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Mortgage REITs Are Benefiting From Yield Gap
This counterintuitive gain happened despite a poor housing environment -- but why?
Howard L. Simons     

When asked what he thought of Western civilization, Gandhi allegedly replied, "I think it would be a good idea." I'm getting to that point on the question of free markets after watching years of central bankers acting like central planners. At least the Federal Reserve has finally adopted the pretense that it's doing anything for reasons beyond simple whim. I can do that and have the scars to prove it.
 
This brings me back to mortgage REITs (real estate investment trusts), a topic I last wrote about in July 2013. The largest of this group -- Annaly Capital Management (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC), NorthStar Realty Finance (NYSE:NRF), Starwood Property (NYSE:STWD), Chimera Investment (NYSE:CIM), and Two Harbors Investment (NYSE:TWO) -- were among the intended beneficiaries of QE1 and QE3. I noted at the time that this group was facing the strong headwind of its bond yield curve steepening relative to the Treasury yield curve. Worse, years of artificially low mortgage rates and other housing subsidies were lowering the affordability of homes for buyers, something that we've seen confirmed in recent data on home sales and construction.
 
It's the Yield Gap, Stupid

Mortgage REITs started to outperform all REITs after last September's postponed tapering of QE, even though they've underperformed all REITs since QE1 began in March 2009. (Will I remember all of these QE-related dates in my dotage instead of important stuff, like where I left the house keys? Just wondering). Moreover, they've done it in the aforementioned poor environment for housing and with the yield curve for mortgage bonds still steepening relative to the Treasury yield curve.
 

Click to enlarge

How can this counterintuitive gain in relative performance be explained? As in the case of so many things in our yield-starved age, you have to look at relative yield gaps. Let's rearrange the data in the chart above to a relative performance measure and map it against the yield gap between mortgage REIT bonds and the dividend yield on the S&P Comp1500 (INDEXNYSEGIS:SPSUPX) supercomposite. That yield gap started to expand about one year ago, and as it did, the performance of mortgage REITs relative to all REITs stabilized and turned higher.
 

Click to enlarge

The sensitivity of this relative performance index to the yield gap of mortgage REIT bonds to equity dividends indicates the group is being valued more in comparison to equities than to Treasuries. As there's a long history of yield-chasing ending badly, I will have to nod in this direction and simply note that this trade will end badly if and when long-term rates rise. However, this is unlikely to be a short-term concern.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
Mortgage REITs Are Benefiting From Yield Gap
This counterintuitive gain happened despite a poor housing environment -- but why?
Howard L. Simons     

When asked what he thought of Western civilization, Gandhi allegedly replied, "I think it would be a good idea." I'm getting to that point on the question of free markets after watching years of central bankers acting like central planners. At least the Federal Reserve has finally adopted the pretense that it's doing anything for reasons beyond simple whim. I can do that and have the scars to prove it.
 
This brings me back to mortgage REITs (real estate investment trusts), a topic I last wrote about in July 2013. The largest of this group -- Annaly Capital Management (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC), NorthStar Realty Finance (NYSE:NRF), Starwood Property (NYSE:STWD), Chimera Investment (NYSE:CIM), and Two Harbors Investment (NYSE:TWO) -- were among the intended beneficiaries of QE1 and QE3. I noted at the time that this group was facing the strong headwind of its bond yield curve steepening relative to the Treasury yield curve. Worse, years of artificially low mortgage rates and other housing subsidies were lowering the affordability of homes for buyers, something that we've seen confirmed in recent data on home sales and construction.
 
It's the Yield Gap, Stupid

Mortgage REITs started to outperform all REITs after last September's postponed tapering of QE, even though they've underperformed all REITs since QE1 began in March 2009. (Will I remember all of these QE-related dates in my dotage instead of important stuff, like where I left the house keys? Just wondering). Moreover, they've done it in the aforementioned poor environment for housing and with the yield curve for mortgage bonds still steepening relative to the Treasury yield curve.
 

Click to enlarge

How can this counterintuitive gain in relative performance be explained? As in the case of so many things in our yield-starved age, you have to look at relative yield gaps. Let's rearrange the data in the chart above to a relative performance measure and map it against the yield gap between mortgage REIT bonds and the dividend yield on the S&P Comp1500 (INDEXNYSEGIS:SPSUPX) supercomposite. That yield gap started to expand about one year ago, and as it did, the performance of mortgage REITs relative to all REITs stabilized and turned higher.
 

Click to enlarge

The sensitivity of this relative performance index to the yield gap of mortgage REIT bonds to equity dividends indicates the group is being valued more in comparison to equities than to Treasuries. As there's a long history of yield-chasing ending badly, I will have to nod in this direction and simply note that this trade will end badly if and when long-term rates rise. However, this is unlikely to be a short-term concern.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
Mortgage REITs Are Benefiting From Yield Gap
This counterintuitive gain happened despite a poor housing environment -- but why?
Howard L. Simons     

When asked what he thought of Western civilization, Gandhi allegedly replied, "I think it would be a good idea." I'm getting to that point on the question of free markets after watching years of central bankers acting like central planners. At least the Federal Reserve has finally adopted the pretense that it's doing anything for reasons beyond simple whim. I can do that and have the scars to prove it.
 
This brings me back to mortgage REITs (real estate investment trusts), a topic I last wrote about in July 2013. The largest of this group -- Annaly Capital Management (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC), NorthStar Realty Finance (NYSE:NRF), Starwood Property (NYSE:STWD), Chimera Investment (NYSE:CIM), and Two Harbors Investment (NYSE:TWO) -- were among the intended beneficiaries of QE1 and QE3. I noted at the time that this group was facing the strong headwind of its bond yield curve steepening relative to the Treasury yield curve. Worse, years of artificially low mortgage rates and other housing subsidies were lowering the affordability of homes for buyers, something that we've seen confirmed in recent data on home sales and construction.
 
It's the Yield Gap, Stupid

Mortgage REITs started to outperform all REITs after last September's postponed tapering of QE, even though they've underperformed all REITs since QE1 began in March 2009. (Will I remember all of these QE-related dates in my dotage instead of important stuff, like where I left the house keys? Just wondering). Moreover, they've done it in the aforementioned poor environment for housing and with the yield curve for mortgage bonds still steepening relative to the Treasury yield curve.
 

Click to enlarge

How can this counterintuitive gain in relative performance be explained? As in the case of so many things in our yield-starved age, you have to look at relative yield gaps. Let's rearrange the data in the chart above to a relative performance measure and map it against the yield gap between mortgage REIT bonds and the dividend yield on the S&P Comp1500 (INDEXNYSEGIS:SPSUPX) supercomposite. That yield gap started to expand about one year ago, and as it did, the performance of mortgage REITs relative to all REITs stabilized and turned higher.
 

Click to enlarge

The sensitivity of this relative performance index to the yield gap of mortgage REIT bonds to equity dividends indicates the group is being valued more in comparison to equities than to Treasuries. As there's a long history of yield-chasing ending badly, I will have to nod in this direction and simply note that this trade will end badly if and when long-term rates rise. However, this is unlikely to be a short-term concern.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
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