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Why the Rally in Mortgage REITs Isn’t Just a Fluke

By Amanda Alix - Nov 19, 2012 at 10:27AM

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Mortgage REITs rallied on Friday -- and chances are good that it wasn’t simply happenstance.

Mortgage REITs have been on a rollercoaster ride since the presidential election, as a multitude of issues that lurked on the political horizon surged closer, threatening the sector's future. After a fairly depressing week or so, however, a rally was clearly in effect on Friday. Was this some kind of market glitch, or are investors finding their faith being restored in mREITs?

It may be a little early to tell, but, for the record, here's my take: The rally was no accident, and it is sustainable. There is good reason to believe that the sector will handily survive the next year or two, and here are a couple of indicators that point very clearly in that direction.

A thoughtful analyst upgrade lifted all mREIT stocks
Timely upgrades, courtesy of Wells Fargo ( WFC 2.95% ), certainly didn't hurt the mortgage REIT sector. Wells boosted Annaly Capital ( NLY 1.32% ), Hatteras Financial (NYSE: HTS), Invesco Mortgage Capital ( IVR 1.31% ) and Capstead Mortgage ( CMO ) to Outperform from Market Perform on Friday, and all three saw a rise in their stock prices of between 4% and 5%.

Wells Fargo is only one of many analysts, of course. Also, as others have noted, Annaly in particular has been scrutinized by a handful of ratings agencies lately, largely because of its announced bid for CreXus Investment (NYSE: CXS). However, Wells' note was the most recent, and it focused on the entire sector, even as it upgraded each individual company.

What I found most intriguing was the commentary itself. Wells touched on each of the most recent headwinds facing the industry -- the possible replacement of Federal Housing Finance Agency head Edward DeMarco, fiscal cliff issues, QE3 and the specter of QE4, to name a few -- and still saw its way clear to upgrade these companies. Not only that, but the firm considers the entire sector oversold and a historic bargain at about 0.88 book value.

In other developments, notable insider buying has occurred of late at Annaly. Its chief operating officer purchased 10,000 shares at $13.25 on Election Day, and the chief technology officer bought 15,000 for the same price -- double the number she picked up back in September -- on Nov. 14. But the biggest buyer was the company's president, who loaded up his plate with 100,000 shares purchased at $13.90 apiece just this past Wednesday.

What does it all mean?
It seems clear to me that Wells, in addressing in its analysis all the problems facing mREITs, is essentially pointing out that what is known can be dealt with. If these issues were insurmountable, why would the sector be such a bargain? Wells sees the recent price drops for what they were -- panic selling, which has now abated.

As for Annaly's insider buying, it's hard to imagine that these executives expect the company to take a nosedive any time soon. Making such a large investment certainly can be taken as a sign that Annaly's president is looking to make some money from the company -- providing a fairly concrete reason for investors to believe.

After a few days of uncertainty, it appears that investors are now seeing the forest for the trees. For those who want the big dividends right away, mREITs may not be able to deliver for a while. But investors who understand the value of waiting out the tough times are staying put, and perhaps picking up some bargains.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
$8.46 (1.32%) $0.11
Invesco Mortgage Capital Inc. Stock Quote
Invesco Mortgage Capital Inc.
$3.10 (1.31%) $0.04
Wells Fargo & Company Stock Quote
Wells Fargo & Company
$50.25 (2.95%) $1.44
Capstead Mortgage Corporation Stock Quote
Capstead Mortgage Corporation

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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