The Implications of Real Estate Becoming a Sector
Thursday, December 11, 2014

There is a change coming in industry classifications: S&P Dow Jones Indices and MSCI are moving real estate out of the financial sector and into its own sector. The change could have a wide-reaching effect. Among those potentially affected by the reclassification are many funds, portfolio allocation models and sector-rotation strategies.

A bit of background will explain why this change is noteworthy. S&P Dow Jones Indices and MSCI oversee the Global Industry Classification Standard, which is more commonly referred to as the GICS (pronounced “gicks”). It currently comprises 10 sectors, 24 industry groups, 67 industries and 156 sub-industries (excluding the forthcoming creation of the new real estate sector as well as the creation of a copper sub-industry). The GICS determines what sector or industry a particular publicly traded company is considered a part of. It underlies various funds, portfolio allocation models and likely sector-rotation strategies. It also used in various screening tools and trading systems.

It’s not the only industry classification system out there. FTSE (the “ICB”), Morningstar and Thomson Reuters, for instance, have their own proprietary classification systems. (We use Thomson Reuters’ classifications in our Stock Investor Pro database and screening program.) There are other organizations with their own classification systems. Though there is some overlap, there are enough differences between them to make apples-to-apples comparisons of results based on the various classification systems difficult.

The ICB currently classifies real estate a part of the financial industry. (The ICB’s system classifies sectors within industries.) Thomson Reuters classifies real estate under the services sector, instead of the financial sector. Morningstar gives real estate its own sector. Other systems may do something different.

The announced change, which will tentatively take effect after the market’s close on August 31, 2016, will only affect funds, models and strategies based on GICS. For example, the Financial Select Sector SPDR (XLF) will likely lose Simon Property Group (SPG) and American Tower Corp. (AMT). These REITs are currently the ETF’s 12th- and 18th-largest holdings. All historical performance for any fund or asset allocation strategy based on current GICS classification of real estate will need an asterisk placed by it since future returns will be different. All asset allocation and sector rotation models based on GICS will also be altered, potentially affecting how portfolios are allocated.

Precisely how big a ripple this change will create is unknown. I don’t have access to data showing how popular one classification system is over another, but my perception is that the GICS is widely used. If you have questions about whether a sector fund, an allocation model or a sector rotation strategy you use is based on the GICS, call the company and ask.

As far why there is not one standard for classifying sectors and industries, blame the influence of commercial enterprises. Industry classification systems and market indexes are licensed products. Each organization has their own rationale for why their classification systems are better and use the logic to help sell their data packages. I’ve heard requests from many individual investors throughout my career for a single standard and it has yet to happen. This is why when comparing similar-sounding sector or industry funds, you should always look at their actual composition and methodology instead of assuming they are the same.

More on

The Week Ahead

Hanukkah starts on Tuesday. Happy Hanukkah to those of you celebrating the holiday.

Dow component Nike (NKE) will report its fiscal second-quarter earnings on Thursday. Joining it will be 10 other S&P 500 companies with their own quarterly reports. Included in this group are Darden Restaurants (DRI) on Tuesday and FedEx Corp. (FDX) and Oracle Corp. (ORCL) on Wednesday.

The Federal Open Market Committee will hold its final meeting of the year starting on Tuesday. The meeting statement and forecasts from the committee members will be released at 2 p.m. ET on Wednesday. Federal Reserve Chair Janet Yellen will hold a press conference at 2:30 p.m. ET on Wednesday.

Elsewhere on the economic calendar, the December Empire State manufacturing survey, November industrial production and capacity utilization and the National Association of Home Builders’ December housing market index will be released on Monday. Tuesday will feature November housing starts and building permits as well as the December PMI manufacturing flash. The November Consumer Price Index (CPI) will be released on Wednesday. Thursday will feature the December Philadelphia Fed Survey.

Friday will be a quadruple witching day, meaning both options and futures contracts will expire.

The Treasury Department will auction $16 billion of five-year inflation-protected securities (TIPS) on Thursday.

What’s Trending on AAII
  1. The Individual Investor’s Guide to Personal Tax Planning 2014

  2. Avoid the Top 10 Mistakes Made With Beneficiary Designations

  3. Social Security: Delay Benefits at the Expense of Personal Savings?

AAII Sentiment Survey

Optimism rebounded among individual investors in the latest AAII Sentiment Survey, extending the current streak of above-average bullish sentiment readings. Neutral sentiment also rose, while bearish sentiment declined.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 2.3 percentage points to 45.0%. The rise puts bullish sentiment above 40% for the ninth consecutive week and above its historical average of 39.0% for the 17th out of the past 18 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, edged up 1.3 percentage points to 32.6%. The rise keeps neutral sentiment above its historical average of 30.5% for the second consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.6 percentage points to 22.3%. The decline keeps pessimism below its historical average of 30.5% for the eight consecutive week and the 41st week this year.

The current streak of 10 consecutive weeks with bullish sentiment above its historical average is the longest such streak since early 2012. Optimism stayed above its historical average for a 14-week period running from December 29, 2011 through March 29, 2012.

Keeping individual investors optimistic is the overall upward momentum in stock prices, earnings growth, the Federal Reserve’s ending of its bond purchasing program, falling energy prices and sustained economic expansion. Keeping other AAII members cautious are geopolitical events, a sense that prevailing valuations are too high, the pace of economic growth and worries that a larger drop in stock prices is forthcoming.

This week’s special question asked AAII members for their opinion about how attractive oil and natural gas stocks are right now. Respondents largely fell into one of three groups. Slightly more than one third (34%) think the recent drop presents a buying opportunity. Many of these respondents said energy stocks are attractively valued right now, especially from a long-term perspective. Nearly 29% of respondents are pessimistic, with many thinking that prices could fall even further. About 16% are waiting for oil prices to stabilize or fall further.

Here is a sampling of the responses:

  • “Valuations are inexpensive and downside risk, though still a factor, has been somewhat reduced.”
  • “I think the price will continue to decline for the next few months.”
  • “Attractive for the long term; not so sure about the near term.”
  • “Good, but I’m waiting to invest. Prices may go lower…”
  • “Never catch a falling knife! I think we have a way to go to hit bottom.”
  • “If there were years left to my investing future, I would be a buyer.”

This week’s Sentiment Survey results:

Bullish: 45%, up 2.3 points
Neutral: 32.6%, up 1.3 points
Bearish: 22.3%, down 3.6 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!