It's only been a month since I last reviewed the type of real estate investment trusts (REITs) that invest in agency mortgage backed securities. However, in the past week or so, a few issues have come up that are putting downward pressure on the REITs.
In the last five trading days, the 10-year Treasury yield has risen and the REITs have all, in traditional fashion, declined in price. Annaly Capital Management (NLY), PennyMac Mortgage Investment Trust (PMT), Chimera Investment (CIM), American Capital Agency (AGNC), CYS Investments (CYS) and Capstead Mortgage (CMO) are all down between about 1% and 2.5%.
That's a perfectly logical move and it doesn't relate to the strength of their businesses. It's simply a standard reaction to increasing Treasury yields, which implies rising purchase money mortgage rates, and that the resale values of the mortgages within the securities the REITs hold would sell for less if they were to do so. It is not a cash flow issue for the REITs, however, so it does not indicate that dividends will be reduced.
However, bond traders and those in markets whose value is tied to or derived from bond yields are increasingly nervous about the near-term trajectory for yields and the implication for assets correlated to them.
On Sept. 6, famous and successful bond trader, David Tepper, stated publicly "It's the beginning of the end of the bond market rally. We are done."
This is a huge call since the bond market rally has been ongoing for 32 years and many others throughout that period have erroneously made the same call.
Three days later, another bond market expert, Jeff Gundlach, stated that the 10 year yield is range bound between 2.2% and 2.8% for the rest of this year. When he said that the 10 year yield was right in the middle of that range at 2.5%.
Given the nervousness concerning the Fed's rate normalization trajectory though, the markets were, and are, more focused on the upper end of that range. That nervousness is exacerbated by the bond yield pop that occurred during the latter half of 2013 when yields rose at the fastest rate in history. They moved from 1.66% on May 1, to 3.04% on Dec. 31.
That move also caused mortgage rates to rise at the fastest rate in history and caused the prices of REITs to decline -- some of them dramatically.
Between May 1 and Dec. 31 of 2013, Annaly's price dropped by 37%, American Capital's by 41%, and CYS Investments' by 39%.
That was a big enough move to shake out many investors. Right now, it's important to note that this "weak money" never returned to that sector. Therefore, it is not there to supply the irrational selling necessary to cause a replay of last year's selloff -- even if the 10 year yield continues to move higher and approaches the 3% level again.
Further, as strong as the price performance of the REITs has been this year, they are still priced very near the lows that were put in last year. That's exactly what income investors should want.
The REITs are investment vehicles. The underlying value of the assets that produce that income will fluctuate with bond yields and mortgage rates. However, that is separate from the ability of the REITs being able to continue to pay our their high dividends. That income stream is not impacted by the near-term moves in Treasury yields and should be disregarded as a determining factor with respect to the future income potential of the REITs.
The bottom line is that if you own REITs for income, keep them. If they go on sale and you have capital available, buy more. If you don't have any more capital to invest for income don't worry about it. The dividend streams will be little impacted by moves in the prices of the REITs.
If you own the REITs for growth, you never should have been in that sector to begin with.
