You can still bet the house on mortgage stocks.
Stocks of mortgage finance companies went through the roof over the past year as interest rates fell. Now, some investors are wondering if it's time to pack up their gains and head for the door. But at least one analyst thinks they should stay a bit longer.
"Investors who want to lighten up should become more selective and focus on the large-cap, still attractively valued companies," said
Salomon Smith Barney
analyst Thomas O'Donnell. "The obvious suspects are the usual suspects," he wrote in a report Monday, pinpointing names like
As tech and "other fast-growing stocks are showing life," said O'Donnell, investors are questioning the logic of staying in mortgage finance stocks. And many of them have already posted impressive gains in the past 12 months: Fannie Mae is up nearly 65% in the past year, while Freddie Mac is 53% higher and Washington Mutual has more than doubled. Still, O'Donnell thinks these companies "can produce earnings matching or exceeding expectations" in the quarters ahead.
The force behind the eye-opening gains has been the
campaign of interest rate cuts -- not to mention
anticipation of the cuts that started creeping into the market and the stocks in the last quarter of 2000.
The Fed has slashed rates by 2 percentage points in the past six months in an effort to jolt the economy out of its sharply lower pace of growth. The cuts, which make it cheaper to borrow money, have fueled a surge of mortgage business as buyers move to take advantage of lower rates through both refinancing and new loans.
Clearly at some point the mortgage activity will peak and begin to fall off. The trick is in predicting when that will happen. But as evidence of a slowing economy continues to mount, a number of investors think more rate cuts -- and more mortgage activity -- are on the way. Observers are already eyeing the next Fed meeting on May 15 in hopes of another cut, with bets on the size of the cut running as large as 50 basis points.
"We expect selected stocks in our universe to perform very well in the second half of the year," says O'Donnell, predicting even wider margins at thrifts such as
and Washington Mutual.
Lastly, Salomon highlighted the stocks of a handful of mortgage insurers, companies that protect lenders against default risk. O'Donnell concedes the stocks are "higher-risk" than their plain vanilla counterparts but contends they are undervalued after being pressured by fears about a spike in canceled policies in the first quarter. Insurers including
turned out "eye-popping" earnings by focusing on writing new business, he says. Thus the companies were able to offset weakness from canceled policies with new business, but the stocks don't yet reflect it, said O'Donnell. His target on MGIC is $78. The stock currently trades near $65.