Why are Hedge Funds Investing in Mortgage-Backed Securities REITs?

As detailed in other articles on this site. hedge fund investing in real estate assets has reversed from the upswing since last year.  Two recent real estate investment trust initial public offerings, Silver Bay Realty Trust (NYSE: SBY) and American Residential Properties (NYSE: AHRP), have fared poorly.  Due to that, another real estate investment trust, Colony American Homes, postponed its initial public offering earlier this month.

There are undoubtedly many hedge funds that wish they had also postponed their purchases of shares of publicly traded mortgage-backed securities real estate investment trusts.

According to 13F filings with the Securities and Exchange Commission, Appaloosa owns 2.4 million shares of Two Harbors (NYSE: TWO), a $4 billion market cap real-estate investment trust that primarily invests in residential mortgage-backed securities and other mortgage loans. Brookside Capital, the hedge fund of Bain Capital, also loaded up on Two Harbors in the first quarter, per its 13F filings.  As the chart below shows, it has not been a profitable investment, on paperat least, so far.

For the most recent quarter of market action, Two Harbors Investment Corp. is down by 13.64%.  That is a stunning reversal from its previous trading pattern.  Over the last year, Two Harbors Investment Corp. is higher by 24.91%.

It is likely to fall even more based recent developments.

Federal Reserve Chairman Ben Bernankes remarks last week that Quantitative Easing III would be tapering off resulted in a massive sell-off in the Dow Jones Industrial Average.  This culminated a period of rising interest rates, obviously anticipated such a development.  Over that time span, stocks for companies sensitive to increasing interest rates, such as real estate investment trusts that invest in mortgage-backed securities, have plunged.

This should be expected to continue.

As a result of quantitative easing measures, the Federal Reserve has expanded its balance sheet from around $700 billion in 2007 to well over $3 trillion.  By the time Quantitative Easing III declines, it will be around $4 trillion.  No one knows what the impact of that much in assets, about one-quarter of the United States gross domestic product, on the Federal Reserve balance sheet will be for the long term.

But in the period leading to the huge increase in the Federal Reserve asset sheet as it acquired trillions in securities, it has led to lower interest rates.  Therefore is seems only natural that interest rates will rise when the Federal Reserve moves to reduce the size of is balance sheet.  That has very bearish implications for mortgage-backed security real estate investment trusts and other related firms.

As part of Quantitative Easing III, the Federal Reserve has been loading up on mortgage backed securities.  Every month, it acquires $40 billion in mortgage-backed securities for its asset sheet.  There is also $45 billion in Treasury Bonds acquired, too.  That is all part of a program to recapitalize the global financial system and maintain a low interest rate environment.

Should the Federal Reserve start to sell off its massive mortgage-backed securities program, real estate investment trusts in this sector will suffer.  Initial pain will be from interest rate swings destroying their mortgage-backed bond holdings.

That is bad enough.

Adding additional damage will be the fall in price due to more mortgage-backed securities now being on the market.  The fundamentals of basic supply and demand will kick in here.  The greater the supply, the more the price falls for any asset.

For a real estate investment trust with massive holdings in mortgage-backed securities, it does not get much worse than to have the market turn against both the income and principal portions of the bonds owned.  That certainly explains why Two Harbor has been pounded in recent market action.

What it does not account for is why Appaloosa, Brookside Capital, and other institutional investors have been buying.  The yield is certainly attractive, but becoming less so as interest rates rise.  Further actions by the Federal Reserve are likely to have Two Harbor and others in its sector declining even more.

Will Home Depot Reward its Hedge Fund Faithful if the Housing Market Falters?

With interest rates rising, there has been a plunge in those assets classes sensitive to such developments, ranging from utility stocks to real estate investment trusts.  Housing stocks have also fallen, due to the fear that higher mortgage rates will dampen the real estate rebound from The Great Recession.  But hedge funds such as the Chilton Investment Company and Renaissance Technologies have increased their holdings of Home Depot (NYSE: HD), a home improvement retailer with more than 2200 stores in all 50 states, Canada, Mexico, and other locales.

