Mortgage REITs notched a 1.5% gain in February, extending their average stock gains for the year to 10.2%. Not bad.
Real estate investment trust investors are generally in it for the high yields these stocks pay, but it doesn't hurt when underlying stocks perform well, too.
February Price Change
Year-to-Date Price Change
Chimera (NYS: CIM)
Invesco (NYS: IVR)
American Capital Agency (NAS: AGNC)
Two Harbors (NYS: TWO)
Annaly Capital (NYS: NLY)
Source: S&P Capital IQ.
So what's going on? As I noted in December, valuations had gotten cheap after last year's 16.5% average loss. Although most REITs had been trading at cheap valuations, exotic REITs such as Chimera, Invesco, and Two Harbors, which invest part of their portfolio in non-federally guaranteed securities, were really cheap partly due to credit market turmoil. While each of the stocks above doesn't trade much above book value, only Chimera, which has the greatest exposure to nonguaranteed investments, still trades at a discount to book value (9%).
In January, the Federal Reserve announced that it expected short-term interest rates to remain near zero through 2014. Low short-term rates have been one of the key drivers of the enormous profitability of mortgage REITs in recent years because they reduce REITs' cost of funding, juicing their interest rate spreads and dividends.
Of course, a Fed that's more aggressive on unemployment can be a double-edged sword for mortgage REITs. Besides holding short-term rates near zero longer, the Fed can also push long-term rates down. That hurts REITs' investment income, because their business model involves buying medium- and long-term assets. And to the extent that measures like Operation Twist and quantitative easing speed along the recovery, they reduce the travel time for REITs' low short-term-rate gravy-train to arrive at its destination.
To that end, REIT investors received more encouraging news at the end of February. In his month-end testimony to Congress, Fed Chairman Ben Bernanke basically noted that because employment gains had run ahead of growth last year, he didn't expect unemployment rates to come down significantly in 2012. He also didn't mention anything about when QE 3 might come, indicating that if and when it does, it'll happen later than many had expected. The Fed is probably being extra-sensitive to inflation concerns at a time when geopolitical risks are pushing up energy prices. Still, many experts, including Vincent Reinhart, a top economist and Fed expert currently at Morgan Stanley, sees stronger Fed action coming at some point this year.
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At the time thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.