American Capital Agency (AGNC) has plummeted in 2013 in response to two major concerns; the fact that the Federal Reserve may slow or cease its mortgage asset purchases sometime this year and the fear that rising interest rates will crush portfolio holdings of the mortgage real estate investment trusts (mREITS). The most recent unwarranted selling was just last Friday (7/5/13) which resulted from another better than expected jobs number showing that the market added 195,000 jobs in June. That day, when AGNC was trading down 7.5% at $20.21, I came out with a call to buy the panic selling. Since then the stock is up over 10%, with the first bounce coming shortly after the release of the article. Still, despite the evidence I have laid out in multiple articles and despite the fact that closer examination of the jobs number revealed a still gloomy view of the economy, I am inundated with inquiries as to whether it is time to just give up on AGNC altogether. While I would argue that despite AGNC shedding 1/3 of its share price since April, if you truly believe the sector is still doomed, then you could sell into this nice rally. Maybe you followed my advice and got it around $20.20 and picked up a quick 10%. That is a nice return in less than a week. I would not blame anyone for taking those profits. However, to those calling for shareholders to simply give up on AGNC I'd like to offer two new reasons why you should not.
Reason 1: Despite Headlines the Fed Is NOT Ready to Take the Training Wheels Off of the Economy's Bicycle.
Upon the release of the latest FOMC meeting minutes, combined with Ben Bernanke's comments in Boston following their release, AGNC got a nice bump. But why? It was because the meeting minutes plainly indicated that every member except one had advocated for an extension of the Fed's current economic stimulus program, because of the information available to the committee in regards to the economy. They did not advocate for tapering of asset purchases ahead of stable economic news and/or meeting the economic goals laid out when the program was announced. There was only one member of the FOMC who viewed the employment numbers as a positive indicator of an economic turnaround. However, while all members are heard, majority often rules on the committee and as such that member was overruled. Clearly the consensus opinion was that the economy is not ready to ride on its own. As I had also predicted ahead of the FOMC meeting, the issue of short-term interest rates were discussed, and the FOMC was adamant that the low-rate situation or the zero rate interest policy (ZIRP), will not change until the unemployment rate drops to 6.5%. This is not likely until late 2014 or 2015. Further, Ben Bernanke said in Boston that the current unemployment rate of 7.6% might be overstating the "health of the labor market," and as such "highly accommodative monetary policy for the foreseeable future is what's needed."
Reason 2: Despite the Negative News Surrounding Interest Rates, There Are Clear Benefits of Rising Interest Rates For AGNC
The short-term pain from rising interest rates has been damaging to AGNC, but in the long-term, AGNC stands to gain from rising rates. The Fed has kept short-term buying rates near zero levels, and this is about the rate at which AGNC can borrow money. The Fed , as evidenced in the minutes cited above, has just told us that low rates are here to stay at least until unemployment hits 6.5%. Prior to this release, Atlanta Federal Reserve President Dennis Lockhart recently spoke in which he said that nothing has changed in the Fed's overall monetary policy. He also said that the Fed wouldn't consider raising interest rates until 2015. Thus, for the time being, it will not cost more for AGNC to borrow relative to the last few years. In fact this was supported in the recent comments following the FOMC meeting "the committee decided to keep the target range for the federal funds rate at zero to one-quarter percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above six and a half percent."
The Fed will also keep rates lower so long as "inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's two percent longer-run goal." Keeping the short-term borrowing rates low is key to the mREITs being successful going forward. By keep their borrowing rates low, while long-term rates rise, they can use borrowed money to sell longer term debt at higher rates. As the longer-term rates rise while the borrowing rate remains stagnant, the interest rate spread (that is the difference between what AGNC pays to borrow and lend) will widen, subsequently feeding the top and bottom lines. This last quarter or two have been periods of transition, where existing holdings in the portfolios have declined, been possibly sold, and the proceeds used to re-weight the portfolio.
One criticism I have received from individuals who believe it is time to give up on AGNC is what happens when the short-term rates do rise? They point to the ten year treasury having spiked to 2.71% as an example. My response is generally that when you buy a stock, you are buying the management team. Gary Kain and his team are among the best in the business. I have confidence that my recent decision to pyramid down in to this name is wise, despite the short-term headwinds the company has faced. I believe that management is being put to the test and will pass with flying colors. They have known rising rates would be coming eventually and I will be watching with great angst to see how their hedges have performed when the company reports its Q2. I will also add that when short-term rates rise, it will only be detrimental if long-term rates remain stagnant, or worse start to decrease while the short-term rates rise. Should this happen, I would reevaluate, but it will not happen any time soon so long as our economic indicators are this poor.
As a long-term investor, I think it is prudent to buy stocks that are on sale during times of panic provided the management team is sound and the business model still works. I have been questioned on the latter, but the evidence presented above indicates that the mREITs are until a place to invest, specifically because the Fed is keeping borrowing rates low and asset purchasing is not ceasing as nearly all of the FOMC is feeling dovish. In fact, AGNC is on sale after shaving 33% of its share price. There is no doubt the company is in transition and as a result, people have dumped the stock. However, I just do not see much downside left. Much of the bad news is priced in. The next price moving catalyst will be earnings. The report and conference call will give clear direction as to what management is planning and how their hedges are performing. Because much of the fear in these names has been over the Fed ceasing asset purchasing as early as September, and the fact that rising interest rates are not bad for AGNC long-term, I argue that it is not time to give up on the stock. Rather, these fears have been slightly irrational. Instead, as painful as it can be, you have to hold during these times or buy more if you want to make a profit. In a sector like this it is also prudent to remember that your buying strategy and timing are everything. The Fed has telegraphed low rates and continued purchasing. Combined with the decline in share price, AGNC is a buy.