Renaissance Technologies, founded by billionaire Jim Simon, has doubled its position in Home Depot.  Chilton Investment Company, led by Richard Chilton, also has large holdings.  Overall, institutional investors such as hedge funds, pension groups and others own more than 75 percent of Home Depot.

Business has increased for Home Depot, along with the surging housing market in the United States.  On a quarterly basis, earnings-per-share growth is up more than 10 percent for Home Depot.  Sales have risen 7.4% for the same period.

This year, earnings-per-share growth is up 21.50%.  Analysts are very bullish on this metric.  Over the next five years, earnings-per-share growth is projected to increase by 14.43% for Home Depot.  As the chart below shows, much of this comes from the housing recovery in the United States as Home Depot has soared along with the exchange traded fund for home builder, SPDR Home Builders (NYSE: XHB).  As detailed in other articles on this site, hedge fund buying has been instrumental in the real estate recovery .

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But, as the chart below shows,  Home Depot has slipped in recent market action.

Down slightly for the last week of trading, Home Depot is just under $77.

That is about 5% beneath its 52-week high of $81.16.    The relative strength index for Home Depot is 50.40.  That is significantly below the 70 level for a stock to be considered overbought and due for a tumble.

Due to the high level of institutional ownership in Home Depot, there is a low beta only 0.83.  That is almost 20% under the average of 1, for the stock market as a whole.  Studies have shown that low beta stocks outperform the market over the long term, too.

But on a price-to-book ratio, Home Depot is richly valued at 6.91.  That is above the industry average of 5.40.  It is much the same story with the price-to-sales ratio of 1.48 for Home Depot, as the mean for its sector is 1.25.

For income investors, Home Depot delivers more than the industry mean and the average for a member company of the Standard & Poors 500 Index.  Home Depot has a dividend yield of 2.02%.  That is slightly above what the average company of the Standard & Poors 500 Index pays out quarterly to its shareholders.  The dividend yield for its sector is just 1.70%.

With a payout ratio of around 40%, Home Depot is beneath the historic average for the Standard & Poors 500 Index.  That allows for the cash flow to increase the dividend and initiate share buyback programs to reward owners of the stock.  As a Dividend Aristocrat, Home Depot has a history of increasing its dividend annually.  For the last five years, the dividend growth rate for Home Depot has been 5.73%.

It is worthy of noting that Home Depot continued to increase its dividend over the course of The Great Recession, even with the housing market collapse in the United States.

Like hedge funds and institutional investors, the analyst community is bullish on Home Depot, too.  The mean analyst price target for Home Depot over the next year is $84.73.  That is about 10% higher than the present price level, and above the high for the last 52 weeks.  With its dividend yield, that is right around a 12% total return from Home Depot over the next year, as projected by the mean estimates of the analyst community.  As Home Depot is up more than 50% for the last year, that is a decline from those lofty levels, but still a solid double digit return.

Is the Door to the Exit Strategy for Hedge Fund Investing in Real Estate Closing?

Billions and billions of dollars have been spent by hedge funds and other institutional investors in buying real estate in the United States.  The Blackstone Group (NYSE: BX) has been active in the Tampa area of Florida, as but one example.  Seeking to profit from the natural gas riches of the Bakken Basin, KKR (NYSE: KKR) has investing heavily in North Dakota real estate.

While the investing framework of hedge funds and other institutional investors is never publicly stated for obvious reasons, there was much speculation that a public offering as a real estate investment trust was the exit strategy for many.  That is why the hedge funds and others were buying properties, fixing up the units, and then renting out the real estate.  It was hoped that from this approach that an earnings base could be established so that the investment community would buy into the initial public offering of these novel types of real estate investment trusts.

But recently Colonial American Homes postponed its initial public offering.  The company owns partial shares in close to 10,000 homes in nine states, including California and Georgia.  It had hoped to sell 20 million shares priced between $11.50 and $13 each.

There have two other real estate investment trust initial public offerings for entities that own and rent out single-family homes: Silver Bay Realty Trust Corp (NYSE: SBY), the first going public last December; and American Residential Properties (NASDAQ: ARPI), which went public in May.  The performance of both must certainly have contributed to the decision of Colonial American Homes to postpone its initial public offering.

