Wells Fargo Upgraded Key REITs to ‘Outperform’ in Mid-July
Indicators Show International Investors Still Prefer US Real Estate
REM and the yield curve
Amid China’s stock market bubble and the Greece bailout discussions, the ten-year US Treasury yield has come off its highs, as US Treasuries are viewed as a safe-haven asset. The apparent flattening of the yield curve looks like a major problem for mortgage REITs. Investors in mortgage REITs are subject to substantial fluctuations in their capital when Treasury rates move. A decline in yields leads to erosion of capital for mortgage REIT investors since the difference between the yield on mortgage assets and the cost of funds is quite narrow.
Mortgage REITs need to use substantial leverage to deliver an appealing return to investors. Though mortgage REITs hedge their risk through interest rate swaps and other futures contracts, the issue for mortgage REITs is that they do long-term loans and fund them with short-term money.
Under this backdrop, one option for mortgage REIT investors who want diversification in their mortgage holdings is investing in the iShares Mortgage Real Estate Capped ETF (REM). REM has a substantial diversification in its holdings that protects investors during global economic downturns.
Upgraded REITS are oversold, according to the relative strength index or RSI
Recently, Wells Fargo has upgraded some of mortgage REITs to “Outperform” from “Market Perform” that have a significant weighting in the REM ETF. These REITs are Annaly Capital (NLY), American Capital Agency (AGNC), PennyMac Mortgage (PMT), American Capital Mortgage (MTGE), and MFA Financial (MFA).
The Wells Fargo upgrade has already helped mortgage REITs rebound after two mortgage REITs reached their 52-week low and were heavily oversold. Looking at the 14-day relative strength indices (or RSI) for Annaly Capital (NLY) and American Capital Agency (AGNC), we see that both mortgage REITs were heavily oversold in the past two weeks. An RSI below 30 indicates that a stock is oversold. Few other mortgage REITs that are oversold based on their last 14-day RSIs are included in the table above.
It’s worthwhile to look at the Market Vectors Mortgage REIT income ETF (MORT), which is also a diversified REIT.
Browse this series on Market Realist: