With the latest labor reports and signs that the economy is recovering there has been a lot more media focus on the fact that the Fed will scale back or stop its quantitative easing sooner, ex. late this year, rather than later, ex. late next year. So I wanted to open the discussion regarding the good and the bad of interest rates going up, the effect on the prices of mREITS and the potential strategies to protecting ourselves.
The good (as I currently see it):
There is a chance of increase in spreads
There will be less prepayments
The bad (as I currently see it):
Book value decreases
The yields increase too fast and the mREITS can’t take advantage
Investors will sell mREITS and move to more stable income producing alternatives that benefit from the increasing yields
The possible effect on prices:
I would suspect to be some sort of panic or herd mentality selling as rates rise so a short term sell off would be in order. But over the longer term if the mREITS can take advantage and increase the dividend then that should stabilize and potentially increase the price over the longer term
Strategies to protecting ourselves:
Purchasing long term puts, probably a year or so out
I’m interested in hearing people’s opinions and possible strategies.
How are you doing Hgft101/HXH? Love the three post history and the moniker "Tell" with the.. (well I won't tell...;-))
"Strategies to protecting ourselves:
Purchasing long term puts, probably a year or so out"
I don't think you understand the premiums which comprise the price of the Leap Puts, especially in the high yield stocks. Take the 15Jan35Put as an example at ask 11.40. Why does it cost 11.40 if the 35 strike is only a little over 2.00 ITM?
The reason is that it has every dividend between now and then built into the premium you are paying or 8 dividends(10.00). So you are paying two years worth of dividends when you purchase that option. The PPS would have to be 35 - 11.40 or 23.60 before you started to make money at 15Jan OPEX.
Instead I would sell or short that 15Jan35Put and buy the 15Jan25Put for a 7.00 credit spread. Your max risk is 3.00 at 25 or lower at OPEX. Max profit is 7.00 at 35 or higher. If you truly think we will see less than 24 by 15Jan then go for the purchase. Realize that 85% of Long Put purchasers lose money, as this would at any PPS above 24.00.
Doc...sorry to say I am someone who lurks the board and rarely posts and I don't know who Hgft101/hxh is?? But I am familiar with your strategy and was just trying to look for other ways to try and protect myself without putting out much money. The stampede out of these stocks can be sudden and I don't want to caught with my pants down. But I hate paying so much for those Puts....especially when like you said 85% of them exipre in a loss position.
Or I'm just trying to understand if my current way of thinking is correct. For example it seems from other posters that the big risk is how fast these rates increase. So how would one define a fast increase? What "tells" should we look for and follow to try and stay ahead of the crowd?
It all has to do with how fast they raise rates. If they do it quickly then mREITs will start to lose money and some may even go bankrupt. If they do it slowly then mREITs will start losing money on older loans but they will make money on newer loans and that will compensate for it to some degree. My guess is the average spread will decline until enough of those older loans are off the books that they are no longer a drag. However, who is going to give up their 3% loan unless they are moving? People will get seconds and hold on those low rate loans as long as they can. In fact, if interest rates go up enough, they will be making more on their savings account than they are paying on their home mortgage which would mean they would have to be lame to pay off their home loan. many of these loans may be on the books for their entire 30 year term. That is a concern if you are a mREIT and you are paying more interest to the Fed than the interest you are getting paid.
The way I see it, there will be a period of a few years when average mREIT spreads decline and thus the dividend declines. I could be wrong, but that makes logical sense to me. This of course is all speculation on my part. Some may understand why my description is too pessimistic because of some factors that I have not considered. I would welcome hearing those points of view.
I think spreads are increasing a little as we write this. Most important, I think, is that there is no sign that the rates will increase too fast for the MREIT's to adjust, and there is no sign that this will change in the near future. I'm not worried at this point because I think we can spot a change in time to adjust our portfolios.
All that yappin'....
not a word about a balanced portfolio. As to new money verses old money. As long as the spo machine works, which is several points away, as long as div. Is close to double digits....green. Benji ain't gonna collapse the inflatable market. As all know the big banks..and ib's all need to get normalized performance and savings rates are a joke as is cd's. Go agnc. Go hts. Boooo cim. And the paid posters club....boo....
fear mongers don't benefit longs. Neither do those exploiting this board to pump quick trades. Pumping their book. Sad. and quite weak.
you are exactly correct. it has everything to do with how fast rates go up.
as an example, if mortgage rates went to 5% tomorrow, we would get such a shafting. if it took 12 months, not so bad. even in a period of rising rates, there are prepayments, which would wipe out some of the capital loss, and free up funds to purchase new, higher spread securities.
FWIW, i see the Fed eventually making moves that put the fed funds rate at 0.5 to 0.75% naturally. meaning without intervention. other rates would follow. not so much tightening, as a lack of additional easing.