As the chart below shows, Silver Bay Realty Trust has fallen sharply in recent market action, down more than 10% for the month.

It is not much been better for American Residential Properties, Inc.

American Residential Properties, Inc. is down more than 8% for a year that has seen double digit growth in the stock markets.

Converting to real estate investment trusts that are publicly traded results in huge constraints for the companies.  Just being publicly traded is very expensive.  A huge degree of control is lost, too.  While there are tax benefits, a dividend must now be paid by these companies is the real estate investment trust status is to be maintained.

The analyst community is bullish on both American Residential Properties, Inc. and Silver Bay Realty Trust, which is hardly surprising in the period right after the initial public offering.  Now trading around $16.70, the mean analyst target price for Silver Bay Realty Trust over the next year of market action is $21.70.   Just under $18.90, for American Residential Properties the mean analyst target price over the next year is $22.67.

What should be concerning to the hedge funds and others looking to go public with their real estate holdings is how the volume has dropped off for both American Residential Properties, Inc and Silver Bay Realty Trust.  Since the initial public offering for each, the level of volume has plunged, which is a negative indicator.  For whatever reason, the investment firms taking the companies public have not been able to sustain the support for Wall Street in a period when both the stock market and housing sector were very strong.

That could easily change when American Residential Properties, Inc and/or Silver Bay Realty Trust begin to pay a dividend, however.  That will expand the number of equity income mutual funds and others that can buy shares of the stock.  Each will also become more attractive to those investors yield hunting in a low interest rate environment.  For now, however, the postpone of its initial public offering by Colonial American homes along with the bearish performance of American Residential Properties, Inc. and Silver Bay Realty Trust can hardly be considered a bullish sign for those hedge funds and other institutional investors who were hoping to cash in with an initial public offering as a real estate investment trust.

Is the REIT Conversion Rally About to End?

Much of the rebound in the American real estate market has been due to heavy buying from the hedge fund industry and other institutional investors.  A significant portion of that has been from hedge funds, private equity groups, family offices and others seeking to cash in when real estate-rich companies maximize shareholder value by converting to real estate investment trust (REITs).  But the Internal Revenue Service is considering changes that change the definition of “real estate” which could substantially erode the holdings of hedge funds and others.

Many hedge funds have invested with an exit strategy of the company converting to a REIT.  SAC Capital Advisors recently upped its position in Lamar Advertising (NASDAQ: LAMR), a billboard advertising company, to 4.2 million shares, which is 5.3 percent of the company.  There is speculation that SAC Capital Advisors has invested so heavily in Lamar Advertising as it will be applying for REIT status soon.  As a result, Lamar Advertising is up more than 60% for the year.

If Lamar Advertising does attempt to convert to a REIT, it will be another company with significant real assets joining a recent trend.  According to a research report just released from Jeffries, a Wall Street firm, ““It is not a far stretch to envision REITs concentrated in railroads, highways, mines, landfills, vineyards, farmland or any other ‘immovable’ structure that generates revenues.”  At present, there are about 1,000 REITS.  Only a fraction are privately traded companies.  By law, 90 percent of taxable income must be paid to shareholders as a dividend if the special tax status is to be maintained by the REIT.

What is causing concern is the hedge fund industry is an unusual  press release concerning the U.S. Securities and Exchange Commission and Iron Mountain (NYSE: IRM), an information management services company.   The Internal Revenue Service issued a negative private letter ruling regarding racking structures constituting “real estate” so that Iron Mountain could convert to a REIT.

For Iron Mountain to be allowed to become a REIT and enjoy the significant tax benefits, the racking structures must be considered real assets. In a release from the law firm of Skadden & Arps, “Racking structures are the steel storage racks inside Iron Mountain’s warehouses that hold the boxes stored by tenants. The IRS historically has taken the position that some racks are comparable to permanently secured supermarket counters and do not qualify as real property for REIT purposes. In that sense, close scrutiny by the IRS of these assets is not surprising, as the IRS carefully evaluates REIT PLR requests to ensure consistency with the REIT rules in the tax code and with the IRS’s prior rulings. In addition, there always will be areas in which changes in technology, for example, require the IRS to apply the definition of real property to new facts, requiring thorough analysis.”

