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Spotting Trends: Sector Opportunities for the Reopening and Digital Transformation

  • The recent strong performance of real estate investment trusts (REITs) is well supported by improved growth prospects, strong balance sheets and attractive valuations.
  • Strong demand for freight transportation and the recovery of leisure travel may provide tailwinds for the transportation industry.
  • As the world becomes more digitally connected, the number and cost of cyberattacks have increased exponentially, which may boost cybersecurity spending by private and public sectors.
Senior Research Strategist

With 53% of the US population having received at least one COVID-19 vaccine and more than 46% fully vaccinated, the economic reopening is shifting to a higher gear in the US.1 Forty-six states have fully reopened, meaning there are no group gathering limits and businesses are allowed to operate without capacity constraints.2 And US mobility indicators at post-pandemic highs indicate that people are returning to shops, restaurants and entertainment facilities and using public transportation.3 The pandemic also has accelerated the digitalization of our world, fueling demand for stronger and more versatile cyber defense. Given the pickup in economic reopening and the urgent need to upgrade cybersecurity, we see three industry opportunities.

REITs: Playing Catch-up with Other Cyclicals

Thanks to its economic sensitivity, the real estate sector has historically outperformed the broad market by 18% on average during economic recovery periods.4 As the current reopening accelerates, the real estate sector has shown strong price and flow momentum, outperforming the S&P 500 Index by more than 10% over the past six months and gathering $5.1 billion of assets on a trailing three-month basis — the third-largest net inflows among the 11 GICS sectors.5 The sector’s earnings sentiment has also improved lately, as 2021 earnings estimates have been raised by 19% since March, compared to 10% for the broad market.6

The strong performance of real estate investment trusts (REITs) are well supported by improved growth prospects, strong balance sheets and attractive valuations. Demand for apartments rebounded quickly in Q1, with increasing occupancy rates and accelerating rent growth.7 Landlords had offered concessions on rents to attract tenants during the economic downturn last year, but these concessions narrowed in Q1, leading to a 2.9% increase in funds from operations (FFO, the common measurement of REITs’ profitability) of residential (REITs) to just 9% below the pre-pandemic level.8 The recovery of retail REITs may also gain traction this year, as the easing of social distancing restrictions gets people more comfortable with visiting stores and returning to malls for shopping and leisure services, such as dining, movie theatres and fitness. Indeed, retail REITs’ FFO increased for the third straight quarter in Q1, up by 16% from its pandemic low. In addition, industrial REITs, such as warehouses and distribution centers, are likely to continue benefiting from expansionary manufacturing activity and strong demand for consumer goods.

Despite its strong performance this year, the real estate sector is still lagging the other cyclical sectors, including Financials, Industrials and Materials, by at least 8% on a trailing 12-month basis,9 as investors are concerned about the financial health of the sector and the damage to retail and office REITs caused by the pandemic. It sent REITs’ relative valuations to their lowest level since the peak of the Global Financial Crisis (GFC), as shown in the chart below.

Source: Nareit, T-Tracker, Q1 2021. Price-to-FFO ratio is used to measure REIT valuations, since FFO is a more common metric to evaluate REITs profitability. Price-to-earning ratio is used for valuations of the broad market. 

Unlike the GFC period, REITs have maintained strong balance sheets throughout the pandemic, with the debt-to-book assets ratio sitting around 50%, compared to 57% during the GFC.10 Low leverage combined with low interest rates have led to the lowest interest expense-to-net-operating-income ratio on record. In our view, there are still needs for retail stores and office space. In-person contact helps build social connections, reach customers, foster collaboration among employees and improve productivity. The pandemic will push real estate operators to rethink the changing needs of their tenants and reinvent their space in line with emerging retail models and hybrid flexible working environments.

As the recovery of REITs catches up with other cyclical sectors, investors may want to consider the SPDR® Dow Jones® REIT ETF (RWR), which provides exposure to the publicly traded REIT securities in the US.

