What happened
Standard & Poor's has selected mortgage investment company Annaly Capital Management (NLY 1.69%) to join its MidCap 400 index. The news is drawing new interest to Annaly stock, sending the shares up as much as 6% on Tuesday morning.
So what
Annaly is a mortgage real estate investment trust (REIT), a company that invests in mortgage-backed securities. The company makes its money via principal and interest repayments as servicing rights, another name for the administrative task of collecting payments and managing the loans.
A decade of low rates has made for a difficult environment for Annaly, and the shares are down more than 60% over the past 10 years. But with the Federal Reserve indicating that it is winding up its long-running rate-tightening cycle, investors have taken a fresh interest in Annaly as a way to benefit from higher rates in the future.
On Friday, after markets closed, the index division of S&P Global announced Annaly will be joining the S&P MidCap 400 index. Annaly and Dynatrace will enter the index, replacing American Eagle Outfitters and Minerals Technologies.
Stocks tend to get a boost when they are added to an index because mutual funds that track the index are required to add the stocks to their portfolios, creating buying demand.
Now what
The index inclusion is providing a short-term boost for Annaly, but it is going to take Federal Reserve action to make the long-term bull case for the stock a reality.
The Fed, as part of its unwind to fight higher inflation, is scaling back its purchase of mortgage-backed securities, ending a policy that has created artificial stress on the market in recent years. Analysts had been expecting the departure of a major buyer to put downward pressure on asset prices, though a decline in new supply due to a slowdown in mortgage applications could help to offset that pressure.
NLY price-to-book value. Data by YCharts.
The real issue with Annaly shares is valuation. The stock trades today at a higher premium to its book value than at any point in the last 10 years. Historically, the stock has worked out best for investors when purchased at or below book. Given the valuation, investors should be careful buying in here on the index inclusion.
