Runway Is Clear for Market's Hottest Dividend Sector

This article is part of our Rising Star Portfolios series.

Part of the thesis behind the selection of Annaly Capital (NYS: NLY) for my Special Situations portfolio was that the economy would be mired in a funk for some time, meaning Annaly and its mortgage REIT peers would be able to continue pumping out those delicious dividends. In the last couple of weeks, we've received further confirmation of this thesis.

Perhaps the most bullish piece of news for the sector is that the Federal Reserve sees lower-than-anticipated growth and has pledged to keep interest rates at 0% and 0.25% until at least the middle of 2013. That was in response to S&P's downgrade of U.S. credit and lackluster 1.3% annualized growth in GDP during the second quarter. That growth was the weakest since mid-2009. And the recent agreement between Congress and President Obama to cut some $2.4 trillion in spending from the federal budget over the next 10 years does little to bolster investors' confidence in the economy's near-term prospects.

Low interest rates should help Annaly, Chimera Investment (NYS: CIM) , and American Capital Agency (NAS: AGNC) continue to earn solid rate spreads. And the stability of interest rates means they can continue to maintain high leverage.

We've also seen further confirmation of the attractive conditions from recent earnings reports from Annaly, Chimera, and Armour Residential REIT (NYS: ARR) . While the spread at Chimera went down, Armour saw spreads remain basically flat and Annaly saw spreads fatten. Cypress Sharpridge (NYS: CYS) also saw its spread widen in the quarter.

Annaly CEO Michael Farrell also confirmed these attractive conditions in the company's recent quarterly conference call. Farrell said: "The uncertainty surrounding sovereign credit risk, regulatory reform and tepid economic performance is causing near-term volatility in asset prices and investor confidence, but the long-term implication of these conditions is that the very favorable operating environment in which we find ourselves is likely to persist for a significant period of time."

Even before the S&P's silly downgrade of U.S. debt, Farrell warned: "Anyone who has concern about the selling off of assets under forced liquidations because of a downgrade is making a severe misjudgment."

Such attractive conditions, including low funding costs, have led many existing mortgage REITs, such as Annaly, American Capital Agency, and Invesco Mortgage (NYS: IVR) , to raise additional funds. Those conditions have also propelled new mortgage REITs into the market, including Apollo Residential Mortgage and AG Mortgage (NYS: MITT) .

With things lining up nicely for mortgage REITs and poorly for much of the rest of the market, it looks like the sector is a good place to stash some cash.

Interested in Annaly or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here.



At the time this article was published Jim Royal, Ph.D., owns shares of Annaly. The Motley Fool owns shares of Chimera Investment and Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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