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Week in Review: Adjusting to the Brexit Vote

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Week in review

Last week was pretty light in terms of economic data, but markets were concerned with adjusting to the Brexit vote. Stocks sold off hard due to the Brexit vote on both Friday, June 24, and Monday, June 27, but recouped all of their losses by the end of the week. For all the worries about Brexit overseas, it simply won’t have much of an effect on US corporate earnings. Bonds continued to rally as the German Bund kept pushing further into negative yields.

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In terms of economic data, we saw the third and final revision to 1Q16 GDP, which came in at 1.1%. Home prices continued to rise, according to the S&P/Case-Shiller Home Price Index. Construction spending missed estimates by a country mile, falling 0.8%, while Wall Street was looking for a rise of 0.6%.

Implications for mortgage REITs

Last week, bond yields fell 12 basis points to 1.44% as global bonds rallied and US Treasuries were pulled higher by relative value trading. Markets readjusted their federal funds rate forecasts and predicted lower rates going forward. This is generally good news for MBS (mortgage-backed securities) investors. Indeed, the iShares Mortgage Real Estate Capped ETF (REM) fell just $0.03 on Friday, while the rest of the Market was hammered.

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That said, recent volatility in the bond market isn’t necessarily good news for mortgage REITs. They hedge the interest rate risk of their portfolios, and readjusting their hedges works against them. The perfect scenario for them is a Treasury market that moves very little and allows them a good yield pickup. For REITs, the good news is that the Fed (Federal Reserve) is pretty much on hold.

A more dovish Fed is generally good news for agency REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC). It will also help mortgage originators like PennyMac Mortgage Investment Trust (PMT) and Redwood Trust (RWT).

Investors interested in making directional bets on interest rates can look at the iShares 20+ Year Treasury Bond ETF (TLT).

Implications for homebuilders

Homebuilders such as PulteGroup (PHM) and CalAtlantic Group (CAA) will also benefit from the Brexit vote. Lower mortgage rates make their homes more affordable to buyers, which will help them raise prices. While there may be a slight chance of a recession from the Brexit vote, the event should generally be good news for builders. In the long term, builders will have an opportunity to meet pent-up demand when the economy finally starts hitting on all cylinders. Homebuilders still lack the confidence to really push out volume. Meanwhile, pent-up demand continues to build. You can invest in homebuilders through the SPDR S&P Homebuilders ETF (XHB).

In the next part of this series, we’ll look at bond yields’ reaction to the Brexit vote.

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