This Calls for Defensive Maneuvers

 | Jan 28, 2014 | 10:00 AM EST
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"How prone to doubt, how cautious are the wise!" -- Alexander Pope

The increased volatility in equities continued Monday: The market started the day with a rally, then staged a huge selloff, only to climb back to even -- and, in the last hour, stocks declined significantly once again. 2014 is not just going to deliver the same straight-up shot as what we saw last year.

In my column yesterday, I postulated that this volatility would continue for a while, until worries subside about the impact from the Federal Reserve's stimulus-tapering and slowing Chinese economic growth. I advocated buying blue-chips like Microsoft (MSFT) and ConocoPhillips (COP) on any dips in equities. As my reasoning goes, these are names with little exposure to the emerging markets that have lower valuations than the overall market and high dividend yields, so they should outperform in a market fraught with rising turmoil.

On that same thread, at the moment I also like high-yield sectors, such as real estate investment trusts (REITs). REITs tend to underperform when the stock market surges or when interest rates back up substantially, and both of these took place last year, so these stocks significantly underperformed in 2013.

However, 2014 is likely to be a very different year. It should bring a more subdued market, and I don't foresee interest rates rising dramatically. In this sort of environment, REITs should provide superior performance to the overall market, which they have done during two-thirds of the last 25 years on an annual, total-return basis.

Following are a couple of REITs I would love to add funds to in any continued broad pullback.

I do not like the retail-property space overall due to accelerating risk that this sector will become Amazon'd (AMZN). However, I do like and continue to add in my position in American Realty Capital Partners (ARCP). This REIT owns and operates mainly single-tenant retail properties, and the company has a presence in almost all 50 states.

American Realty is digesting a major acquisition that will give it more substantial heft and economies of scale -- nearly at the size that market leaders Realty Income (O) and National Retail Properties (NNN) command. Currently American Realty provides a 7.1% dividend yield, much higher than its bigger brethren. Its valuation is lower, as well, at 12.5x forward funds from operations (FFO, the key metric used for REITs).

That's a discount of about 20%, and I think this disparity will disappear as the firm integrates its recent acquisition. Insiders must share that view, as they have been significant and frequent buyers of the REIT over the past couple of months.

I also like BioMed Realty Trust (BMR) at current levels and will add to my position on any dip in the major averages. This REIT provides facilities to the biotech and life-science industry in the U.S. Almost half of its properties are located in the life-science centers of Boston and San Francisco.

Several factors are bolstering the life-science and biotech industries. First, more drugs were approved in 2013 than at any time in the last decade and a half. These industries are seeing solid research-and-development spending, and the biotech sector is red-hot right now. All of this bodes well for demand for BioMed's properties.

BioMed shares yield at 5.3%, and the REIT has doubled its payouts over the past four years. The stock is reasonably valued at 13x forward FFO, and comes in around 20% above book value. It looks as if it has technical support just below this level, and shares are down 15% from their highs in May, which they hit before interest rates started to rise on the Fed's "taper talk."

Neither of these selections is going to set the world on fire in 2014. However, with their high dividend yields and reasonable valuations, these stocks should outperform equities overall in a more constrained market in 2014.

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