WARNING: These Stocks Will Crush You (Strong Sell)

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Log in to your brokerage account… Call your broker… Request a plan prospectus from your pension administrator… Jump online and review the holdings in your "target retirement" funds, ETFs, variable annuities…

Do whatever it takes to find out – today – how much exposure you have to real estate investment trusts (REITs), and mortgage REITs in particular.

Then get rid of as many of them as you can.

The Market Vectors Mortgage REIT ETF (MORT) is down 24% in less than five months. And a number of its components are down more than 30%.

But it's going to get worse. A lot worse. And that's why I'm issuing a warning, because practically every "properly diversified" portfolio in America cashes these REIT checks.

Many people depend on them.

This is dangerous, especially when two of the most widely held mortgage REITs also happen to be two of the worst.

To be sure, aside from the one (big) exception you'll see today, a longtime high-yield darling is about to get crushed…

The REIT Spoiler

You can pin this one on the U.S. Federal Reserve, too…

Thanks largely to its pernicious tinkering of monetary policy – first via artificially low interest rates and then via direct injection of capital into the financial system to the tune of $85 billion per month of direct bond buying ($45 billion specifically spent on mortgage-backed securities) – the Fed has created an environment in which interest rates are destined to rise.

In fact, the mere mention by Ben Bernanke back in May that the Fed will soon "taper" its bond-buying program now has caused interest rates, as measured by the benchmark 10-year Treasury Note, to rise to their highest levels in more than two years.

With the biggest buyer moving out of the market, MBSs are sure to take a hit. Moreover, the pace of rate increase has been anything but subtle, with the 10-year yield spiking to 2.90% – a 40% jump in three months.

Because mortgage REITs generate income by essentially borrowing money at short-term rates and then investing in higher-yielding MBSs, any significant increase in the cost of borrowing can devastate mortgage REIT book value.

And they're about to lose their safety net…

As the Fed has basically, and repeatedly, told the markets that tapering is a fait accompli, it means that the buyer of last resort for MBS is about to remove – or at least slowly pull back – the MBS safety net.

Adding more uncertainty to the mortgage REIT equation is so-called "agency risk."

The current debate over the fate of mortgage-related agencies Fannie Mae and Freddie Mac, and the future limited role these embattled agencies could play in the MBS space, also has caused the smart money to jettison mortgage REITs.

Two of the worst mortgage REITs to own right now also happen to be two of the most widely held ones, and they are Annaly Capital Management Inc (NYSE: NLY-C) and Two Harbors Investment Corp. (NYSE: TWO).

In the case of Annaly, the fund invests primarily in MBSs guaranteed by Fannie and Freddie, so it's little wonder why the exodus from this fund has sent NLY cascading some 25% over the past three months. As for Two Harbors, the spin-off of its equity-REIT Silver Bay Realty operations in May turned it into much more of a conventional MBS play. The market saw this, got spooked, and the result was a 20% smackdown over the last three months.

So, are there any REITs that still are okay to own these days? The short answer is yes…

Join the conversation. Click here to jump to comments…

  1. Edouard d'Orange | August 28, 2013

    Specific and reasoned investing advice. Outstanding, because you don't find this analysis anywhere else, unless you're willing to pay a lot.

  2. Dom Brunone | August 28, 2013

    While I appreciate that long interest rates will rise, the Fed will be holding short rates pegged pretty much where they are now for the foreseeable future. Under that assumption, mortgage REITs, which borrow short to lend long, should have their spreads widen, enhancing profits.

    What am I missing?

    • Robert in Canada | August 29, 2013

      You are correct Dom. That's how mortgage REITs work.

    • H. Craig Bradley | September 15, 2013

      TROUBLE WITH RATE INCREASES

      The FED can not possibly hold down short rates as long rates increase for very long. The market won't tolerate it. Initially, the national debt will cause rates to go up, not inflation. So, you should expect short term rates will move up dramatically in the next 2 years, as they did in the 1970's, the last time the FED flooded the economy with cheap money and low interest rates. Remember, we had stagflation and a flat stock market for 10 years. You could hardly make any money.

  3. Robert in Canada | August 28, 2013

    This article is misleading. This is so typical of news writers trying to get attention by making sensational baseless non-factual claims.

