Like much of the rest of the stock market, January was a strong month for mortgage REITs. Investors in REITs are generally interested in the whopping dividend yields these companies have to offer, but they sure don't mind capital gains. On average, shares rose 8% last month.
January Price Change
|Two Harbors ||16.1%||7%|
|American Capital Agency ||19.1%||5%|
Part of the gain likely had to do with investors' increasing comfort with owning stocks in general. REIT valuations had been cheap lately, and the rise in shares partly reflects a return to more normal valuations. Chimera, Invesco, and Two Harbors, like many REITs that invest part of their portfolio in non-federally guaranteed mortgages, have been trading at particularly cheap valuations lately due to turmoil in credit markets. But REITs also got a bit of important news in the last month that all investors in every mortgage REIT need to be aware of.
In January, the Federal Reserve announced that it expected short-term interest rates to remain near zero through 2014. Low short-term rates have been one of the key drivers of the enormous profitability of mortgage REITs in recent years because they reduces REITs' cost of funding, juicing their interest rate spreads and dividends.
The content of the Fed announcement shouldn't have been surprising; unemployment is still high and core inflation is unlikely to rise much while the economy remains in a liquidity trap. Nevertheless, there are pundits and Fed board governors out there who consistently warn about a looming wave of inflation no matter what the circumstance may be. So investors were reassured to hear that the end date of the mortgage REIT dividend bonanza may be pushed further out.
Still, I don't think the Fed announcement is unambiguously good news for REIT investors. To the extent that it's another indication the Fed is getting more serious about tackling unemployment and boosting economic growth, it brings us one step closer to another "Operation Twist" or QE3 to lower long-term interest rates. Unlike falling short-term interest rates, which reduce REIT costs, falling long-term rates reduce REIT income.
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Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.