For fundamental reasons, the broader stock market has benefited substantially from increasing investor confidence in the riskier equity asset class or stocks. Furthermore, capital flows into equity funds have been, and should continue to be, a critical driver of stocks. Annaly Capital Management (NYSE:NLY) has done even better than the market this year, and because of its standout dividend yield, it should continue to benefit in a special way from focused capital flows into income mutual funds.
The SPDR S&P 500 (NYSEARCA:SPY) is higher by 8.5% year-to-date through March 6, 2013, while Annaly Capital shares are up 9% on the year while offering an 11.8% dividend yield to boot. Gains have come to the market for many reasons, some good and some just less bad (read politics). Disregarding the most recent reporting of GDP and the Employment Situation, the economy has been growing in the U.S. The financial crisis is but a memory to most, save perhaps Standard & Poor's of McGraw-Hill (MHP), thanks to the recent Justice Department claim against it. Europe has moved past its own sovereign debt crisis, though it continues to contend with disgruntled citizens who are struggling due to austerity measures. And with the debt ceiling issue finally recognized for its great importance, and the fiscal cliff mitigated, there's little to get in the way of stocks today, and so they are rallying on P/E expansion.
The fellows on Main Street are taking notice too, with capital flowing into equity mutual funds like gangbusters. In the week ending February 27, the four-week moving average of capital flows into equity funds measured $8.8 billion. A good portion of that capital is coming out of money market funds; average outflows measured $8.5 billion there. I think it's also clear that capital is coming out of gold and gold relative shares, with the SPDR Gold Shares (NYSEARCA:GLD) down 5.4% year-to-date and the Market Vectors Gold Miners ETF (NYSEARCA:GDX) down 19%.
Annaly Capital has thus far benefited from capital flows into equity funds because many of those funds are income funds, which buy dividend paying stocks like NLY. Annaly, with its standout dividend yield, offers institutional income investors an option that is hard for many mutual fund managers to pass up. There are a few good reasons why I would be concerned about owning the stock for too long if the economy progresses as I expect. However, I've come to realize that my long-term view will be overwhelmed by this capital flow driver in the near-term, and I'm therefore recommending the stock over the short-term.
As the rally gains momentum, assuming no change to positive economic trends and no unexpected event, capital should get more discriminating and head to riskier high-beta names for outsized returns. That should lead them away from the mortgage REITS like Annaly and American Capital Agency (NASDAQ:AGNC). However, NLY will still receive its share of income directed capital. Over the longer term, if interest rates begin to rise as significantly as I believe they could, then investors could face special risk in the mREITs. In the near-term, though, Annaly should keep gaining on focused mutual fund flows.