Consider Annaly Capital Here For 17% To 33% Capital Appreciation

| About: Annaly Capital (NLY)

When last we spoke, I suggested mortgage REIT investors not fight the Fed. Today, I'm saying buy back Annaly Capital here for some capital appreciation to complement your big dividend yield. What's changed? The most important thing has changed. The catalyst behind the decline of mREITs has faded; the abrupt rise of interest rates has moderated, and it could get even better this week. So you might consider picking up a stake here while pundits are still shunning this group, and let the herd lift you up when it comes around later.

Mortgage REIT

Year-to-Date

Annaly Capital Management (NYSE:NLY)

-14.5%

American Capital Agency (NASDAQ:AGNC)

-20.1%

Chimera Investment (NYSE:CIM)

+14.6%

CYS Investments (NYSE:CYS)

-28.3%

Two Harbors Investment (NYSE:TWO)

-7.5%

Click to enlarge

When interest rates were recently rising and seemed set to continue rising given the Fed's "tapering" plan for its asset purchase program, investors shunned the mortgage REITs. Among the pariah were industry marquee Annaly Capital, and also its peers American Capital Agency and CYS Investments. The cause of concern was at least two-fold. First, rising interest rates could cull the real estate recovery and the economy, and that thought revived nightmarish memories of Mortgage-Backed Securities (MBS) at 10 cents on the dollar.

The second concern is actually more worrisome to investors in mREITs; it is the risk tied to the asset portfolios already held by the mREITs. If rates rise, the fixed income securities held by Annaly and American Capital fall in value. Changes to book value weigh heavily on tightly regulated financial sector companies and affect their ability to do business, and even more so in the post crisis operating environment.

Guess what though? Interest rates have moderated some, though all you hear from TV pundits is that interest rates will rise forever more. This week's GDP report threatened to change that popular opinion because of economists' expectations for growth to slow dramatically in Q2. However, it was reported up 1.7%, better than the consensus expectation for 1.1% growth. The media will want to cling to economists' expectations for better growth for the rest of the year, but they will still speculate about what may come if the pace of economic growth continues to drag. What matters most is that the market seems to have adjusted to the change in Fed outlook, and rates appear to have settled.

Now that we have been reassured of a Fed perspective determined by data, the media will continue to contemplate various Fed possibilities on each reported data point. Still, the current trend in rates says they are settling lower and are better reflecting today's true economic reality. Plus, the housing recovery is hitting stumbling blocks, including that caused by rising rates. But there are also seasonal issues weighing as we approach the start of school, when home buying tends to stall. As a result, there is all the more reason for rates to fall back, and that will remind investors about those old favorites of theirs in the mortgage REIT space, including our favorite, Annaly Capital.

Chart forAnnaly Capital Management, Inc.

Chart at Yahoo Finance

What's more, the price chart in NLY shows you that the stock has settled along with interest rates, and that selling pressure is subdued now. At today's price level of $12, a move back up to $16 represents an uncharacteristic 33% capital appreciation opportunity and seems unlikely near-term. However, if the stock's price-to-book value moved from 0.78X to 1.0X, we would get about the same appreciation (+28%), so perhaps investors should give the scenario some weight if risks have dissipated. I'm not aiming that high, though, but I see $14 as attainable. If the stock could recover the two dollars per share it would take to get there, investors would get a 16.7% return to take home with their 13.6% dividend yield. Obviously, there is risk, including those tied to abrupt changes in interest rates, as I've explained in previous articles. Still, I see much of that risk already accounted for, and I'm suggesting investors who are willing to accept that risk to consider buying back some Annaly Capital shares here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.