HCN: How Do Interest Rates Impact Value?

Market prices are always fluctuating around true fundamental value.  Sometimes, investors become overly optimistic about a particular company or the market as a whole.  When this happens, prices often increase beyond what long-term fundamental growth can justify.  

Other times, an overly pessimistic outlook drives the price of a stock too far down.  At Donaldson Capital Management, we call these kinds of companies “vexed”.  In other words, the market is discounting a stock based upon a current or upcoming headwind.  These headwinds can come in many forms including concerns about future company growth (IBM), legal problems (JPM), or concerns about a particular economic region (AFL).

The market often overreacts to these headwinds, causing these “vexed” companies to be driven below their true fundamental value.  Investors who can see through the short-term doom-and-gloom have an opportunity to purchase high-quality companies at a temporary discount.

One particular company we believe is “vexed” right now is a real estate investment trust (REIT) Health Care REIT, Inc. (HCN).  HCN owns a diverse portfolio of healthcare real estate that includes senior housing communities, skilled nursing facilities, and inpatient/outpatient medical centers.  The price of HCN has dropped by over 29% from highs near $80 in mid-May 2013.

The most obvious reason for HCN’s decline has been the upward hike in interest rates.  An increase in interest rates is negative for REITs such as HCN for two main reasons:

Will the Fed Taper in December?

In May, Federal Reserve Chairman Ben Bernanke mentioned the potential for the Fed to begin tapering their asset purchase program, Quantitative Easing (QE).  Since then, the financial markets have been obsessed with tapering and – more specifically – how it may affect interest rates. 

Many Fed watchers have predicted the Federal Reserve will begin to taper QE sometime in early-to-mid 2014.  After the latest jobs report, there is talk that the Fed may reduce asset purchases sooner rather than later.  

On December 6^th, the Bureau of Labor Statistics released the November jobs report, which showed nonfarm payroll employment grew by 203,000.  The jobs numbers were significantly better than expected and lowered the unemployment rate sharply from 7.3% to 7.0%.

The seemingly good economic news propelled the stock market higher.  That same day, the Dow Jones was up nearly 200 points and the S&P 500 rallied back up above 1,800.

The positive job numbers led many to forecast a QE taper starting at the Fed's last meeting of 2013.  Will the Fed start to taper in December?  Probably not.  Here's why:

The ABCs of Dividend Investing, Part IV: Who Are the ABCs?

After our series of posts titled "The ABC's of Dividend Investing", we received many requests from people asking us to show some specific examples of A, B and C stocks.  We don't typically talk about individual securities on our blog, but we decided to identify a few companies that we own and discuss their dividend characteristics and why we own each of them.

We chose three stocks – one each from our A,B,C sub-portfolios.  For those who have read our posts on the ABC's of Dividend Investing, the features of these sub-portfolios are probably familiar to you.  For those of you that have not, here is a brief summary:

           

What Are the A, B, Cs?

In the early 1990s, we restructured our main dividend investment strategy away from a portfolio focused primarily on high dividend yielding stocks with modest dividend growth into a portfolio comprised of three distinct types of dividend stocks.

B-U-L-L: Anatomy of a Bull Market

Today’s investors have not seen a bull market in a very long time.  Some have never invested through one at all.  The last time we saw a true bull market was in the 1990s right before the technology bubble of 1999-2000 took hold.  The stock market downturn in 2008-09 was more of a shock-fear reaction to the financial crisis than it was the end of a bull market. 

The market is certainly in a bull market today.  We’ve used the acronym B-U-L-L in the past to describe the characteristics of a bull market and help us understand market behavior.

U.S. Corporations Going Global for Growth

Since 2009, stock prices are up well over 100%.  The stock market has moved higher for a variety of reasons - including an economy that has improved dramatically from the Great Recession and continued stimulus from the Federal Reserve to keep interest rates low (read our post on the economy and interest rates here). 

The primary driver for growing prices has been improving fundamental values.  Long-term stock market appreciation cannot exist without increasing dividends and earnings.  As we have said many times, dividends have shown to be highly correlated with stock prices over the long-term.  Since dividends are real cash paid out to shareholders, they ultimately must be backed by actual corporate earnings.

Is The Market Overvalued?

The stock market is in constant conflict between buyers and sellers.  Aside from very short-term traders, these purchases and sales are based upon the perceived value of the underlying company being greater or lesser than the current trading price.  In aggregate, all these many purchases and sales determine stock prices. 

Whether or not the market is very good at accurately pricing a particular stock close to its intrinsic value has been thoroughly debated, but our opinion is that the market gets it wrong many times.  An overall bullish sentiment about a particular company will drive its stock price beyond its intrinsic value, while another stock will get hit hard by missed earnings or other pessimistic news.

What drives these wild fluctuations above and below fair value?  Two major forces: fear and greed.

Why Weak Economic News Might Be Good for Stocks

As we mentioned in last week's article, we are providing our most current outlook on global economic growth.  We will update our projections periodically to reflect our latest views.

Economic indicators have been very confusing for investors.  “Good news” about economic growth has been perceived by the markets as “bad news”, as it could lead to reduced monetary stimulus from the Federal Reserve.  In this article, we will identify some key economic information and separate each point into good news and bad news, then come to a final consensus as to our specific views about the economy and how it will impact stock market growth moving into 2014. 

1. Slow Economic Growth

Economic growth in the United States has been mostly flat coming out of the recession in 2008-09.  In the 2^nd quarter of 2013, real GDP growth was a mere 2.5%.  The economy has been “muddling along” for quite some time.  We anticipate slow economic growth will continue into 2014.