Bet the Farm on This mREIT

by Bryan Perry | November 21, 2012 11:00 am

It’s been quite a ride lately for investors in mortgage real estate investment trusts (mREITs).

Last week, the whole sector was engulfed in a wave of “sell first, ask questions later” volatility thanks to uncertainty in the larger market as to what taxes will look like in 2013. But now the mini-flash crash in mREITs has subsided, and the rebound in this sector is the biggest encouragement that I’m seeing on my screens this week.

Monday’s release of the Existing Home Sales for October showed 4.79 million homes changing hands against a forecast of 4.50 million, and the National Association of Home Builders Index[1] came in with a reading of 46 versus a forecast of 42. This was backed up by home improvement retailer Lowe’s (NYSE:LOW[2]) topping estimates by 5 cents[3] after Home Depot (NYSE:HD[4]) did the same dance last week.

While stocks like Best Buy (NYSE:BBY[5]) continue to tumble, the bullish beat goes on for the housing market — and it’s providing a major reference point for bulls as to why the big picture is showing further improvement that justifies buying the dip.

Despite the selling pressure that we’ve seen in the broader market after Bernanke’s remarks[6], I expect the rebound in mREITs to ultimately continue. Prepayments could accelerate if the HARP program is modified, and principal still would be guaranteed by the Feds.

As for last week’s selling, it’s important to understand that a lot of these high-paying stocks are held in margin accounts — that, too, probably caused a great deal of liquidation. But the repairs are under way, and we should see a full recovery to the highs in the weeks ahead.

Plenty of mREITs out there have good fundamentals, but I particularly like Armour Residential REIT (NYSE:ARR[7]), with a whopping 16% dividend yield.

As I’ve mentioned before[8], it runs a highly leveraged portfolio of mortgages to support that yield. The composition of ARR’s portfolio is quite different from the more popular American Capital Agency (NASDAQ:AGNC[9]), and thus is better suited for the current market that’s pressuring the spread of borrowing short and investing long.

Armour invests not only in fixed-rate mortgages, but also in hybrid adjustable-rate and adjustable-rate residential mortgage-backed securities issued or guaranteed by U.S. government-chartered entities. This is a key point because floating rate loans don’t get prepaid. When rates eventually rise, so will its portfolio interest income.

Investors in the stock were surely relieved to see ARR trading back up almost to $7 after seeing $5.75 last week. ARR remains a buy — but I would warn that it usually never pays to pay up for high-yield assets after a major snapback rally. They aren’t pure momentum stocks. So after such a powerful snapback rally, I would see if it holds this move back up, then buy the next dip. A slight correction usually is the case after such a volatile move.

All in all, I’m not ready to pull out the New Year’s party hat just yet. We still have zero information as to what investment-related taxes are going be. However, it’s nice to have seen some pre-Black Friday shopping occurring in the market, even with those risks still out there. It sets the tone for a good week — one where we can focus on the importance of giving thanks.

Bryan Perry is editor of Cash Machine[10], a newsletter focused on dividends and income investing.

  1. National Association of Home Builders Index:
  2. LOW:
  3. topping estimates by 5 cents:
  4. HD:
  5. BBY:
  6. Bernanke’s remarks:
  7. ARR:
  8. As I’ve mentioned before:
  9. AGNC:
  10. Cash Machine:

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