Seeking Alpha
Value, long only, special situations, growth at reasonable price
Profile| Send Message| ()  

Fixed income investors must feel like John Paulson lately. If you don't know of him, he is the hedge fund maven who made the September, 2010 comment:

"If you don't own a home buy one; if you own one home, buy another one; and if you own two homes buy a third and lend your relatives the money to buy a home."

That prediction turned out to be famously true, 12 months later. But until the real estate market bottomed, he lost another 50% on his housing stocks, and then had to sell stocks to cover redemptions.

His gold call turned out to be splendid for the next year, but he stuck around too long for that one (a trade that had been good for a decade), and his gold fund fell 65% by July, 2013 (ouch).

Lastly, his 2010 call on rampant inflation? Nowhere in sight. Bonds continued to rally for another 18 months and yields fell to generation lows.

So as the proverbial saying goes, "Timing is everything".

I learned two painful lessons earlier in my investment career:

  1. It's possible to be early; way too early. I could be right eventually, but being early could cost me dearly.
  2. Don't stick around too long if an investment is souring.

The fixed-income market had its worst year in a decade in 2013 and as 2014 rolled around, these investors were flat on their backs with 30% losses. What made the sting worse was their capital-gains brethren. They had clocked +30% last year in one of the best years since 1997!

So what brought this misery about? Until May 5, 2013, absolutely nothing. Things had hummed along nicely for fixed income investors since the end of the financial crisis in 2009.

But in May, 2013, an unexpected melodrama began at the Federal Reserve (Will we taper? Will we not?); followed by a government shutdown, and then a debt ceiling debate that went down to the final evening before insolvency. And just when this situation seemed resolved, interest rates spiked again, rising 20% in Q4; and then end-of-year tax selling kicked-in. Many of the REITs finished near their lows for the year during the last week of 2013, down 30% YTD.

Is it any wonder fixed income investors are scared to go back into the waters they fled in terror?

But for those of us who have not gone through this trauma, or who are able to invest when things appear incredibly insecure, the flip side of this misadventure looks enticing.

First of all, sentiment. After all the fallout ($) from so many depressing events in sequence, which new piece of bad news is not already priced into the shares? All my research on REITS tells me the spread is what counts - the difference between short and long rates. Interest-rate spikes ruin that delicate balance. A similar thing happened in 2005-06, and that also caught the industry by surprise.

But the interest-rate spike in the summer of 2013 was the greatest short-term spike EVER, rising nearly 90% off the lows. No REIT could be pre-prepared for such an outcome. On the other hand, every rate-spike of this magnitude in the past has always reverted to the mean in the months ahead. (See: Are Bonds On A Collision Course With Housing, History, And The Fed?, December 2, 2013)

Secondly, there is the massive insider-buying going on in these names. Might they know something about their business model that we don't know? Insider buying on this scale is akin to an "open-house" corporate board meeting. All the numbers are opened, prospects discussed, and everyone agrees it's time to buy on the open market with their own money.

Thirdly, there is the big-picture aspect of the taper. Chairman Bernanke once likened the QE stimulus to the accelerator on a car. You press down, the engine revs up, and the economy (err...stock market?) takes off.

Why wouldn't the opposite occur if you took your foot off the accelerator? The engine RPMs slow down; the economy slows down. An economic cooling-off period would be a positive for bonds and our now-reeling REITS, as long as it is "gradual". At the time of the December taper, REITs fell to their lowest of the year, and have been gradually rising since then.

I think this is a once-in-a-blue moon opportunity for savers and retirees to build long-term positions in Mortgage REITS like Annaly Capital Management (NLY), American Capital Agency (AGNC), Western Asset Management (WMC), New York Mortgage Trust (NYMT), Healthcare Trust (HTA) and Invesco (IVR). And if they have lost money in them, to return to them.

Two important aspects of such a plan would be to keep the cost-basis of the shares low, and then re-invest the dividends.

I utilize an inexpensive online brokerage, Interactive Brokers, that offers low (1.59%) margin rates. I acquired NLY and WMC in December, 2013, and leveraged each position. I plan to hold them through ex-dividend dates, keeping enough cash on hand to purchase additional shares during the week following the ex-dividend date, equal to the dividend. (The week after ex-dividend is usually the low for the quarter.)

By my pencil, I should be able to double the amount of shares every 3.5 years and eventually cut my cost-basis in half. This assumes, of course, no more dividend cuts, and too, no more capital losses. However the potential for capital appreciation at multi-year lows also carries its own degree of probability. I am not anxious about that with these established companies. It's the long term that I am interested in.

For 17 years the median range of NLY has fluctuated between $13 and $18; and the average dividend has been 45 cents a quarter. That is 50% above the current dividend of 30 cents.

Dividends can offset vicissitudes. In 2013, WMC had $5.10 in capital losses (-30%), but it also paid out $5.10 in dividends, balancing out what would otherwise have been a horrid year.

Anyone who has followed the fortunes of Netflix (NFLX), Facebook (FB), Pandora (P), Sunpower (SPWR) or Groupon (GRPN) can see from the chart that their first 20% off the bottom came the quickest. As I write, Annaly Capital is already 10% above its December lows and has just paid a 30 cent dividend, for a $1.30 return in a month. The stock is now at the price most insiders paid in 2013.

Source: Is It Safe To Return To REITs?