A huge “market top” indicator just flashed for the stock market yesterday.

I mean, it was momentous — something not seen in 17 years. A press release was sent out. News stories were written. Did you catch the news?

Don’t worry if you didn’t. On the face of it, the announcement was a snoozer…

In a nutshell, since 1999, the hundreds of companies that make up the S&P 500 Index have been classified into 10 official investment sectors — financials, technology, health care, etc.

The big news yesterday? The folks who oversee all these meticulous classifications at Standard & Poor’s introduced an 11th sector: real estate investment trusts (REITs).

See, I told you it was a snoozer. “Big deal!” Right?

But as I’ll explain, it has hugely negative implications for real estate’s rebound and the U.S. economy, too.

To appreciate the significance, you have to develop what I’ll call an “irony indicator.” Irony is one of those recurring contrarian themes we see at stock market tops (and bottoms).

For instance, in September 1929, a then-renowned economist named Irving Fisher told reporters that “stock prices have reached what looks like a permanently high plateau” — and the market then proceeded to crash 90% over the next 18 months.

That’s irony.

In 2005, I was on hand as a reporter in Las Vegas as developers announced the start of “CityCenter” — a $9 billion building project next to the strip. As executives proudly noted at the time, it was the largest privately funded development in the history of the United States. By 2009, the project’s backer was on the verge of bankruptcy.

That’s irony, too.

“Can’t Miss Stocks”

Getting back to the importance of yesterday’s news, we often see these same contrarian ironies when companies and sectors are added (or subtracted) from the S&P 500 and Dow Jones Industrial Average.

One of the most famous wrongheaded moves within the indexes involved IBM.

As the granddaddy of all tech stocks, it was actually a member of the Dow for most of the 1930s. But the Dow’s keepers decided to remove it in 1939 — precisely when IBM’s revenue began to accelerate on an exponential scale.

In 1979, after 40 years of growth and untold profits, IBM was finally added back in as a Dow component. And guess what happened then? The shares gave investors a heart attack by dropping nearly 40% over the next 18 months (though the stock did eventually recover those old highs).

Yahoo! was added to the S&P 500 in November 1999, with the company’s stock price at $100. It still trades for less than half that now, nearly two decades later.

To say that timing isn’t this group’s strength would be a bit of an understatement.

I could go on with more examples, but the point is that changes don’t happen very often to the major indexes. And when they do, it’s usually only after a long period in which growth appears very solid and assured.

Real Estate Investing Conundrum

That’s what has me worried about Standard & Poor’s introduction of REITs as the 11th official sector for the S&P 500.

REITs have been around for a long, long time. The first were introduced in the 1960s following congressional legislation. Their benefits as investment vehicles, their rapid adoption by development companies and financiers and their huge investment gains and dividend increases in recent years are certainly nothing new.

As Chad Shoop explained earlier this month: “Previously, they were lumped into the financial sector in benchmarks created by the S&P Dow Jones and MSCI … large institutions and most mom-and-pop investors relied on buying individual stocks or the limited number of smaller REIT ETFs with lesser liquidity … a factor that wouldn’t allow large institutions to get involved in trading REIT ETFs.”

So why would a committee of learned men and women at Standard & Poor’s adopt REITs as a new sector within the S&P 500?

I’d say that it’s the perception of REITs as bulletproof investing vehicles.

I can see why they’d make that assumption. As USA Today recently noted, REITs have “outpaced the S&P 500 for the past three-, five-, 10-, 15-, 20-, 25-, 30-, 35- and 40-year periods ending June 30.”

Equity REITs have outperformed every major investment class across every time frame. They’ve done better than the Dow, the S&P 500, small caps and even Nasdaq tech stocks.

With performance like that (and better dividend yields than the major averages, too), who wouldn’t want to own REITs by the basketful? Particularly, as Chad stated, “investors can now easily and with greater liquidity invest in a pure REIT ETF.”

But if you turn on your “irony indicator,” well, the picture’s not so rosy. The real estate market has been a major beneficiary of central banks’ money printing. And there’s nothing like near-zero interest rates to revive the animal spirits of any real estate developer or financier.

But then again, where else do interest rates have to go?

As Jeff Opdyke and The Sovereign Society have been warning for some time, higher interest rates — as unlikely a possibility as that might seem to some — ultimately mean a dramatic revaluation of real estate assets.

And what if the threat of higher interest rates is an empty one? Suppose we’re still stuck, despite the Fed’s money printing, on a Japanese-style path toward a deflationary collapse?

Well, just look at what happened to real estate in the Land of the Rising Sun. Property prices collapsed, and the country struggles with the aftermath, even now.

With the Federal Reserve set to announce its latest interest-rate decision tomorrow afternoon, investors may well be best served sitting on the sidelines for a bit, waiting for the dust to settle. Higher rates against a weakening economy could finally push us over the edge, trashing nearly all the sectors — including REITs.

If the Fed should decide to hold pat, REITs may breathe a sigh of relief and enjoy some more heady — if temporary — gains. Be sure to catch Jeff Opdyke’s and Chad Shoop’s commentaries to stay ahead of the Fed and the real estate sector.

Kind regards,
Has Real Estate Hit Its Peak?
JL Yastine
Editorial Director