Two ultra-high-yield dividend stocks with yields above 12% that are ideally positioned for a rate easing cycle
One of the best things about putting your money to work on Wall Street is that there is no one-size-fits-all investment approach. With thousands of publicly traded companies and exchange-traded funds (ETFs) to choose from, there is sure to be one or more securities that can help you achieve your goals.
But among the countless ways to build wealth on Wall Street, few strategies have proven more consistently successful than buying and holding high-quality stocks. dividend stocks.
The appeal of dividend-paying stocks is simple: They are almost always profitable on a recurring basis and have proven themselves over time. A company that regularly shares a percentage of its profits is one that investors rarely have to worry about before they go to sleep.
More importantly, dividend-paying stocks have completely crushed non-dividend-paying stocks in the return column over the past 50 years. A report released last year by investment advisers Hartford Funds (The Power of Dividends: Past, Present and Future) compared the performance of equity stocks to fixed-income stocks over the past half-century (1973-2023). What Hartford Funds found, in collaboration with Ned Davis Research, is that equity stocks They more than doubled the average annual return of non-payers — 9.17% vs. 4.27% — during this period.
But this doesn't mean investors can just throw a dart at the paper and pick a winner. All dividend-paying stocks are unique, and companies with ultra-high yields (those with four or more times the company's yield) are unique. S&P 500 Index) often carry added risk. Since performance is a function of stock price, a company with a failing business model can “trap” income seekers with a lucrative but unsustainable return.
But not all supercharged high-yield stocks are worth avoiding. Now that the Federal Reserve has kicked off a rate-easing cycle this week, two equity stocks with truly astonishing yields of 12.5% and 13.9% are perfectly positioned to thrive.
The light at the end of the tunnel has arrived for Wall Street's most hated industry
While “most hated” is a somewhat subjective term, there has arguably not been an industry that analysts have disliked for a longer period than mortgage real estate investment trusts (REITs).
Mortgage REITs are companies that aim to borrow money at lower interest rates in the short term and use that capital to buy higher-yielding, long-term assets, such as mortgage-backed securities (MBS), hence the industry name. Mortgage REITs' goal is to maximize their net interest margin, which is the average return on the assets they own minus their average short-term borrowing costs.
As you've probably gathered, the mortgage REIT industry is highly sensitive to changes in interest rates. When the country's central bank began its steepest rate-hiking cycle in four decades in March 2022, it caused short-term borrowing costs to skyrocket. The result for the mortgage REIT industry was a narrowing of the net interest margin.
And it's not just higher interest rates that the sector should be concerned about. The speed of monetary policy moves matters, too. If the Fed makes slow, calculated and well-communicated moves, mortgage REITs have the opportunity to reposition their assets to maximize returns. But as the Fed is chasing a four-decade peak in the prevailing inflation rate, the slowdown in its rate-hike cycle quickly fell by the wayside.
Virtually all publicly traded companies in the mortgage REIT industry have seen their book value decline (most mortgage REITs are trading very close to their respective book values) and net interest margin narrow since March 2022.
However, the light at the end of the tunnel has finally arrived for Wall Street's most hated industry. Annaly Capital Management (NYSE: NLY) and AGNC Investment (NASDAQ:AGNC)Offering respective yields of 12.5% and 13.9%, they now have an excellent opportunity to outperform.
Annaly and AGNC are ideally positioned to thrive during a rate easing cycle
Now that the prevailing inflation rate has dropped to 2.5% in August, the lowest reading seen since February 2021, the country's central bank has had every incentive in the world to embark on a rate-easing cycle.
When the Federal Reserve engages in dovish monetary policy and lowers the federal funds rate, it tends to reduce short-term borrowing costs and allows Annaly and AGNC Investment's net interest margins to widen. At the same time, these two major mortgage REITs have been able to acquire mortgage-backed debt securities at higher yields over the past two years, which may provide an additional boost to their respective net interest margins.
Equally important is the fact that the Federal Reserve is currently walking on eggshells when it comes to monetary policy. Having left federal funds rates at historic lows for too long and, in retrospect, having sent them soaring in the wake of high inflation, the Federal Open Market Committee is prone to delay any future changes. Well-announced measures will allow Annaly and AGNC to position their portfolios for optimal success.
A rate easing cycle would also be expected to lead to an eventual normalization of the yield curve.
Typically, the Treasury yield curve slopes upward and to the right. This means that longer-term bonds that mature in 30 years offer higher yields than Treasury bills that mature in one year or less. We recently witnessed the longest yield curve inversion in history, with short-term yields comfortably outperforming those on long-term bonds. When the yield curve normalizes, mortgage REITs shine.
The final piece of the puzzle for Annaly Capital Management and AGNC Investment is that they invest predominantly in agency securities. An “agency” asset is one that is backed by the federal government in the unlikely event of default.
Annaly ended the quarter ended June with $66 billion of its $74.8 billion portfolio invested in highly liquid agency assets, while AGNC had all but $1 billion of its $66 billion portfolio allocated to agency mortgage-backed securities (MBS) and miscellaneous agency securities. The additional protection enjoyed by Annaly and AGNC from agency securities allows both firms to prudently leverage their portfolios to maximize returns and maintain their outsized dividends.
Although both companies have severely underperformed in the current bull market, Annaly and AGNC appear ready for their moment in the spotlight.
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Sean Williams has positions in Annaly Capital Management. The Motley Fool has no positions in any of the stocks mentioned. The Motley Fool has a Disclosure Policy.
Two ultra-high-yield dividend stocks with yields above 12% that are ideally positioned for a rate easing cycle Originally published by The Motley Fool
