When interest rates rise, my basic understanding is that the value of the underlying mortgage securities will decrease. It also seems that the current PPS of mReits trade partially on the BV. Thus people have been implying that when QE starts to taper off the BV will get hit and there will be a sell off. To counter this, the net interest spread should widen and hopefully the dividends would increase.
But, it seems that before all of the QE’s the PPS of the mREITS were higher. So, my question is how were these valued before QE? How could the PPS be higher if the BV was lower (for example NLY was between $16 and $18 from 2002 – 2005)? Does this imply there would be some short term pain as people don’t understand that the mReits are in better shape without QE?
Reported book tracks almost exactly with RMBS prices, which seems quite logical. Taking into account for the tax selling that probably occurred at the end of 2012, the stock price has pretty consistently been above book by about 10% or so. If QE were to suddenly end and interest rates rose sharply, book value would be decimated and the stock price will drop. If QE is likely to continue at a reasonable rate, book will be sustained and the stock price will probably rise by almost 10%. According to comments made by Kain, he doesn't expect QE to be materially diminished before the end of the year.
When interest rates went down, and book values went up, originally investors thought it was good and increased the prices for reits. Then when it sunk in that the lower spreads would hurt the dividend, people sold off reits, dropping the price. I expect the opposite to occur when interest rates rise... an initial sell off due to the lower book values and then a move to the upside as the market realizes the higher spreads will mean higher dividends. Buy after the drop when interest rate fears arise.