We Could See Major New Highs In The mREIT Sector, Along With A 13% Yield

 |  Includes: AGNC, NLY
by: Regarded Solutions

Just when some folks think that things are falling apart (not us, but many of the doom and gloom crowd) in the mREIT sector, as prices dropped a bit last week in both of our "Team Alpha" favorites, Annaly Capital (NYSE:NLY) and American Capital (NASDAQ:AGNC), lo and behold the economic data comes to our "rescue," as do the latest Treasury yield numbers.

The latest numbers for inflation were tame, to say the least. The July CPI for 12 months came in at just 1.4 percent, the lowest number in just about one year. The core CPI (which does not count food and energy), added only 0.1 percent. That was the smallest rise since February, breaking 4 straight months of 0.2 percent increases.

The data was duly noted right here:

The tame inflation reading leaves the door open to more monetary stimulus from the U.S. central bank, even though data on job growth and retail sales have hinted at a bit of a pick-up in economic activity early in the third quarter.

Economists say growth is still too weak to do much to lower the nation's uncomfortably high 8.3 percent unemployment rate.

What This Means For The mREIT Sector

Here is an overview of how the developments help the sector:

  • Short term rates can be kept low for a longer period of time.
  • Longer term rates could be kept stable as the Fed continues to utilize Operation Twist.
  • With a stable interest rate environment, the mREIT sector can actually take on additional leverage, if they so desire, which will add more profits, and give shareholders more dividend potential.
  • The likelihood of a quickly rising interest rate environment is once again "muted", which gives shareholders somewhat less risk in this sector, while the dividend yields remain healthy.

Ok, But What About The "Spread"?

Obviously, the mREIT sector loves a steepening yield curve to go hand in hand with the lovely Fed policies. Lately, the spread between the 2 year and 10 year treasury had been tightening. That put some downward pressure on Annaly's and American's share price for a week or so.

Now we have just the reverse. The spread is widening, and it could widen further if the trend continues. As reported in this article, the 10 year rose to 1.812%, and the 30 year rose to 2.92%:

U.S. Treasury prices tumbled Wednesday as global growth concerns eased, lifting yields to their highest levels since mid-May.

Long-dated Treasury prices have now fallen eight of the 11 trading sessions in August, a month that had served gains to the market in each of the last eight years. But so far this August, somewhat better U.S. economic readings and the lack of dire news about the euro-zone debt crisis have encouraged investors to sell the safe-haven asset.

The yield on benchmark 10-year notes rose as high as 1.812%--the highest since May 16. The 30-year bond yield climbed as far as 2.919%--the most since May 17. Bond yields rise when prices fall.

Shareholders of mREITs could not ask for a better scenario for the time being. The "perfect storm" of a low interest rate environment, with stability virtually being mandated by the Fed, should give shareholders of all mREITs a good night's sleep. Especially by owning the "big dogs" in the mix, Annaly and American Capital.

The Headwinds Remain The Same

As we have noted on a regular basis, the headwinds for the entire mREIT section are still the same.

  • A yield curve spread that flattens or inverts, making it very difficult for the sector to profit.
  • A quickly rising interest rate environment, that could cause mREITs to de-lever at levels that impact earnings, as well as revenues.
  • If pre-payments increase, profits would be squeezed, which would also impact dividends and the share price.
  • The Fed changing direction and exiting the ZIRP (zero interest rate policy) it has embraced.

My Opinion

Once again, I am reiterating my own personal satisfaction in owning NLY and adding AGNC to our portfolio. I cannot think of a better risk/reward play than these 2 stocks for now, and into the foreseeable future.

These stocks do carry more risk than the mega cap blue chip stocks we love, but with 13% and 14% dividend yields, we are getting a big bang for our buck!

Disclosure: I am long NLY, AGNC.