2023-07-07 06:25:00 ET
The American economy is doing modestly well. On Thursday, data by ADP showed that the country’s private sector added over 480k jobs in June. Additional numbers on consumer confidence and housing have shown that the economy is firing on all cylinders.
On the other hand, the bond market is slowly warning about an impending recession. The yield curve has inverted to -1.08, the lowest level in decades. Historically, a yield curve inversion leads to a recession.
US bonds are also having strong yields. The 2-year yield jumped to over 5% on Thursday, the highest level in over 16 years. Similarly, the 10-year and the 30-year jumped to 4.1% and 4%, respectively. In this article, I will look at Annaly Capital (NYSE: NLY), one of the best-known mortgage REIT companies in the world.
Yield curve inversion
What is Annaly Capital?
Annaly Capital is a Real Estate Investment Trust ( REIT ) with a twist. Instead of owning buildings, the company invests in mortgage-backed securities that are backed by the government or companies like Freddie Mac and Fannie Mae.
It then uses significant leverage to boost its rewards. By using this leverage, the company tends to be highly affected by high-interest rates. These rates have moved from 0% in 2022 to over 5% today. And with the US economy doing well, analysts believe that the Fed has more rates to hike.
Most of Annaly’s business is in its agency segment. It also provides Mortgage Servicing Rights (MSR) and residential credit.
Most people who invest in Annaly Capital do so because of its high dividend. While the company has slashed payouts several times, it has a 24-year record of delivering to shareholders. Its forward dividend stands at over 13%, which is higher than what the bond market is offering.
There are better alternatives
I believe that Annaly Capital Management is not a good investment for three main reasons. First, for my retirement funds, I prefer making investments that allow me to sleep well at night. Annaly is not one of those. For one, some analysts have questioned its business model.
Second, while the company has an impressive dividend yield, its total returns have been significantly weaker than other popular funds. As shown below, Annaly Capital stock’s total return in the past ten years stood at 37.61%. In contrast, JEPI had a total return of 41% while SPDR S&P 500 ETF and SCHD had 215% and 190%, respectively.
Past performance is not always a good indicator of future performance. However, in this case, a comparison going back to decades shows that Annaly Capital has underperformed the broader market.
Finally, I expect interest rates to remain high for a while since the country’s economy is doing well. This means that Annaly will need to keep buying more MBS in a high interest environment. It can also not dump most of the assets it bought when interest rates were near zero. The chart
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