This series , brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, Wall Street gives the thumbs up to United Parcel Service, Inc. (NYSE:UPS), but then turns pessimistic and downgrades two popular mortgage REIT stocks — ARMOUR Residential REIT, Inc. (NYSE:ARR) and American Capital Agency Corp. (NASDAQ:AGNC). Let’s tackle those in reverse order.
Analysts at investment banker Sandler O’Neil cut their ratings on two of the nation’s big mREIT shops this morning, advising investors to sell both ARMOUR Residential REIT, Inc. (NYSE:ARR) and American Capital Agency Corp. (NASDAQ:AGNC). Details on the precise reasons for Sandler’s downgrades are hard to come by … but it’s not too hard to guess.
Over the past year, shares of ARMOUR are down 45%; American Capital Agency Corp. (NASDAQ:AGNC) has lost 35% of its value. And while it’s true that both stocks pay extremely high dividend payouts — 20.8% at ARMOUR Residential REIT, Inc. (NYSE:ARR), according to S&P Capital IQ, and 17.7% at American Capital Agency Corp. (NASDAQ:AGNC) — that’s small comfort to investors. The declines in values of the underlying shares have been so massive as to wipe out any profits from the dividends, entirely.
Meanwhile, concerns continue to grow that the Fed is looking for an exit from its $85 billion monthly bond-buying binge. Interest rates on 10-year U.S. Government Treasury Bonds hit 2.9% not long ago, and according to some pundits, the Fed could decide as early as this week to begin “tapering.”
This could all be very bad news for mREITs like ARMOUR Residential REIT, Inc. (NYSE:ARR) and American Capital, as fellow Fool Boniface Mirigu explained in a column just last week. Because mREITs obtain their financing from short-term borrowings, any increase in short-term interest rates takes a bite right out of their profits, by increasing their costs. So what Sandler is suggesting is that if you think the news has been bad for ARMOUR Residential REIT, Inc. (NYSE:ARR) and American Capital Agency Corp. (NASDAQ:AGNC) so far, just wait and see what happens when interest rates really start spiking …
Or rather, don’t wait. Get out now, before it’s too late.
That actually sounds like good advice to me. And yet, investing based largely on what everybody expects the Fed to do, which is what Sandler seems to be counseling, has its own risks. For example, just over the weekend, we learned that Larry Summers — who had been expected to favor an early tapering of Fed bond-buys — has withdrawn his name from the contest to replace Ben Bernanke as head of the Fed. Now the odds seem to favor Janet Yellen, whom the Potomac Research Group now calls “the clear favorite” to replace Bernanke, and who is believed to be “significantly [less] aggressive” about tapering than Summers would have been.
Long story short — no one really knows who will end up running the Fed, or what they’ll do when they get there, or what all of this portends for ARMOUR Residential REIT, Inc. (NYSE:ARR) or American Capital Agency Corp. (NASDAQ:AGNC). Then again … that uncertainty alone might be good reason to shy away from the stocks.