Just the rumor that a company is planning a REIT conversion will take the share price much higher.  Investors are attracted by the high income, particularly in today’s low yield environment.  As the chart below shows, however, the recent IRS letter re Iron Mountain has taken the stock price of Lamar Advertising much lower.

It could go even lower as Lamar Advertising has a debt-to-equity ratio of almost 2.5 with a price-to-earnings ratio of over 150.  The cash indicators are anemic with a price-to-cash ratio of over 50, which will get much worse if it converts to a REIT as no dividend is presently paid.  The profit margin is slim as little more than 2%.  Obviously, SAC Capital Advisers has tremendous influence with Lamar Advertising.  Should Lamar Advertising attempt to change its corporate structure to that of a REIT and fall, further price declines will be likely.

Will Oil be the Next Bear Market Plunge for Hedge Funds?

As detailed in previous articles on this site, hedge funds have lost heavily from gold and foreign currencies falling in value in recent market action.  Many hedge funds and other asset managers were caught with positions that anticipated the market would react the same way it did when Quantitative Easing III was introduced last September as it did when Quantitative Easing II was announced in August 2010.  When that did not transpire, hedge fund and losses from other investor entities were severe with gold and other asset classes plunging.

But oil as continued to maintain a high price level.

There are concerns, however, that it will be falling soon as the Federal Reserve is thought by many to be ready to pull back Quantitative Easing III.  That was the topic of prepared remarks released by Kansas City Reserve Bank President Esther George last week that sent the Dow Jones Industrial Average tumbling.  Recent articles in Forbes magazine and The Wall Street Journal have warned that Quantitative Easing III being ended or reduced could take the price of oil down much lower.

That is due, in large part, to how Quantitative Easing II took the price of oil much higher.

As the chart below shows, both gold (NYSE: GLD) and oil (NYSE: USO ) soared after Federal Reserve Chairman Ben Bernanke introduced Quantitative Easing II in a speech at Jackson Hole in August 2010.  Quantitative Easing II was a program from November 2010 to June 2011 that entailed the Federal Reserve expanding its asset sheets by $700 billion to acquire Treasury Bonds and mortgage-backed securities to repcapitalize the global financial system in an effort to maintain a low interest rate environment to stimulate economic recovery around the world.

Due to the creation of so much in fiat currencies without the corresponding economic growth, the US Dollar and other paper money denominations fell.  Investors piled into assets such as gold, oil and other commodities.  But, as the chart below reveals, this did not happen after Quantitative Easing III, the open-ended acquiring of $85 billion each month, was introduced by Federal Reserve Chairman Bernanke last September.

There are many factors why oil has stayed strong as gold has crashed.  Almost all of gold goes to jewelry and investment end uses.  By contrast, almost all of oil goes industrial end purposes.   The stocks of major oil firms also have generous dividend incomes.  That has attracted a great deal of investor attention in a yield hungry world.  Stocks are propped up by this buying.

But that all could be ending soon, with many hedge funds heavily invested in oil company stocks.  Chevron (NYSE: CVX), ConocoPhillips (NYSE: COP), and Occidental Petroleum (NYSE: OXY) all have institutional ownership levels of over 60%.  Should the level of oil crash, it is likely the share prices of these companies will follow.

The fundamental economic forces to force down oil prices are certainly present.  US oil production is at a record high.  With fracking, it should only be expected to increase even more.  According to a recent article in Harpers magazine, fracking is so efficient that operations now are not so much drilling, as plumbing for oil.

Oil inventories in the United States are also high.  There are 394 billion barrels of oil in commercial stocks in America, the most since the early 1980s.  Demand is the United States is also expected to fall for the third straight year to 18.6 million barrels a day, according to the International Energy Agency.

Higher interest rates are also making it more expensive to hold oil in storage.  If this continues to happen, then profits on the oil carry trade will fall.  From that, speculators will sell oil holdings.  That flood of oil into the market could depress prices even more.

