At the start of this week, I sat down for a Q&A session with our editorial director, John Persinos. During that interview I predicted, “Once interest rates, and bond yields, start dropping, income investors will once again revert to high dividend payers such as REITs and utilities” in 2024.

This year, real estate investment trusts (REITs) and utilities have significantly underperformed the overall stock market. Through the end of last week, both sectors have posted negative returns this year versus a big gain in the S&P 500 Index.

With respect to utilities, rising interest rates have contributed to their downfall. Utility stocks appeal to income investors due to their relatively high dividend yields.

Utilities soared while the Fed was artificially suppressing interest rates. That’s because bond yields were near record lows, forcing income investors to buy higher yielding stocks.

But now that interest rates are considerably higher, income investors have been dumping utilities in favor of fixed-rate bonds. This year, the yield on the 10-year Treasury Note rose above 4% for the first time in fifteen years.

At the same time, office vacancy rates are soaring in the aftermath of the coronavirus pandemic. Simply put, there is more supply than demand for commercial office space.

For that reason, REITs that own commercial office space have taken a beating this year. Some municipalities are projecting no net growth for that type of real estate through the end of this decade.

I do not disagree with those arguments against owning utilities and REITs. However, I believe Wall Street has overreacted to them.

Countermove Coming?

Since peaking above $72 in January, the Utilities Select Sector SPDR Fund (NYSE: XLU) fell below $60 two months ago. Since then, it has struggled to sustain a rally while the rest of the stock market surged higher.

A similar story can be told about Boston Properties (NYSE: BXP), the largest publicly traded developer of commercial real estate in the United States. It peaked above $78 in early February but fell below $52 three weeks ago.

If rising interest rates caused the downfall of utilities, then falling interest rates should be their salvation. After last week’s surprisingly mild CPI (consumer price index) report for October, the Fed is unlikely to raise interest rates when it meets later this month.

In fact, the bond market is behaving as if a rate cut may be the next move made by the Fed. Not this month, but perhaps as early as the second quarter of 2024 if the economy stalls out over the winter.

Since peaking near 5% in October, the yield on the 10-year Treasury Note fell below 4.4% last week. If it drops much more, income investors may start taking a hard look at utilities again.

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Meanwhile, municipalities are already making plans to convert empty office space into residential housing and other uses. Soon, Wall Street may want a piece of that action by owning REITs with desirable properties in major metropolitan markets.

In both cases, this year’s overreaction to recent events could trigger an equally strong countermove next year. If so, then now may be an opportune time to buy into those sectors.

Doubling Down

One way to participate in a rally in utilities and commercial office space REITs is to buy shares of the two securities noted above. If my prediction proves true, then they both should rebound in 2024.

If XLU and BXP make it back to where they began this year, that would result in gains of 10% and 18%, respectively. Not bad, but you can do a lot better than that.

In both cases, suppose we bought a call option that expires in January 2025. A call option increases in value when the price of the underlying security goes up.

Also, let’s assume that we use the strike price nearest to where each stock is currently trading. At the start of this week, the XLU call option at the $62 strike price that expires on January 17, 2025, could be bought for $7.

At the same time, the BXP call option at the $50 strike price expiring on the same day could be had for $9. Compared to their current share prices, those options premiums require the underlying stocks to appreciate about 10% over the next thirteen months to become profitable.

That is what would be expected of them in a normal year. But with this year be abnormally bad for them, next year could be abnormally good. And if it is, these two trades could turn out to be big winners.

Turning stock market mayhem into profitable trades is what I do at Mayhem Trader. During the past month, I have closed out trades for gains of 238%, 375%, and 123%.

Now, I see an opportunity to close out another three trades for big gains. If you’d like to find out more about them, click here.

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