Treasury Secretary Yellen Warns of a Recession: Our Top Picks

On Wednesday, Treasury Secretary Janet Yellen testified before the House Financial Services Committee and warned that the world would suffer “enormous economic repercussions” from Russia’s invasion of Ukraine.

She explains that the recent The atrocities committed by Russian troops in Bucha will only lead to more sanctions as they represent an “unacceptable affront to the rules-based global order”.

These sanctions have a significant impact on Russia, but also on the rest of the world, as they seriously disrupt the supply chains of food, energy and other important natural resources. Here is what Yellen commented on this topic (emphasis added):

We believe this is a significant price to pay to punish Russia for what it is doing in Ukraine. But energy prices are rising, the price of wheat and corn produced by Russia and Ukraine are rising, and the metals that play an important industrial role – nickel, titanium, palladium – the cost of these things is rising. . This will also aggravate inflationary pressures.

This is all the more worrying given that inflation is already at its highest level in 40 years, and Yellen warns that inflation is likely only to pick up from here.

At the same time, economists are now lowering their growth forecasts for 2022, and some, including Goldman Sachs (GS) analysts, are even warning that there is a high risk of a recession over the next year.

Meanwhile, the S&P500 (SPY) is trading near historic highs as if all is well.

High inflation…coupled with high risk of recession…and high valuations…is a perfect mix for poor stock market performance going forward.

Where to find refuge as an investor?

Some investors are turning to cash, preparing for a bear market. Personally, I’m not a big fan of this approach because it’s not possible to time the market, and with inflation at such high levels, you quickly lose your hard-earned money.

Others are getting into cryptocurrencies like Bitcoin (BTC-USD) and Ethereum (ETH-USD) in an attempt to hedge their wallets. My fear here is that cryptos could suffer a major short-term setback as Russia uses them to circumvent sanctions.

Then some withdraw money from the market to buy gold (GLD) and silver (SLV). I prefer this option, but still wouldn’t commit a lot of capital to medals, as they are non-performing assets that are unlikely to produce returns significantly above inflation over the long term.

My preferred solution is to invest in defensive and income-generating real estate assets such as apartment communities, industrial warehouses, farmland and energy pipelines via REITs (VNQ) for the most part, and in some cases , also via MLPs (AMLPs). Today, up to 50% of my portfolio is invested in the top picks highlighted at High Yield Landlord.

The reason I invest so much in these specific investments is because they have superior recession resistance, better inflation protection and more reasonable valuations.

In the chart below, you can see that REITs have historically provided almost 2x the downside protection of the S&P500 during most recessions. This actually makes sense since real estate investments benefit from emphyteutic leases in most cases, and therefore cash flow does not change much during most recessions.

Moreover, they are exceptionally effective hedges against accelerating inflation, as they use fixed-rate, long-term debt to finance real assets that are essential and limited in nature. As a result, inflation causes the debt to lose real value even as its assets increase in value. The impact on equity is exponential.

Finally, REITs are historically cheap today, trading at just 17x FFO, which is a steep discount to the 26x earnings of the S&P500. The 17x FFO multiple is particularly low considering that REIT balance sheets are the strongest they have ever been and capitalization rates have compressed significantly in recent years. Relative to the value of their underlying properties, REITs are also discounted because real estate has appreciated much faster than REIT stock prices since the pandemic began.

This makes me confident that these investments will not only outperform, but will also provide better downside protection in the future.

In today’s environment, you need investments that are resistant to both recessions and inflation. In what follows, we’ll highlight a few of our top picks that we hold in our core portfolio at High Yield Landlord.

VICI Immobilier Inc. (VICI)

VICI is the largest casino REIT in the world. It has trophies like Caesars Palace and the Venetian on the Las Vegas Strip.

Here you might be wondering: how can casinos be considered recession proof or even inflation proof? Aren’t they heavily reliant on discretionary spending?

Well, yes, the business of operating casinos is quite cyclical and they are also suffering from rising labor and other costs. This explains why casino operators like Caesars Entertainment (CZR), MGM Resorts (MGM) and Penn National (PENN) have fallen lately.

However, the job of casino owner is much more resilient and VICI has structured its leases to protect against recessions and inflation.

His leases last for more than 15 years, and as a result he will earn pre-determined rent checks regardless of what happens to the broader economy. His tenants may suffer temporarily, but since they have almost 3x rent coverage, they should still make enough money to pay their rent.

Moreover, VICI is also well protected against inflation for three main reasons.

• No property charges: First of all, it pays no ownership or even maintenance costs. Under its leases, tenants are responsible for all expenses.

• Rent increases and CPI adjustments: In addition, its rents automatically increase each year. About 40% of its leases have uncapped CPI adjustments, and the rest have fixed rent increases and capped CPI adjustments. Since VICI pays no real estate expenses, this is real growth.

• Fixed rate debt: Finally, VICI has financed approximately 40% of its properties with fixed-rate, long-term debt that is now inflated even as the value of its assets continues to rise.

In case you’re still wary of VICI’s recession and inflation hedging benefits, just consider that it increased its dividend by 11% in 2020 and another 9% in 2021. And this despite the pandemic , which has been the worst possible crisis for casinos.

One would expect such a recession- and inflation-proof investment to be valued at a high valuation in the current environment, but contrary to all logic, that is not the case.

Currently, VICI is priced at around 14x FFO and it pays a dividend yield of 5.2%. That’s not much to pay for a company that has resilient fundamentals and a clear path to growth in an uncertain world.

We estimate its fair value to be closer to 18x FFO, which would unlock 30% upside from the current share price. While you wait, you earn a generous and rapidly increasing dividend.

We think the risk-reward ratio is very compelling and that’s why VICI is one of our largest holdings at High Yield Landlord.

Farmland Partners Inc. (REIT)

If you want a REIT that’s even more resilient to inflation and recessions, you might want to consider Farmland Partners (REITs). It is the largest farmland REIT by area.

Farmland is very resilient to recession due to the simple fact that people need to eat, regardless of what happens to the economy. Moreover, since the world’s population continues to grow, but its supply of farmland is limited, the value of farmland remains stable even during most recessions.

Its inflation hedging benefits are also among the best of any asset class.

This is especially true today, as food prices rise following Russia’s invasion of Ukraine. The war in Ukraine is seriously disrupting food supply chains as Ukrainian farmers are busy fighting for their lives and Russia is cut off from the rest of the world.

Since these countries are two of the largest food exporters, the void must be filled by others. This is causing US farmland prices to appreciate rapidly.

According to the latest estimate from the Federal Reserve Bank of Chicago, US farmland is up 20% year over year, and since the REIT is 50% operated, that essentially means its net asset value has increased by 20%. about 40%.

The FPI stock price has started to rise, but we believe this is just the beginning. Currently, it is still valued at a slight discount to NAV and we expect this discount to turn into a significant premium once investors reap the benefits of recession hedging. and REIT inflation.

FPI’s closest peer, Gladstone Land (LAND), is in fact already priced at a 70% premium to NAV. For the REIT to be valued at the same valuation, it would have to almost double its value. It’s not what we expect, but it just shows that it has significant upside potential going forward.

Conclusion

At High Yield Landlord, we are repositioning our portfolio in light of recent events as they are likely to cause even more inflation and potentially also a recession.

We mainly invest in discounted real estate assets that are resistant to recession and inflation. VICI and FPI are two examples we have in our portfolio of 24 positions.