The stock market had a small correction – down about 0.6%. Lowry is still bullish on the intermediate term: “current signs of weakness appear largely short-term in nature, while longer term, the rally appears to be showing signs of renewed strength.”
I am still a bit cautious, but did cover some shorts and did some selective buying, eg including the names that I mentioned last week.
Two ideas this week. One deals with an ETF that I mentioned last week, TBT, which moves in the same direction as the yield on long-term US Treasury bonds, and uses about 2-1 leverage. If you think as I do that yields will move up over the next few years, it makes an interesting long-term investment. The yields have moved down over the last week – 4.6% to 4.4% for the 30-year. And TBT went from 53.7 to 50.29. RYJUX is a way to invest in the same way, without leverage. But TBT has options, and RYJUX does not. So this opens up a way to invest in TBT with short-term strategies. A simple way is to sell Puts. For example, the current price of the TBT Dec51 Puts are 4.50/shr. The strike price is 51 and the exercise date is December 19th. If the stock closes on December 18th (a Friday) below $51/shr, your Put will be exercised and you will be buying TBT for $51/shr. However, when you sold the Put, you got $4.50/shr, so your actual cost is $46.50/shr. If TBT closes above $51, the Put is worthless, and you have made $4.50/shr. But unlike buying the shares outright, your upside is limited to $4.50/shr. Of course, there is a lot of varieties to this strategy, e.g. other months (August, September, January, March), and many other strike prices. Also, once you have sold the Put, you can always buy it back at any time before expiration. Disclosure: I’ve mainly been selling straddles in TBT (which is a lot more complex to explain).
Second idea this week is NLY (Annaly Capital Management). NLY is a Mortgage REIT. “REIT” (real-estate investment trust) implies it pays out 90% of its earnings as dividends, and that the dividends are not eligible for the 15% special dividend tax – they are taxed as regular income. So, if possible buy NLY in an IRA.
NLY invests in Mortgage-Backed-Securities (MBSes), and uses ~6-to-1 leverage, eg for each $1 cash, it borrows $5 (short-term) and buys $6 worth of MBSes (long-term).
These are the important parts of their last quarterly report (key parts in bold):
At June 30, 2009, the weighted average yield on assets was 4.67% and the weighted average cost of funds, including the effect of interest rate swaps, was 2.54%, which resulted in an interest rate spread of 2.13%. Leverage at June 30, 2009, was 5.9:1 compared to 7.1:1 at June 30, 2008, and 6.0:1 at March 31, 2009.
Fixed-rate securities comprised 69% of the Company’s portfolio at June 30, 2009. The balance of the portfolio was comprised of 25% adjustable-rate mortgages and 6% LIBOR floating-rate collateralized mortgage obligations. At June 30, 2009, the Company had entered into interest rate swaps with a notional amount of $19.8 billion, or 31% of the portfolio. The purpose of the swaps is to mitigate the risk of rising interest rates that affect the Company’s cost of funds. Since the Company receives a floating rate on the notional amount of the swaps, the effect of the swaps is to lock in a spread relative to the cost of financing. As of June 30, 2009, all of the Company’s Investment Securities were Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities, which carry an actual or implied “AAA” rating.
. . .Our swap book, which provides the bulk of the floating rate exposure in our portfolio, continues to roll into lower rates and thereby lower our cost of funds. After taking into account the effect of interest rate swaps, at June 30, 2009, our portfolio of Investment Securities was comprised of 37% floating-rate, 25% adjustable-rate and 38% fixed-rate assets.”
So, they have “safe” MBSes – excellent. 38% of their portfolio is exposed to a rise in short-term interest rates. When this happens in a significant way, earnings will decrease, and with that dividends. How much, I don’t know. However, even if the dividend rate were to drop by 33% (which has <25% probability, in my view), say 2 years from now, that would still be OK.
Mark-to-Market accounting could make their earnings look strange (as mortgage interest rates rise, the value of their fixed-rate MBSes will go down). But this should not effect the dividend.
As a very long-term investment (more than 2 years), you have to be cautious with NLY. It is possible that the US could enter a period of very high interest rates (comparable to the late 1970’s), and this would be bad for NLY. So this bears monitoring. But for the next 2 years this stock, with its dividend should do well. Disclosure: I am long NLY. Initial position was about 1 year ago, and I added to it this past week.
In some sense, an investment in TBT or RYJUX hedges an investment in NLY. As all interest rates rise, the NLY dividend (and possibly, its stock price) could go down, but TBT and RYJUX would rise.
Fred's Corner 