Combined, all of these could result in oil holdings being the next area of heavy hedge fund losses.

Hedge Funds Still Buying After Marathon Petroleum Doubles!

There is much to be said for a spin-off that more than doubles in value in less than a year.

Hedge fund managers T. Boone Pickens and Andreas Halvorsen have been paying Marathon Petroleum (NYSE: MPC) the ultimate compliment in buying up its shares.  Since leaving its parent, Marathon Oil (NYSE: MRO), last year, the stock price of Marathon Petroleum has more than doubled.

Even with that price surge, there is still much to like about Marathon Petroleum.

For value investors, Marathon Petroleum is trading at a price-to-sales ratio of just 0.30.  That means that every dollar of sales is going at a 70% discount based on the stock price.  That is after the stock price soared more than 130% for the last year of market action.  It is also below the industry average

Growth investors should be particularly enticed by the low price-to-earnings growth ratio.  According to legendary investor Peter Lynch, this is one of the most important indicators.  A price-to-earnings growth ratio of 1 is fair value: the lower, the better.  The price-to-earnings growth ratio for Marathon Petroleum is just 0.70.  Pickens, Halvorsen, and the other shareholders have been buying the future growth of Marathon Petroleum at a 30% discount

The price-to-earnings ratio is also appealing for Marathon Petroleum.  At just 7.69, it is very low.  The average price-to-earnings ratio for its competitors is 11.10.

Income investors will like the 1.70% dividend yield, but love the potential for a higher payout.  There is ample cash flow for Marathon Petroleum to raise the dividend and/or start a stock buyback program.

Its capital structure is also better than the others in its industry group.  Marathon Petroleum has a debt-to-equity ratio of just 0.28.  Modest in itself, it compares very favorably with others in the sector as the average is 0.36.  That results in much more robust cash ratios to increase the dividend, fund a stock buyback, or acquire other companies.

Unlike other commodity securities, Marathon Petroleum is in an ideal position to benefit from the quantitative easing policies of global central bankers.  As detailed in other articles on this site, many hedge funds have suffered tremendous losses due to gold falling in value.  Gold is expected to fall even more by Jim Rogers. and others, as pointed out by other articles on this site.

As the chart below shows, the exchange traded fund for gold (NYSE: GLD) continues to fall.

But this is not so for oil, and its exchange traded fund, United States Oil (NYSE: USO).  The USO has soared as the GLD has plunged.

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That was a shift in trading patterns.

Both the GLD and the USO surged after Quantitative Easing II was announced by Federal Reserve Chairman Ben Bernanke in August 2010 at the Jackson Hole summit.  But as the chart above shows, the trajectories diverged after Bernanke introduced Quantitative Easing III back in September.

Marathon Petroleum and other energy securities continue to benefit from this for a variety of factors.  These stocks offer what investors now seek in the era of massive quantitative easing by global central bankers to keep interest rates low: a commodity play with an income feature.  That is certainly not the GLD or a gold bar.  But it is companies in Marathon Petroleums sector, which have an average dividend yield of 3.60%.  For the Standard & Poors 500 Index, the mean dividend is around 2%.

With some signs of the global economy rebounding and the demand for oil starting to pick up, Marathon Petroleum is situated well to profit from the recovery.  There is a strong demand for its services, as shown by its quarterly sales growth of 15.14% and its quarterly earnings-per-share growth of 27.89%.  For the year, earnings-per-share growth is higher by 48.30%.  With an institutional investor ownership level of 84.75%, there are many hedge funds and others expecting Marathon Petroleum to continue to outperform the others in its sector;

Will Republic Airways Remain a Hedge Fund Favorite?

It has been a good year for the airline industry.

While the stock markets are hitting record highs, the airline industry is moving into a new business model featuring far greater fee income that hedge funds and other institutional investors have found to be very appealing as it is generating billions more in new revenue.  There has also been tremendous consolidation in the sector which has resulted in higher ticker prices from the basics fundamentals of supply-and-demand.  Taken over have been such familiar names as Continental, American, and AirTran.  Others have gone bankrupt.

