We saw another rough day on Wall Street yesterday with the Dow falling another 1,300 points, which feels relatively "good" compared to the 2,300 it was down a few short hours before the close. The Mortgage REIT world was especially hard hit but there was a little sun hidden in the gloom.
There was a scare in the market that liquidity would dry up, and investors sold everything under the sun with no reference to past success or future earnings potential. Annaly Capital Management (NLY) dropped 20% to $5.30 and hit $3.50 at the low. At the close the stated dividend yield is now 18.8%, which looks extremely tempting on the surface. Of course, the next thought out of our heads is, "what if they cut the dividend?" And yes, that’s a real possibility. We don’t have an immediate answer for you here. Less than a month ago the stock was at $10.50.
These companies need a normal yield curve and for months they have been fighting the flat curve forcing them to borrow at roughly the same rate at which they lend, leaving them without a lot of ways to make money. The 2-10 spread* hit 0.12% a month ago (that’s flat) and has now widened to 0.64%, a huge move in just the past few days. One would think that this is good for Mortgage REITs in general and Annaly, as one of the giants in the space, will recover first. It's just a question of when.
*2 yr note to 10 yr note difference in interest rates.
As to New Residential (NRZ), the company was floating along at the $16-17 level just two weeks ago but fell to $10 yesterday, and then today when the rumors were flying about dried up liquidity in the repo markets the stock fell over 50% bottoming at $4.36 before rallying to close at $5.73.
We’ve seen the stock rebound beyond $7 in after-hours trading last night. It now is yielding 23%. Unheard of. Once again, can the company sustain the dividend? If you listen to the conference call of the past week, there appears to be no problem. Book value at the end of the year was $16.20, and the CEO said this at the end of the year: “Book value is understated and the actual book value could be something between $18 and $20 a share.”
There are two ways to invest in this company. 1) Buy the common stock. 2) Buy preferred shares. There are three preferred issues: NRZ-PA, NRZ-PB, NRZ-PC. All are listed on the NYSE and like most classes of preferred stock sell at or around $25 a share. New Residential’s are trading between $10 and $12. Why? Because the markets are in disarray.
We’ve talked to many of our contacts on the Street and one in particular said that this is one of the best gifts he has ever seen Wall Street give us in his professional career. At $10, what was once a 7% yield is giving you an 18% yield . . . and when the stock reaches $25 by 2024-5 when the loans come due, that's a 150% gain on equity invested. Not bad for four or five uncertain years. We can’t guarantee this is going to happen, but we find the concept fascinating.
Oh, one more thing. Several corporate officers and the CEO himself bought stock recently. Here are the details:
- Robert McGinnis, Director – 10,000 shares at $5. 18.
- Andrew Sloves, Director - 10,000 at $5.01 yesterday
- Tyson Alan L. CFO, CAO and Treasurer - 10,000 at $5.01 yesterday
- Nicola Santoro Jr. CFO, CAO and Treasurer - 50,000 shares yesterday at $5.84
- Michael Nierenberg Chairman, CEO & President - 226,000 shares at $15.14; 124,000 shares at $15.51; 920,000 shares at $16.37 – all on March 5.
AGNC Investment (AGNC) has been steady as a rock between $16 and $19 for six months but in two days the stock cratered to $9.70 today after touching $6.25! It’s up after hours over $10. With at $1.92 dividend, that’s 19% with the potential to reach $16 again in the next year, for a total return of 80%. All research that we have done points to survival and even "thrival" (if can become a word.) But seriously, with the US government pouring money into the financial system, we believe that this company will do well in the future.
As how the government will pay back what's soon to be $25 trillion in debt, that’s another story. But we are not fans of Treasury debt right now.
That's huge. It means that enough people are shopping from home that even Amazon is hitting its limit. The warehouses are full. While dealing with all the orders is going to be a strain, it's not a bad problem to have.
And the third-party sellers Amazon is turning away will go to Shopify (SHOP), which surged 10% yesterday. If you want to buy anything but essentials once Amazon runs out of stock, you'll need to go to a Shopify store. Likewise, sellers will need to use Shopify technology to take advantage of this unprecedented online shopping wave. Brick-and-mortar stores are out of key items throughout their supply chains. As third-party vendors step up to meet demand, Bezos has ensured that they'll work with Shopify. After all, if you sell canned food, you already compete directly with Bezos and his Whole Foods operation. Why work with a direct rival if there's an alternative?
So it's nice to see the Retailers sort themselves out. We also have to shout out Dollar Tree (DLTR), up close to 15% yesterday. That company sells the small things Amazon rarely bothers to stock. They'll do well in this environment. As we've said, if anyone is out shopping in physical stores, odds are good that a trip to Dollar Tree is as far as they'll go.
Beyond Retail, we're seeing constructive signs of the economy showing real backbone. The entire Treasury yield curve is now lined up on a normal slope for the first time since the first inversions appeared at the end of 2018. Short-term debt pays low rates. As you move out toward longer-denominated bonds, interest rates rise. That's how the funding market works in a healthy environment. Even if we discount this as a symptom of the Fed's massive intervention in the credit markets, it's a good thing. The Fed is getting what it wants.
And this is a great thing for our High Yield recommendations, which generally depend on borrowing cheap and lending at higher rates. The low end of that transaction is now extremely low, with one-month Treasury bills now paying just 0.12%. The high end remains depressed, but with 30-year bond paying 1.63% there's now a 1.5% differential for Financing companies to exploit. In our view, the worst is over for companies like Annaly Capital Management (NLY). Lock in yields now . . . Annaly has been beaten down to the point where it pays 15% a year.
Finally, we've revised our earnings targets to reflect what could be a significant economic stall in the current quarter. Thursday morning's unemployment claims report will be closely watched. We wouldn't be shocked to see new claims jump from barely 200,000 to 2 million or more. After all, entire Restaurant chains have shut down across the country. In New York City alone, that's up to 900,000 people.
The S&P 500 is currently suffering through another quarter of negative earnings growth, in this case seeing a 4% decline from last year. That hurts, but after a year of flat fundamentals it isn't shocking. Investors are used to it. Moreover, with the Fed cutting short-term rates to zero, there's a lot of room for multiples to expand.
What we've seen, on the other hand, is stocks falling faster than our 2020 earnings target. The market as a whole currently commands a 14X multiple on the profit we expect. That isn't expensive at all in a zero-rate world. And that means there's a reason here to start buying . . . once we see that a 4% anticipated decline doesn't turn into a complete catastrophe. We're watching the government every day. The Senate stalling on the stimulus package overnight will hurt the market mood today, but when we finally see progress, the scenarios get a lot better. Hang in there.