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Sector Successes Still

November 21, 2018

The S&P 500 Index has given up all of its gains for the year as it joins the rest of the major market indexes around the globe with negative returns. But when it comes to investing, I don’t just stick with the general stock market—I focus on the market of stocks.

The stock market is not as important as the stocks in the market. This is how I’ve been presenting the holdings in the model portfolios of Profitable Investing. During the past few months, I’ve been making the case that the S&P 500 Index is not as important as many of the underlying sectors of companies capitalizing on specific industry and market developments.

During the months between February and July, I continued to show that the range-bound S&P 500 was concealing what was working in key industries, including real estate investment trusts (REITs), utilities and other specific sectors and companies.

And as the S&P 500 Index finally caught on in July, it only made it easier for these segments and their underlying stocks to continue to succeed.

The jolt in early October shouldn’t be dismissed, as it turned into what I and many are calling Red October, which has gone worse into November. But like the jolt in late January into early February, it wasn’t the end of many investments that were and continued to be working. But the key is to see what’s still viable on its own despite the S&P 500 Index woes, and why current conditions still support companies in these successful sectors.

Real Estate

Real estate investment trusts (REITs) were one of the first of the sectors that I brought to the attention of my Profitable Investing subscribers this year. REITs provide quality assets in limited supply, with revenues that rise over time in a growing economy. As I continue to point out, the sector was down in the beginning of the year on interest rate spike fears and a missed or misunderstood tax deduction for individual investors in the Tax Cuts and Jobs Act (TCJA) that became law at the end of 2017.

Since February, the sector has performed well, with ample dividend income complete with a tax deduction of 20% of the dividends paid. My benchmark for the sector is the Bloomberg REIT Index (BBREIT). It has generated a return from February 2 to date of 14.45%.

Two of my favored REITs are worth noting. The first is W.P. Carey (WPC) with its vast collection of corporate, education and government properties. It continues to see gains in revenues. This, in turn, fuels its rising dividend payouts with successive raised distributions—the payout currently yields 6.00%. Since February, the REIT has turned in a return of 21.07%.

The other is Digital Realty Trust (DLR), one of the leaders in data center properties. Data centers are leased by a number of companies for the data processing and transmission that is at the source of the quickly expanding market for cloud computing. The shares took a pause with an additional share issuance to fund expansion in its portfolio, which is one of the primary means of expansion for REIT companies. It is also a good dividend payer, with a rising payout yielding 3.74%. And since February, it has generated a return of 12.14%.

Utility Players

Utilities continue to be positive in the market. After the pullback in January, the essential services companies have been one of the more powerful performers. The S&P Utilities Index has out-performed the S&P 500 Index by a wide margin. From February 1 to date, the S&P 500 is down 6.38% in price while the S&P Utilities Index turned in a positive return of 12.14%.  And from the opening day of Red October, the Utilities Index gained a return of 4.46% as the S&P suffered its losses amounting to 9.67% on a price basis.

Utilities continue to benefit from some specific advantages. They generate predictable cash flows from ongoing services, which in turn fuels regular high-yielding dividends. This buys patience for investors, particularly during general stock market volatility.

Then they benefit from economic growth. With the American economy expanding, overall demand for power and other essential services grows as well, adding to revenues. And while utilities have parts of their business with regulated rates and profits, the best also have additional unregulated businesses that further bolster revenue growth.

It’s this combination of the security of the regulated and the addition of the unregulated that is driving some of the best that I follow, including NextEra Energy (NEE).

NextEra Energy has regulated power markets in the strong growth market of Florida. But the company is also one of the largest wind and solar power generators, with revenue-generating assets throughout the nation.

With a reliable dividend yielding 2.48%, with the distribution having gained 10.82% per year on average for the past five years, its performance even leads the successful Utility Index, with a year-to-date total return for NextEra of 16.83%. That makes for a great example of what is still very much working in the successful sectors like this one.