Stop Investing in Stories – Focus on Fundamentals

Bonds, Interest Rates, Real Estate Investment Trusts (REITs)
Alarm clock and gold coins on a table.

Last week I spent a few days on the road with my travel trailer. On those long driving days, I like to listen to CNBC on Sirius XM. That service is the greatest thing ever for road trips, and listening is especially fun when the market is having a big down day.

You would think that business news professionals could be less histrionic, but you’d be wrong.

The discussion had me paraphrasing Dr. Strangelove’s famous subtitle: “How I Learned to Stop Worrying and Love Volatility.”

The recent almost-inverted yield curve and the idea that the Federal Reserve wants to bring interest rates back to normal levels – normal for those of us who have been in the markets for more than a decade – is causing a lot of turmoil in the financial markets.

But it doesn’t have to cause turmoil for your portfolio…

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Rising interest rates cause a lot of market disruptions: they push bond prices lower, make shares of non-profitable companies less attractive, and make home purchases more expensive (which shuts down the mortgage refinancing business).

On top of these disruptions sits inflation, plus a materials and components shortage.

My takeaway from the hours of radio listening is that the investing themes that worked over the last two years have stopped working, and many investors and traders don’t know where to go next.

One guest money manager nailed it by saying investors need to stop investing in stories and start investing in fundamentals.

Mortgage rates and companies are one area where the fundamentals have quickly changed. Mortgage rates have climbed above 5%. Just over a year ago, I refinanced the loan on my house at 2.25%. That is a monstrous move.

At risk are companies that depend on mortgage refinancing and those finance REITs that use massive leverage to turn a small spread into big dividends. But along with losers, there will be winners due to higher mortgage rates.

I could spend half a day discussing the ramifications of mortgage rates vs. Treasury rates and mortgage-backed securities (MBS) pricing. One effect will be to extend the duration of MBS with low coupon rates. The longer expected duration will increase the value of mortgage servicing rights (MSRs).

One company that will benefit is New Residential Investments (NRZ), which owns full servicing rights on $158 billion of unpaid mortgage balances and excess servicing rights on $81 billion of balances. MSRs are one-quarter of one percent per year. The recent rise in mortgage rates means the MSR cash flow stream will last much longer, increasing the value of those MSRs.NRZ currently yields 9.6%, and I expect up to a 20% dividend increase this year. And that’s just one stock in my low-risk, high-dividend portfolio in The Dividend Hunter. Today, you can get access to the full portfolio and a strategy that can turn just $25,000 into a lifetime of income. Click here to get started.

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