Transportation: Booming Freight Transportation and the Travel Recovery
As demand for consumer goods remains buoyant and manufacturing activity continues to expand, freight transportation is in high demand. The shipment component of the Cass Freight Index, which measures domestic freight shipment for goods by trucks, railroad and air freight, grew at its fastest pace ever on a year-over-year basis in May, reaching its second-highest level on record.11 Shipments have also increased on a two-year basis for the first time in 20 months,12 indicating a strong growth trend beyond the pandemic recovery. While the year-over-year growth likely will moderate in the coming months as the base effect due to the pandemic will be behind us, demand for freight transportation probably will remain strong as the supply chain constraints are eased and merchants start inventory restocking for holiday seasons later this year.

The recovery of leisure travel may provide another tailwind for the transportation industry. Positive vaccination progress has encouraged people to travel. The number of people flying has risen steadily since February when vaccine distribution picked up. As shown in the chart below, by June the number of passengers at airport checkpoints had recovered to around 75% of its pre-pandemic level.

Source: Transportation Security Administration, as of June 17, 2021.

Leading indicators of airline traffic, including online search interest for business and leisure travel as well as credit card transactions on airlines and travel agencies, are all within 10% below 2019 levels.13 People are also optimistic about traveling later this year, with bookings for travel in November and December up 30% from this time two years ago.14 Even international travel has shown some green shoots. Given the high vaccination rate and low infection rates in the US, the European Union lifted travel restrictions for Americans in June heading into the summer travel season. Searches for Europe flights have nearly doubled compared to May, while airfares between the US and Europe are just 6% below fares from two years ago.15

People’s strong desire for leisure travel gives airlines more pricing power, evidenced by 10% and 7% month-over-month increases in airfares in April and May, respectively.16 This pricing power will help airlines pass rising fuel and labor costs on to travelers, supporting earnings recovery and maintaining profit margin.

To position for booming freight transportation and recovery of travel, investors may consider the SPDR S&P Transportation ETF (XTN), which includes companies across the market-cap spectrum that provide all types of goods and passenger transportation.

Cybersecurity: Upgrading our Defense in a Digitally Connected World
One long-lasting impact of the pandemic is the trajectory of digitalization of our world, such as the Internet of Things (IoT), cloud-based computing and data storage, and e-commerce. As individuals and organizations move more activities, operations and financial transactions to the digital world, cyberattacks have increased exponentially. Last year, the FBI’s Internet Crime Complaint Center (IC3) received a record number of cybercrime complaints, representing a 69% increase in total complaints from 2019, with reported losses exceeding $4.1 billion.17

Cyberattacks also have become more sophisticated, evasive and costly. The ransomware attack on the Colonial Pipeline forced the shutdown of the largest petroleum pipeline in the US for almost a week, causing fuel shortages and price increases. The SolarWinds hack went unnoticed for months, allowing hackers to access the information system of up to 18,000 companies and government agencies. According to a study of data breaches in more than 500 organizations globally, the average cost of a data breach in 2020 was $3.86 million, while taking the organization 280 days on average to identify and contain the breach.18 These numbers and examples show how vulnerable our society is to cyberattacks and the urgency of upgrading cybersecurity.

The increasing number of high-profile cyberattacks like Colonial Pipeline and SolarWinds are expected to boost global cybersecurity spending and refocus the government’s attention on cyber defense. According to the Gartner 2021 CIO Agenda Survey, cybersecurity was the top priority for new spending or increasing investment for 61% of the more than 2,000 CIOs surveyed. As shown in the chart below, annual global cybersecurity spending is expected to reach $270 billion by 2026, up 56% from 2020. In May, President Biden issued an executive order to modernize cybersecurity defense and strengthen the cybersecurity standards for the software sold to the government. To support the commitment, the FY 2022 President’s Budget includes $9.8 billion for civilian cybersecurity related activities, a 14% increase from the estimate for 2021.19

Source: Australian Cyber Security Growth Network, The Global Outlook for Cybersecurity, December 31, 2020. *Estimated. The above estimates are based on certain assumptions and analysis made by the Australian Cyber Security Growth Network. There is no guarantee that the estimates will be achieved. 

Given society’s increasing investment in cybersecurity, companies whose products and services are driving innovation behind future security may present long-term growth potential. To capture the broad range of innovative firms in this area, investors may consider the SPDR S&P Kensho Future Security ETF (FITE).

To learn more about emerging sector investing opportunities, you can also visit our dedicated sectors webpage.

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