As the U.S. 2-Year Treasury Yield has remained inversely related to the U.S. 10-Year Treasury Yield for some time now, this has signaled concerns for many investors and economists, as historically this points to a recession ahead.
What Happened: The U.S. 2-Year Treasury Yield is currently at 3.437%, which is more than double the average corporate dividend yield in the SPDR S&P 500 (ARCA: SPY (NYSE:SPY)), which is at 1.57% on Friday.
With short-term treasury bonds offering higher yields than companies in the S&P 500, this could help gain traction for the 60/40 portfolio previously abandoned by many investors. Among the stocks being impacted by the market down turn are real estate investment trusts (REIT).
The BTIG Analyst: Eric Hagen downgraded Redwood Trust (NYSE: RWT) to Neutral from its previous Buy rating with a past price target of $10.50 per share, as they currently have no expectations of the shares falling below $7 per share.
The Redwood Trust Thesis: Due to the uncertainty surrounding rising interest rates and mortgage spreads, the BTIG analysts do not recommend initiating a long position in Redwood Trust, and most non-Agency mortgage REITs.
This is because Fed hawkishness and yield-curve inversions have dragged the stock down for most of the year, and will cause the outlook for capital appreciation to remain foggy for the second half of the year.
However, BTIG analysts still believe that certain elements could propel Redwood Trust earnings growth, particularly in single-family rental loans and the transitional loan space, but due to the market volatility they cannot accurately provide a price target.
Also Read: BTIG Maintains Buy Rating for FREYR Battery: Here's What You Need To Know
Dividend Yields: On August 28, Redwood Trust dividend yield soared above 12%, but as of August 31, 2022, the dividend yield had decreased to 11.3% or 92 cents per share annually as short-term treasury yields remained elevated.
Hagen mentioned that Redwood is trading at a deep discount to net asset value, which is primarily due to the limited visibility for earnings growth, although the analysts are not expecting the company to cut dividends anytime soon.
Best Case Scenario: The analysts think that the strongest catalyst is increasing home price appreciation, which could expand the company’s addressable lending market.
If the housing market continues to grow, companies such as Redwood Trust will play an important part providing liquidity in the lending market to support the growing supply, which will strengthen the return to shareholders.
Worst Case Scenario: If Hawkish Fed policy and tighter spreads continue to support weaker housing and consumer credit performance, this could slow new originations, weakening the future economic returns including its mark-to-market book value.
Therefore, if liquidity in the capital markets decreases, this could pressure the company’s ability to support its $875 million of unsecured debt while still delivering a competitive return to stockholders.
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