    The fact is most REITs own buildings (but not the businesses that occupy the buildings) and lease their buildings out on a triple net basis with rent re-sets built into the leases.

    Triple net leases allow the REIT to increase rents they charge when costs such as property tax and mortgage rates increase.

    So most REITs will be able to increase rents that they charge to tenants as and when mortgage rates go up.

  4. Andy Schuck | August 28, 2013

    This smacks of JP Morgan manipulating the gold markets, shorting them like crazy and then going long at cheap prices that they drove down. So this reporter jumps on the bandwagon and spreads the crap around…..ignore it

  5. Brian | September 4, 2013

    The writer ASSumes that the Fed will taper, but there are plenty of writers saying the opposite, and providing good arguments for it. Charles Schwab recently gave NLY a strong buy recommendation, so, who are you going to believe?. I've acted on advice from Money Morning Newsletter before and got burned.

    • David Zeiler | September 4, 2013

      Brian,

      We here at Money Morning aren't always going to be right. No one is right all the time. But we have a pretty darn good track record, and a lot of folks have made a lot of money following the advice of our experts.

      -Dave Zeiler

      • Brian | September 4, 2013

        To improve your track record, I suggest dropping Garrett Baldwin, one of your alleged "experts.".

      • Dolores | September 4, 2013

        I'm with Brian. In the last month, I've bought 10 stocks recommended by Money Morning and right now 6 of them are in the red. The other 4 are just barely in the black including NLY. I've become very skeptical about the recommendations that are made.

        • David Zeiler | September 4, 2013

          @Delores: We've advised AGAINST buying NLY several times in the past few months here at Money Morning.
          Some other points:
          Money Morning is a free financial news site, which means the stocks we suggest are a starting point for investors to then do their own research. Buying stocks based on what you read in a single article, whether it's on Money Morning or anywhere else, is not sound investing strategy. That said, we try hard to make worthwhile suggestions based on our research.

          We also recommend that investors minimize inevitable losses by limiting how much money they put into any given investment, and by using trailing stops of 25%.

        • H. Craig Bradley | September 15, 2013

          MAKING MONEY: ITS A JOB LIKE ANY OTHER

          Pundits can recommend almost anything to readers in general because they do not have a client relationship with individual readers. (No accountability). Suitability is of no real concern. Neither are outcomes if they are wrong. Besides, if they knew the next big hit, they would be sipping wine in the Bahamas by now, not pounding out newsletters for years and years and making trades using their proprietary software or methods.

  6. Jeff | September 6, 2013

    Most mREITs dropped in the first part of May 2013, so this Robert Hsu is 4 months late if the Fed lets rates rise. If the Fed does not keep rates a low as it can, event if it goes up by a tenth of a percent $17,000,000,000 * .001 = an extra $17,000,000 cost to tax payers. Why would the Fed destroy the U.S. economic recovery? Also the unemployment rate is not calculated correctly at the "U3" number, the "U6" number is closer showing the real picture. In conversation with Jeffrey Sacks we think that the U.S. economy will never recover because of the dark problem of the "lower wage job cancer" has hit the U.S.

    • H. Craig Bradley | September 15, 2013

      CATTLE

      Its not so much the "low wage job cancer" (or part-time prisoners) you speak of or the underclass ("White Trash") that it often breeds (growing like a weed). No, its all the mindless or mushy-headed nitwits who are essentially one trick ponies who can only do one function at best. Beyond that, they are just consumers and takers in a service sector based economy.

      The lower classes also tend to have high birth rates, insuring that they will eventually overpopulate society with their low I.Q. babies who become fodder for the international banker class to control and dominate (cheap labor) as they please.

  7. Kevin Jones | September 9, 2013

    The yield on MREIT's says the market does not believe they have a sustainable business model, at least at current valuations. It is not only the damage to be done by rising interest rates but that damage will be magnified by the leverage these companies employ. In my opinion that leverage is enough to wipe out the equity in a lot of companies.

    High Yield = High Risk – what do investors not understand?

  8. H. Craig Bradley | September 15, 2013

    REIT WITH A MONEY BACK GUARANTEE ?

    Vornado Reality Trust only pays a 3.5% dividend. What is so great about that compared to a utility or other fixed-income stream "dead money" investments? Surely not just the ability to get your money back.

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