This is resulted in a superior performance for the airlines remaining in the sector.  As the chart below shows, the exchange fund the airlines industry (NYSE: FAA ) has greatly outpaced the Standard & Poors 500 Index (NYSE: SPY ).  A hedge fund favorite among the airlines sector is Republic Airways Holdings (NASDAQ: RJET ).

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There is much for hedge funds to like on the income statement and balance sheet of Republic Airways.  For value investors, Republic Airways is trading at a price-to-sales ratio of just 0.18.  That means that every dollar of sales for Republic Airways is selling at less than one-fifth of that in the stock price.  The industry average for others in the sector is much higher at 0.83.

While other passenger carriers are trading at a price-to-book ratio of 2.10, for Republic Airways it is just 0.96.  Not only are the assets of Republic trading at a discount, compared to others in its industry group, it is a half-off buy.  For value investors from the Warren Buffett and Benjamin Graham school of value investing (is there any other?), a one-third discount is considered compelling enough to warrant a buy order.

Peter Lynch, another legendary investor, like Buffett and Graham, considered the price-to-earnings growth ratio to be the most important.  A price-to-earnings growth ratio of 1 is considered to be a fair value for a company.  Anything less is trading at a discount to the future earnings.  For Republic Airways, the price-to-earnings growth ratio is just 0.79.

Operations should improve even more for Republic Airways when it spins off Frontier Airlines.  Republic Airways tried at first to sell Frontier Airlines, but there were no takers.  As a result, it has announced that it will spin off Frontier Airlines.  As Republic Airways is up almost 80% for 2013, it appears as if any gains that will be realized from turning Frontier Airlines loose have already been priced into the stock.

What will definitely be a benefit when Frontier Airlines is gone is bringing down the debt-so-equity ratio, now at 3.94 for Republic Airways.  That means that it required almost four dollars in borrowing to create every one dollar in equity on the balance sheet of Republic Airways.  Much of that debt was incurred in the bidding war for Frontier Airlines after it filed for bankruptcy, which Republic Airways won over Southwest Airlines (NYSE: LU V).  By contrast, the industry average is much lower at just 0.82.

Due to the heavy institutional ownership level of more than 95%, the beta for Republic Airways is very low at just 0.33 (the market average is one).  It is doubtful if any hedge fund or other institution will sell before the spin off of Frontier Airlines.  When that takes place, there should be a jump in the share price.  How long that pop will endure remains to be seen.  But with a short float of just 2.14%, there are not many betting that the share price will crash land anytime soon for Republic Airways!

From Your Government and Here to Help Hedge Fund Traders

In an earlier article in this site, it was detailed how Quantitative Easing III would be ending in some form due to the improving US economy.  In that article, Memo to Hedge Funds: CBO Report from 7 Days Ago Alerted all that Federal Reserve will Pull back its Treasury Buys,    it was reviewed how the budget deficit was falling which would alter Quantitative Easing III.  Todays 207.50 rise in the Dow Jones Industrial Average based on a strong US jobs report was also telegraphed in advance earlier this week.

Earlier this week in a prepared speech, Kansas City Reserve Chairman Esther George stated that, I support slowing the pace of asset purchases as an appropriate next step for monetary policy.    That remark sent the stocks market down earlier this week.  But the reasoning for Georges position was a sure tip that todays job report would be bullish:

That the United States was benefiting from improving economic conditions.

Today, two days after the release of her remarks, as reported by USA Today.  Wall Street reacted positively Friday to the release of better-than-expected May jobs numbers, with the major U.S. stock indexes posting sharp gains.  The Dow Jones industrial average jumped 207.50 points, or 1.4%, to 15,248.12. It was the Dows second-biggest gain this year, surpassed only by its 2.4% rise Jan. 2. The Dow rose 0.9% for the week.  The Standard & Poors 500 stock index surged 20.82 points, or 1.3% to 1,643.38. The S&P 500 posted a weekly gain of 0.8%. The Nasdaq composite index gained 45.16 points, or 1.3%, to close at 3,469.21, and was up 0.4% for the week.  The government reported that 175,000 jobs were created last month, 10,000 above analysts estimates.

