Taperless Fed Favors American Capital

Sep.18.13 | About: American Capital (AGNC)

Since the rumors began about Fed tapering at the start of May and long-term interest rates began rising, American Capital Agency (NASDAQ:AGNC) has been on the downslide. The stock declined 26% from May 1st through September 17th on the Fed found fear. Heading into today's Federal Open Market Committee (FOMC) monetary policy statement release, market expectations had been built in for an announcement of Fed tapering. Instead though, today the Fed said it had not yet begun tapering and found reason to keep stimulus in place. Needless to say, American Capital Agency and real estate stocks generally are on the rise Wednesday. AGNC immediately jumped 4.5% to as high as $24.22 on the announcement, before backing off a bit. With long rates likely to fall from here if not at least stabilizing, AGNC has all the reason to recover more ground.

Chart forAmerican Capital Agency Corp.

Chart at Yahoo Finance

The chart above shows the distressing year AGNC investors have suffered through. Still, you can see that the stock stabilized through the summer. That was not so coincidentally consistent with the stabilization of long-term interest rates, which you can see here in the historical yield curve data. The 10-year Treasury note was up 2.77% just after the Fed release, with the yield down almost 11 basis points.

So where do we go from here?

AGNC shares have all the reason to move higher from here. Rising rates spurred concern about the risk of the MBS portfolios of the mortgage REITs including American Capital Agency, Annaly Capital (NYSE:NLY) and Two Harbors Investment Corp. (NYSE:TWO). That risk is relieved today, and so the REIT shares should move higher.

Even heading into today, rates had already stabilized on expectations of Fed asset purchase tapering. AGNC had already started inching higher as interest rates settled in and held about steady. This was a critical sign that it was concern of further rate rise that had driven mREIT shares so deeply lower, and not necessarily the recent level of interest rates. I was so confident that the upside was much more prevalent for the mortgage REITs today that I authored this long idea on Annaly Capital (NLY) this morning, and I did not even expect the Fed to hold off on tapering. Now that it has, I only favor AGNC, NLY and other real estate relative firms even more. In fact, that is an opinion I first made public in late August.

Chart forAmerican Capital Agency Corp.

Chart at Yahoo Finance

This chart of the last three months shows just how dramatically real estate relative shares have declined on interest rate concerns and actual rate increases. Bank of America (NYSE:BAC) is an outlier because as a bank it benefits from widening interest rate spreads more than it could be harmed by an impact to the housing market from higher mortgage rates. You can see, though, that the shares of the SPDR S&P Homebuilders (NYSEARCA:XHB), iShares U.S. Real Estate ETF (IYR) and the mortgage REITs have been severely hampered by a rate rise.

It's my view that the Federal Reserve is walking down interest rates today as part of the strategy. It's a sign that the Fed was disturbed by its counterproductive impact upon interest rates by its own commentary and announced plan earlier this year. The last thing the Federal Reserve wants to do is to disrupt the real estate recovery just as it is finding its own legs and as the economy is gaining traction.

Momentum also helped to drive real estate relative stocks and especially the shares of American Capital Agency and other mREITs lower this year. Mortgage REITs in particular had become widely held due to their hefty dividend yields and the demographics of our nation (read: heavy senior citizenship). Senior citizens require income providing securities more so than aggressive capital appreciation targeting ideas. I believe concern about interest rate risk to the mREITs led to initial selling by institutions, which I believe then manifested into a cascading of selling among seniors and their financial advisors and brokers.

It is unfortunate that so much capital loss resulted from the selloff, but if we can get past the emotional, I believe there remains reason to own these securities. I also believe that future Fed tapering offers positives for mortgage REITs that have been thus far overlooked. The eventual removal of an important purchaser of MBS (the Fed) would drive better pricing for other buyers (mREITs).

AGNC is still paying a 17.5% dividend yield even after its 3.5% stock price rise at this hour today. The reason the dividend yield is so high is because of market concern of a dividend cut, but that risk is decreased on this day's news. Therefore, the other catalyst of dividend yield reduction should come into play to normalize it, price rise. In other words, I see American Capital Agency and its real estate relative peers gaining ground from 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.