and markets are looking forward to higher inflation. I’d want to see signs of rejection before assuming this resistance will hold and yields are not going to get closer to where they were last year.

Previous lows around 2.37% or the April highs around 2.7% look safer assumptions for bond yield resistance.

Goodman Group (GMG: ASX)

So what does this mean for the Goodman Group chart?

If you are not familiar with this stock, it is a major player in industrial real estate. It operates funds that invest in industrial parks; warehouses and distribution centres globally and is a major developer as well. It’s also the kind of stock that investors were buying for yield in the first half of this year.

Just like the 10 year bond yield, Goodman Group has hit its 200 day (40 week) moving average. As I write, is has staged a bounce off it. However, it will need to start making higher highs and higher lows to conclude that this support has been conclusively rejected.

In December last year when the 10 year bond peaked at around 3%; Goodman was trading at 15.3 times forward earnings compared to about 16.5 times now. That would imply a price of around $6.50 and would fit with the potential support of the dashed trend line shown on the chart below.

So while Goodman is already down around 10% from its peak in August, it may yet have further to go in the process of correcting for higher rates even if current supports yield a temporary bounce.