With Annaly Settled, Why The Next Leg Is Higher

| About: Annaly Capital (NLY)

Annaly Capital (NYSE:NLY) shares have settled, and I believe the next leg for the stock will be higher. It's been a tough twelve months for holders of NLY, but the worst may be over now, and the stock may be ready to look toward capital appreciation to go with its current dividend yield of 13.3%.

Chart forAnnaly Capital Management, Inc.

Chart at Yahoo Finance

Annaly Capital shares have been especially impacted by rising mortgage rates since speculation began about Fed tapering in early May. The situation was only exacerbated when the Fed Chairman actually suggested tapering would likely start this year. Today, we expect to receive a detailed plan for the tapering process, with the beginning of lighter asset purchases perhaps starting this month. All of these catalysts have worked to hike long interest rates and mortgage rates, and served to sink Annaly shares and those of other real estate relative stocks.

As interest rates have increased, investors and pundits have expressed concern about the structure of mREIT asset portfolios and their exposure to rising interest rates. Annaly shares are down in price by 22% since May 1st, even after adjusting for dividends. The SPDR S&P 500 (NYSEARCA:SPY) is up by 8.2% over the same span.


05/01 - 09/16

Annaly Capital


SPDR S&P 500


iShares US Real Estate (NYSEARCA:IYR)


SPDR S&P Homebuilders (NYSEARCA:XHB)


American Capital Agency (NASDAQ:AGNC)


Bank of America (NYSE:BAC)


Mortgage lenders who also participate in other lending, including Bank of America, have found market interest because of the benefit they find from widening interest rate spreads. Otherwise, the entire group of real estate relative stocks sensitive to changes in interest rates has underperformed the broader market since May, but the mortgage REITs, including Annaly's peer American Capital Agency, have done the worst. Thus, they should also outperform if rates were to steady or even change direction and turn lower. But why might interest rates settle or change direction now?

Well, up until recently, the market had priced in ongoing ultimate Fed accommodation into both stocks and bond prices. So when monetary policy changed, an inflection point resulted for interest rates as adjustment occurred toward a more normalized set of expectations. The Fed is ready to go to neutral for now, but it has indicated that it is not ready to begin raising interest rates soon.

Long rates adjusted sharply from May 1st, but you can see here that they have settled in more recently. Not so coincidentally, so have the shares of NLY and other real estate relative stocks.

Chart forAnnaly Capital Management, Inc.

Chart at Yahoo Finance

Obviously, Bank of America benefits from widening interest rate spreads, and homebuilders have shown resilience of late. But you can see that all the real estate relative stocks have settled in here and are even inching higher. At this point, tapering is thus priced in, so I propose that interest rates will take their lead from future Fed action beyond tapering, and expectations for the Fed. However, the real catalysts are economic activity and potential future signs of inflation. Given that those two catalysts for interest rates are not flaring at the moment, I expect you can expect interest rates to at least hold steady here.

We should not rule out the possibility of interest rates retrenching to lower ground either. But what might cause rates to decrease from here? Well, a strike on Syria for one. While it is less likely now, it is important to understand that if it does eventually happen, a flight to quality would follow. For as long as the United States is not domestically threatened, and with regard to Syria, it does not appear to be, then U.S. treasuries remain the most likely destination in a flight to quality. Increased demand for treasuries puts downward pressure on long-term interest rates and serves to sink mortgage rates. Thus, I believe we can go so far as to say that there is about an equal chance for rates to decrease from here as there is for rates to increase.

It is also important to note that housing has cooled a bit since rates began rising in May. For as long as that is the case, the Fed remains unlikely to raise interest rates. On net, the Fed's exit from the mortgage backed securities pit means better pricing for Annaly, AGNC and other buyers of MBS. Thus, for as long as rates stay steady or decline from here, the company might even find a better operating environment, and that is certainly not priced into NLY shares today.

In conclusion, if we can set aside emotions regarding the last several months of trading in NLY, we can see reasons for the stock to recover some price ground in the months ahead. With the stock settled, still paying a high dividend yield, and finding a less bad operating environment that the market has priced into its shares, I find Annaly Capital attractive today.

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.