Insiders can't get enough of mortgage REITs

In the continuing search for new ideas, I've stumbled onto an industry-wide insider buying of mortgage REITs (AGNC, TWO, WMC, AMTG). These companies, which borrow short term to buy long term mortgage-backed securities, are in effect leveraged mortgage lenders/banks. They are an implicit bet on the steepness of the yield curve, namely that short term rates (<1 yr) remain (much) lower than long term (mortgage) rates (5 yr+).

Such companies have existed since 2009 or earlier and more have since spun-off and/or gone public in recent years. They have fantastic yields (in 2010, AGNC was yielding 20%+, 16%). In the search for yield, they are near the top in outright securities that retail investors can buy. This is of course not without danger, as seen near last year's rise and fall with the announcement of QE3:

The prevalent fear is that QE3+ will crowd out private investors and reduce the spread above (and therefore dividend). The subsequent fall, however, has given way to mass insider buying.

Perhaps with QE 3+ already announced, the maximum effective of the fed has already been discounted and it only leaves the spread to remain wide? Indeed, wouldn't any Fed unwind start with QE reduction, allowing long term rates to rise before short term?

Of course, the implied leverage, funding requirements are just a few of the risks that can weaken this investment. What do you guys think?

Disclosure: long AGNC, TWO, WMC, AMTG

Why it might be time for long-only (again)

It seems like short selling in the face of the bull market continues to confound even seasoned short-sellers. Einhorn's GMCR jumped over 74% in the last part of 2012, while HLF is now higher than Ackman's announcement.

In this context, and taking the premise that a 90s-style bull market is in the making, is it time for funds to drop the short in long-short equity investing? Given the pent-up demand that has finally started shifting towards equities (note the large inflows to equity mutual funds, the first time in years), will idiosyncratic bear theses simply be overrun by investors chasing the next best thing?

I point out the easy finds are not so easy now:

-Negative fcf (a la GMCR), run over by revenue gains
-Insider selling in the form of unusual secondary offerings (NOW, SPLK, PANW), only get more expensive and have acquisition risk.
-China frauds (FMCN, QIHU) - these are very heterogeneous, but governments and indeed officers have wised up and simply obfuscate harder.

In addition, many of the shorts left are either very crowded or are in fundamentally growing industries. (e.g. Zillow may be a boiler-room selling operation, but still has a housing website that can catch on).

Perhaps one remaining area are the industry declining areas (HPQ), here we find extremely cheap valuations based on the past and take the risk that these companies find a new growth engine.

Disclosure: I have covered all shorts but iron-ore related ones, but may trade in/out later.

Tight oil & USA's new oil renaissance

NPR had a great piece about the impact of tight oil discoveries (e.g. the Bakken formation) and just how much it has changed the energy landscape in the USA. In short:

(credit to NASA/NPR, link above).

The new gold rush has literally lit up the countryside so much that it can be seen from space. What drove such a boom in oil production that the International Energy Agency is now predicting that US production will surpass Saudi Ariabia's by 2017?

In a word, fracking. The same new technology that was all the news in natural gas has been applied (along with horizontal drilling) now to oil-bearing rocks that were previously inaccessible (such as the Bakken Formation).

This resulted in the out-performance of US (midcontinent) refiners, which have cheap access to such crude oil and can sell product at wider margins in the world market:

Yet, wti crude still remains around the 95$ level - a discount to the european/world brent oil prices, but still higher than say in 2006. But, not being an expert on this, does crude oil run the risk of becoming the next natural gas?

Three topics for Chanos

Given the nice start to the new year we've had, I felt it only proper to highlight shorting, specifically with a interview by Jim Chanos which covers his career, the psychology of shorting, and China (July 2012):




Chanos began in 1980 working as an investment banker, working for a Blyth Eastman Webber. As many on this site are well acquainted with, he spent his days on the deal team, making pitchbooks and modeling companies. He then left to join a brokerage firm and eventually did research at Deutsche Bank before being fired and launching Kynikos Associates.

On the psychology of shorting, Chanos believes that the while the skillset for analyzing companies is the same as the long side, the psychology is vastly different. Bringing up a "positive reinforcement cycle" and the associated noise, he notes that because wall street is positively-biased, short sellers face a constant barrage of criticism. Most people psychologically cannot reason competently (or want to) given such stresses, and are therefore unable to successfully (profitably) short.

On China, Chanos explains that his thesis starts from a micro (stock-specific) perspective and only then leads to his overall thesis for China. Starting from commodity producers who were making record earnings during the financial crisis to high rise construction in China, Chanos explains the government/power chain.

Finally, here's an article on some shorts he's looking at for the new year.

MLM Pair Trade (HLF, USNA)

The Herbalife battle is now in full swing, with many well-known managers opposing an-equally well-known Ackman of Pershing Square Capital Management.

I now posit a biased-pair trade (long HLF, short USNA in slighly larger size) to take advantage of arguments on both sides.

Ackman has described HLF as the "best-managed pyramid scheme in the world" - so what is the worst? I believe a good candidate is USNA (Usana Health Sciences), whose distributors are actually going to jail because of employment at USNA.

The fundamental thesis is that any enforcement action that affects HLF will affect USNA even more, although there is no guarantee of either (USNA is far more dependent on China and the catalyst is there).

The best case scenario is that USNA is shut down (by Chinese authorities) or simply slows growth significantly, while HLF squeezes Ackman out of his short simply through robust operations & lack of US enforcement. In the meantime, the daily swings are limited because both are Multi-Level Marketing companies (MLMs).

TEA - Post Trade

Looks like I was wrong on Starbucks' acquisition of Teavana Inc. (TEA). Despite Glaucus' report that Tevana's product contained high levels of pesticides and potential federal liability, SBUX completed the acquisition. 

The key point seems to be this (from a SBUX presentation):

Notice the focus on the store, not product. SBUX may in fact have been more focused on the distribution/locations of TEA. Regardless of the underlying product, SBUX can simply replace the products on the shelves - after all, SBUX is not known for having the best coffee, but rather the easier place to get consistently decent coffee nearby.

This presentation may have well been the turning point, when Howard Schultz, the CEO publicly affirmed the acquisition:

As a result, all the arbitrageurs got up to a 100% annualized return when the deal spread widened after Glaucus' reports.

This may indeed highlight the danger of shorting deals in general - the "truth" (e.g. TEA's pesticides) is less important than the actors/motivations involved.