My apologies in advance for the appearance of hijacking a headline from another contributor, but I must respond to said contributor and his arguments, which suggest that investors of Annaly Capital Management (NYSE:NLY) common stock should "run for the hills" and buy preferred REIT stocks, instead.
The article in question is: Annaly Has Bottomed: Multiple Reasons To Run For The Hills
After noting the large number of comments written about the article as well as the strong counter arguments that can be made in response to, what is, on the surface, quite a persuasively-written piece, I'd like to offer those strong counter arguments here.
Though, I disagree with the premise of the "run for the hills" ("RFTH") article, which infers that there is no catalyst for further gains in NLY, the author did point out the irrational arguments made in several puzzling theses presented on SA, of late.
But, in short, I'll give you a strong catalyst for a continued rally in NLY, from the Dec. 6 low of $9.45.
However, expecting an 11% yield in today's ZIRP without meaningful risk of capital loss is, by a realistic definition, a speculation. So, the tone of the RFTH article, suggesting that investors should be risk adverse (not "speculative," to use his word) by selling NLY common to buy NLY preferred, instead, is oxymoronic from the start.
Both securities are quite speculative, but NLY common should offer a meaningful reward for the risk taken, in my opinion, while the preferred may not offer a better risk/reward at this time.
For those requiring a background on the history of central bank cooperation should read a most brilliant article by José Miguel Alonso Trabanco of Global Research, "Dollar Hegemony," Monetary Geopolitics" and the IMF: The Symbiosis between Global Finance and Power Politics."
Now, To My Point
In my last article, "At $10, Annaly Capital Management Is Cheap," the 10-year Treasury was trading dangerously close to the 3% handle. A significant break above that Maginot Line of 3% would signal to the world's central banks and institutional investors that the Fed had lost control of interest rates, and NLY would be in trouble due to the stock's high negative correlation to the US 10-year Treasury.
Why? Because NLY's model, as well as trillions of dollars worth of balance sheet assets at the Fed and ECB, would result in another implosion of counter-party, tier-3 assets (swaps, et cetera), no matter how many "hedges" investors of MBSs hold.
I "speculated" that the Fed would not allow the 10-year Treasury yield to creep above 3% for more than a day or two. I posed the question: Is it likely the Fed has finally lost control of the Treasury market? Which I, then, stated. "Unlikely."
Since my article's publication date of Jan. 8, the US 10-year Treasury has dropped from approximately 3% to 2.71%. A drop of 30 basis points has soared NLY by approximately 7% in market value within seven weeks (plus the implied 11% dividend rate), outperforming the S&P by approximately the same amount, 7%.
Back to the Original Question Posed by RFTH Author
So, back to question posed by the author of RFTH.
"The question that is not asked enough is 'what has changed to make them go up in value or maintain their dividends and book value?' Stated differently, 'what is the catalyst that will drive prices or dividends higher?'" asks the author.
That catalyst is quite simple: capital gains (which has been demonstrated by NLY's latest earnings beat). That is, capital gains from appreciating market value of the debt securities derived from the lowering of interest rates at the long end of the curve.
However, the RFTH author rightfully points out (I assume) that the yield curve offers only a baseline to NLY's earnings potential. But the real gravy for NLY earnings comes from rates that move lower at the longer end of the curve, therefore, shrinking spreads while rates on the short-end are zero-bound.
To writers of NLY on SA, it appears counter intuitive that the lowering of rates are actually good for NLY's market cap. If management can read the tea leaves of, not only Fed policy, but how the counter parties at the ECB and BOJ can offset the "tapering" scheme with stepped-up purchases of their own, the picture becomes more clear of NLY's potential for continued dividends and stock price appreciation.
Therefore, the following question from RFTH can be answered without missing a step.
It is often stated "don't fight the Fed." Is this the time to start?
"[I]nvestors must consider the mortgage market. The largest buyer of mortgage securities, the Fed, has announced reductions in their purchases of MBS. Without this artificial price support, should investors expect prices to go up or down on MBS? It is often stated 'don't fight the Fed.' Is this the time to start?"
The answer is, no. This is not the time to start fighting the Fed, but it is time to align ourselves with the three "Western" central banks which matter in the fight to continue the ZIRP experiment.
So, the question shouldn't be: Is it time to fight the Fed? The question should be: Is it time to fight the Fed, ECB and BOJ?
Let me explain.
In other words, I contend that, the reduction of the "artificial price support," stated by RFTH is an illusion perpetrated by the Fed. The rug is not being pulled out from the debt securities market, and won't be, ever.
Proof of Fed's NO TAPER
The most compelling demonstration of the illusion perpetrated by the Three-Card Monte of the Fed, ECB and BOJ comes by way of December's Treasury International Capital (TIC) data. The TIC data clearly show something remarkable, even impossible; it clearly shows that smoking-gun proof of unlimited firepower available to CBs to levitate MBSs and, by extension, to provide continued double-digit dividends to NLY investors (assuming competent management).
In the December TIC report, it reveals that tiny Belgium, with a GDP of approximately $490 billion, somehow dug up $56.2 billion to purchase US Treasuries in the final month of calendar 2013 in order to counter China's news-breaking sale of $47.8 billion of Treasuries.
At a one-month purchase of 11.4% of GDP, that size of a purchase made by the US would equate to $1.93 trillion!
Moreover, according to the International Monetary Fund (IMF) the Belgian central bank reported reserves of only $27.1 billion for Jan. 2014, with $30.3 billion reported for October 2013 as the highest level of reserves ever achieved.
somehow the Belgian central bank woke up with an additional $56.2 billion as a Christmas present from someone. And that someone is the ECB.
Through the Fed's swap window, the ECB can enter into repurchase agreements with the Fed. The ECB can, then, use the proceeds to buy euros, as was the case during the EU crisis in the summers of 2010 and 2012, or use the dollars to lend to Belgium, as was the case in December 2013. Belgium, then, buys US Treasuries (thereby, lifting MBS prices and closing spreads with USTs) to fill the gaping hole left by the Chinese.
The entire exercise of the Fed creating credit to the ECB so that the proceeds can be used to buy US Treasuries through a proxy ECB member bank is akin to a 16-year-old kid asking an adult to buy some beer for him at the local package store. The Fed, like the kid, can claim it never did anything wrong. But it did do something wrong, and NLY investors are among the beneficiaries of the scheme.
I expect the Fed swap-window borrowing by the ECB will continue to support US debt markets via ECB proxy banks. And I will provide updates from time to time regarding NLY and central bankers polices.
In the mean time, and as I wrote about NLY here on Jan. 8, I'm looking for the stock to touch $12 per share and continue to provide a minimum of 11% annual dividend until further notice.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NLY over the 1next 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.