That the performance of the financial markets is being driven by the monetary policy of the United States Federal Reserve is certainly nothing new.  But what is novel is the degree of openness from Federal Reserve officials.  Unlike the Greenspan era, Federal Reserve Chairman Ben Bernanke is doing all that he can to telegraph the moves of the American central bank well in advance.

The most prominent have been with the last two rounds of quantitative easing.

In August 2010 at the economic policy in Jackson Hole, Bernanke introduced Quantitative Easing II to the world.  But Quantitative Easing II did not commence until November 2010.  That resulted in tremendous profits for hedge funds, particularly those in the commodity sector as gold, silver, oil and other hard assets soared in value.

The same happened with Quantitative Easing III.

That program, the purchase of $85 billion a month in Treasury Bonds and mortgage-backed securities, was announced by Bernanke in a speech last September.  The primary beneficiary was the equity markets, with the Dow Jones Industrial Average soaring 22% since last November.

Those hedge funds expecting a repeat performance in the commodity and currency markets took heavy looses as the amount of liquidity created by the Federal Reserve and other central banks around the world overwhelmed what the speculative investment community absorb.  As a result, gold and other commodity prices have fallen; along with those of traditional safe haven currencies such as the Japan Yen.

The chart below shows how the exchange traded funds for the Japanese Yen (NYSE: YCL) and gold (NYSE: GLD) have fallen over that period.

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It was certainly no mystery that the Yen was in for a fall as Prime Minister Abe campaigned and has governed on a very expansionist monetary policy.  But as detailed in a recent article on this site, not a single Wall Street analyst expected the Japanese Yen to reach 100 to the US dollar in such as short period of time.   Like todays jobs report that topped the expectations of the investment community, there is plenty of advance notice being given to hedge fund investors and others by government officials at the highest levels.

Is Hedge Fund Buying Creating Another Real Estate Bubble?

Anxious for alpha in a world of low interest rates, hedge funds have piled billions into the real estate market in the United States, both residential and commercial.  Prices are soaring again, there are bidding wars, flipping is back, as are the reality shows about the industry.  Completing the picture is the report of the Federal Housing Administration suffering $115 billion in losses from a “stress test,” much like that conducted by the Federal Reserve for financial institutions.

As detailed in another article on this site, in many areas hedge funds have been the market .  The Blackstone Group (NYSE: BX ) has been very active in the Tampa market, as an example.  Hedge funds have also been gobbling up real estate in the Chicago market, too.  Across the country investments are soaring in commercial real estate, too, as the General Motors building just sold for an amount that values it at $3.4 billion, the most expensive office building in the United States.

While prices have not reached the levels before The Great Recession, neither has employment in the United States.  Recovery from The Great Recession has been weak.  That is shown in real estate buying in that the majority of mortgages are backed by the government.  Of the overall amount, the Federal Housing Administration accounted for about one-third of the loans used to buy housing in the United States last year.

In this regard, hedge fund buying of rental real estate could be functioning as an inverse relationship to the bond bubble bursting, as many expect.  In recent market action, Treasury yields have risen.  So have mortgage rates, as a result.  The end product of that will be higher rents across the country.

For the hedge fund owners of rental real estate, that will serve as an effective cushion to falling stock and bond prices.  The ones that have bought properties to flip could be stuck with capital-draining drags on the performance of the fund.  While the investments can be carried at a higher value, the opportunity cost will be significant, with the potential liability even higher.

In some cases, hedge fund buying could be a stabilizing force, however.

In Tampa, the Blackstone Group, rather than flip, has fixed up single family homes to rent out as income properties.  That comports with the attitude of many Americans now who prefer to rent rather than own.  It also positions the Blackstone Group well for another downturn as during The Great Recession as stock and bond prices were plunging, rental income actually rose in the United States.  The prices certainly fell for real estate, too, but the income component increased.

That could provide a cushion for hedge fund owning great swaths of rental housing if the stock markets plummet due to rising interest rates.  If interest rates rise, so will mortgage rates.  That means there will be fewer Americans qualifying for a loan to buy a home.  As a result, there will be more renters.  From the fundamentals of basic supply and demand, that will drive up the levels of rental incomes, just as happened during The Great Recession.

