Market Commentary | October 13, 2022

When Bad Markets Happen to Good Stocks

Sometimes, when the world seems to have stopped making sense, it helps to get anecdotal.

For example, late last summer we learned that famed short-seller, Jim Chanos, was running a bearish campaign on data centers, claiming that their revenue streams were in jeopardy. We had previously sold most of our data center REITs but maintain a substantial position in Iron Mountain (IRM). IRM was one of the few stocks to defy 2022’s bear market downdraft, so we were excited to attend their September 20th investor presentation in the hope of understanding their singular strength. We wanted reassurance.

During the presentation, CEO Bill Meaney described that IRM’s synergistic collection of records archiving, document digitization, data security, and cloud businesses is a high-margin, cash-gushing cow. This growing cash stream allows IRM to continuously fund business growth without having to return to the capital markets with dilutive equity issuance. He forecast that earnings would compound at an 8% -12% rate over the coming years. We were impressed and relieved.

Over the ensuing nine trading sessions, Iron Mountain shares fell more than $12 (-21.5%).

Another. Back in May we described that we had identified a collection of fixed-to-floating rate preferred stocks. The thesis was that in this rising interest rate environment, these discounted shares would become callable and convert to a higher coupon. At the time 3 Month USD LIBOR was 1.44%; today 3 Month LIBOR is 4.08%. As rates rise, so do the dividends we will ultimately receive.

In the interim period the share prices of these preferreds have languished with the rest of the stock and bond markets, but early last month our reasoning’s merit was finally demonstrated. On September 7th AGNC Investment Corp. (AGNC) announced that they were issuing a new series of preferred stock and that the offering’s proceeds would be used for, among other things, the potential redemption of their Series C Preferred stock (AGNCN) which is callable 10/15/2022. On extremely high trading volume, the discount evaporated, and the price rose to the $25 call price.

Though the AGNCN shares have not officially been called, AGNC is motivated to redeem them because on 10/15 their coupon moves from a fixed 7.00% to 3 Month LIBOR + 511.1 bp (9.19% at today’s rate), a 31% increase in interest expense. Amazingly, on September 7th investors could sell their AGNCN at $25 and buy the remarkably similar AGNC Series E (AGNCO), which becomes callable under similar terms on 10/15/24 for ~$22.25. The rise to call price is a validation that these preferred issues can be an effective hedge in a rising rate environment.

What’re you gonna do?

We are still long and bullish on IRM which closed today at $45.76 (up 4.1% month to date). We are long AGNCO and while its shares have fallen to $19.14, the now callable AGNCN looks attractive as price has slumped to $22.32 (10.29% yield at the new floating rate). The Labor Department this morning said that its core consumer-price index (CPI) rose 6.6% year-over-year in September. Stock prices initially plunged on the news, but quickly reversed with the S&P 500 finishing up 2.6% on the day. Opportunity abounds.

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