Annaly Shareholders Could Be in for a Treat

NEW YORK (TheStreet) -- The cracks which appeared in overseas equities markets and a multitude of peripheral carry-trade currencies blow-ups presages trouble and a reversion back to the so-called 'risk-off' trade. Therefore, and as per my model, Annaly Capital Management (NLY) is poised to benefit from the anticipated drop in yield of the bellwether 10-year Treasury note.

Though there are several facets to Annaly's fundamental analysis, such as the steepness (and rate of change) of the yield curve, and management's ability to negotiate the curve, et cetera, none is more important to the outlook for the price of Annaly than the yield of the 10-year Treasury note.

We must assume, unless shown otherwise, management is competent in their function to execute their model. There is nothing esoteric to the Annaly model; it becomes a matter of execution and a 'bet' by investors on a continued Fed's interest rate policy of a low-yield environment.

In my article of Jan. 8, I outlined my thesis for a bullish case in the share price of Annaly, which included a retreat from the 3% to 3.125% Maginot Line stamped as the Fed's demarcation in the rate of the 10-year Treasury note.

A rebound in prices (lower yields) from the line indicates a Fed still in control of interest rates; and a sustained move above the line indicates a Fed that's lost control of rates, with the latter instance leaving investors of Annaly vulnerable to a loss of asset value and/or dividend payout.

Moreover, I inferred that the Fed and the Bank of Japan would coordinate swaps activity between the two central banks during the $10-billion-per-month 'taper' period.

Though I've received email from readers refuting the notion of Japan's ability to cooperate with the Fed, below, we can see the chart showing the Bank of Japan's rapid increase in holdings of Treasuries as the yield on the 10-year moved back up to 2.5% from record lows reached in March/April.

From the graph, we can see the Bank of Japan trying to keep pace with the decline in the U.S. dollar by selling yen and buying dollars.

At the close of June, Bank of Japan holdings of Treasuries amounted to $1.083 billion. By the end of November, BOJ holdings of Treasuries totaled $1.186 billion, an increase of 9.5%, or a CAGR of 19.9%.

Not only did the Bank of Japan demonstrate its willingness to buy Treasuries during the 10-year note sell-off, it bought at a rate of $20.6 billion each month throughout the five months of the shopping spree, more than double the $10-billion-per-month Fed 'taper'.

Though NLY had bottomed out in anticipation of the December FOMC meeting, shareholders suffered during the rise in interest rates that began in May; but central bank ammunition is on the way to reverse the damage, enough to lift share prices higher from today's $10.42.

First Japan, Now More Central Banks Will Line Up For Treasuries

It's "Deja Vu All Over Again," say Citi FX Technicals analysts. In a communique to clients, released in late December, Citigroup Forex analysts suggest that, contrary to a slew of articles predicting higher interest rates in 2014, lower rates will instead be upon us due to a projected global recovery that won't materialize.

The lead up to the Fed decision to 'taper' in December sent bond yields to the line in that month, creating an unwinding to the carry trade in overseas markets in anticipation of the Fed's intention to make good on its threat to taper, which was predicated on its forecast of a U.S. economic recovery.

However, data coming out of the U.S., Europe and Asia strongly imply that the global recovery is not intact; in fact, it's the opposite, said Citi, and stated it has "concerns with respect to the global economic backdrop" underlying a rise in interest rates.

We "see one last move higher in the 10 year yield over the next few days, potentially as high as 2.95% to 3.00%," stated Citi. "However, such a move would, in our view, likely be the medium-term top and if history is any indication, a move lower in yields from there would be likely . . ."

Especially given the recent sell-off in stocks and rally in Treasuries, it appears that the so-called 'risk-off' trade is back on. Treasuries appear to be back in vogue as investors anticipate a continuation of the correction in global equities that began on the first day of trading in 2014.

Citi targets an initial move back to the 2.5% level on the 10-year Treasury, but "a break below there would confirm the pattern, which would then target just below 2.00%," it added.

From the chart, below, correlation analysis demonstrates a near-perfect negative correlation (-0.96, see bottom section of chart) between the 10-year Treasury yield and Annaly.

If Citi is correct, and I believe it is, Annaly and 10-year Treasury yield could cross at approximately $12 and 2.25%, or 15.1%, sometime during the first half of 2014. And that's atop a 11%+ annual dividend yield!


Forecasts made by many of the Wall Street firms of higher interest rates in 2014 may turn out to be grossly premature at this time. The global equities market sell-off and Treasuries rally may be a beginning of a trend back to lower equities prices and interest rates. Lower rates provide a strong tailwind for the share price of Annaly.

However, the wild card in this assumption is the Fed and its FOMC meeting policy statement scheduled for Thursday, and another one March 20. If the Fed announces a reverse of its taper program, or strongly hints of a reversal between meetings, Annaly could begin another sell-off.

Traders may want to mark 2.5% on the 10-year Treasury as a target rate and assume that the run in lower rates will have been nearly exhausted.

At the time of publication the author held no positions in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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