In this regard, hedge fund buying of rental real estate could be functioning as an inverse relationship to the bond bubble bursting, as many expect.  In recent market action, Treasury yields have risen.  So have mortgage rates, as a result.  The end product of that will be higher rents across the country, bolstering the returns for the hedge fund owners.

Low PEG has Hedge Funds High on this Stock

Legendary investor Peter Lynch considers the price-to-earnings growth (PEG) ratio to be one of the most important indicators for the future direction of a stock.

If the PEG is 1, the stock is fairly valued.  The lower the better, as that indicates that a stock is valued at less than its future earnings growth.   With a PEG below 1 and price-to-earnings ratio falling to 8 from over 29, Ocwen Financial Corp. (NYSE: OCN ) has attracted the attentions of hedge funds such as York Capital Management, Pine River Capital, White Elm Capital, and SAC Capital.  Overall, 37 hedge funds were bullish on Ocwen Financial.

The earnings growth potential of Ocwen Financial, which services mortgage loans, overshadows many serious flaws on the income statement, balance sheet, and capital structure of the company.  As a start, the balance sheet is larded up with debt.  Ocwen Financial has a debt-to-equity ratio of 2.75.  The long term debt-to-equity ratio is only 1.10, making most of the debt looming in the near future.  Much of that debt has come from acquisitions.  Both of those figures are well above the industry average.

Ocwen Financial can hardly be considered a value play, either.

The price-to-book ratio is 3.88.  The industry average is 1.11.  The price-to-sales ratio is 5.32.  The industry average is 2.62.  The price-to-cash flow for Ocwen Financial is 28.30.  The industry average is 14.70.

But earnings growth like that of Ocwen can hide many flaws, as the heavy hedge fund buying and institutional level of ownership at more than 80% attests.  For the first quarter of 2013, revenue increased by 147%.  This should continue as banks are selling off servicing assets to comply with capital requirements and improve the image with consumers.

This trend is increasing the market base for Ocwen.  It claims to have a proprietary technology to assist in increasing the value of homeowners and client’s loans.  Trading at a substantial discount to forward earnings,  Ocwen is selling with a profit margin of around 20% and an operating margin of more than 50%.

While obviously not a value play, Ocwen is certainly a momentum buy.  The stock is up for the last week, month, quarter, six months, and year of market action.  For 2013, Ocwen Financial is trading higher by 23.68%.  Much of that price rise can be attributed to how well two spin-offs have performed, rewarding Ocwen Financial shareholders who were given stock in the new companies, Altisource Portfolio Solutions (NASDAQ: ASPS ) and Altisource Residential Corp (NASDAQ: RESI ).

The Wall Street analyst community is very positive about the prospects of Ocwen Financial, however.

The mean analyst rating is a 1.50, which is very bullish.  Now trading around $42.70, the mean analyst target price over the next year is $47.71.  With such a high level of institutional ownership, Ocwen Financial has a very low beta of just 0.64.

Wells Fargo (NYSE: WFC ) initiated coverage of Ocwen Financial within the last month with a rating of Outperform.

According to analyst Joel Houck of Wells Fargo, Our Outperform rating is based on what we believe is the company’s (1) operating cost advantage, (2) cost of capital advantage, attributable to its strategic relationship with HLSS, (3) tax rate, and its (4) strong and well-seasoned management.  In our view, these advantages will continue to support strong cash flow, allowing the company to capitalize on growth opportunities in origination and servicing. We are establishing EPS estimates of $4.25 and $5.30 for 2013 and 2014, respectively.

As with many other stocks in interest rate sensitive industries, Ocwen Financial took a recent dip as there were concerns that the Federal Reserve would pull back from its Treasury Bond and mortgage-backed security buying binge.  Obviously, any reductions in Quantitative Easing III would have a negative impact on all players in the mortgage business as interest rates would most likely rise.    But the trends in the industry should allow for Ocwen Financial to overcome these potential obstacles, as the high level of hedge fund ownership evinces.