PennyMac Mortgage Investment Trust: The Expensive American Dream Is An Opportunity (PMT)

Introduction

It is January 2021. Millions of Americans have a good deal of cash stored in their bank accounts and brokerage accounts. The stock market is making a roaring comeback after a rapid 35% fall in March 2020. The economy is vaccinated with stimulus shots and the US 10-year yield is close to multi-decadal lows at 0.9%. Amid this backdrop, over the next two years, 28 million Americans plan on buying a new home 2021…

Fast forward to December 2022 and we see the hot housing markets a couple years ago cooling off in 2023. Some research houses such as Redfin (RDFN) predict 2023 home prices to fall for the first time in a decade as demand wanes.

According to a Black Knight report, more than 20% of homes bought under mortgage in 2022 are in negative equity territory as of September 2022. Home affordability is at multi-decadal lows:

Despite home prices starting to correct across the country and 30-year rates dipping by nearly a half percentage point in recent weeks, home affordability remains near a multi-decade low.

– Black Knight October 2022 Mortgage Monitor

The “American dream” is turning into an “American nightmare” for millions of US residents. But there’s a chance to turn this into an opportunity by betting alongside the challenges that are ensuing. Missed 2008? Santa Claus is giving us another chance…

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.

The Stars Are Aligned to Fall on PMT

PennyMac Mortgage Investment Trust (NYSE:PMT) is a Mortgage REIT that invests primarily in mortgage-related assets in the United States. It has exposure to mortgage servicing rights and mortgage origination.

Read of Relative Money Flow

An upward movement on the relative chart of PMT/SPX500 means PMT is outperforming the S&P 500 (SPY). Conversely, a downward movement means the PMT is underperforming the S&P500.

That said, relative to the S&P500, PMT has kicked off a bearish slide after a bullish fake-out, confirming a trap. The historical high volatility reactions at the highlighted monthly resistance suggest that this is a key level. Thus, the current rejection is likely to snowball over the coming months to the lower support band.

The PMT/SPX500 chart shows that PMT has consistently under-performed the SPX index since 2020 and is earnestly hunting for reliable signs of support to introduce new buyers who could help with a 2020-type rebound.

Read of Absolute Money Flow

On the absolute chart for PMT, I expect bearish descent in the medium term becomes as the price begins on a downward breakout journey towards the lower monthly support at $8.31. This is following a bull trap around the critical $15.53 monthly resistance. I anticipate prices to break below the monthly support at $10.57 since that is a location where buyers have already visited for refuel to try create higher highs without success.

My assessment of the situation indicates that price could remain bearish throughout 2023 before macroeconomic factors eventually turn the tide for the real estate industry in the US.

Fundamental Drivers To Watch

Although PMT does have interest rate hedges in place to protect itself somewhat from financing risks, it is still exposed to a downturn in mortgage activity. As mentioned in the introduction, the low affordability of homes and weak demand outlook paint a slow market for mortgage loans in 2023. Incrementally however, the story may change and it is important to track the key high-frequency indicators to nimbly maneuver around positions.

I am keeping an eye on 3 key data points. Two of them are industry related and the third is specific to the mortgage REIT, relative to relevant peers.

The first data point is the US30Y yield as it is a key barometer of mortgage rates:

Higher interest rates will make borrowing more costly and hence drag down mortgage loan origination even further. This will negatively impact PMT’s business. A higher interest rate situation remains my base case as the Fed seems inclined to hold rates higher for longer despite the US inflation print falling for two consecutive months to 7.10% from 9.10%:

The second data point I have my eyes on is the Black Knight Home Price Index that is published in their monthly housing market reports. This will help me get a sense of the shifts in affordability levels that may cause me to rethink my thesis.

The REIT specific data point I am tracking is return on equity (ROE). I compare this relative to relevant peers for PMT; Rithm Capital Corp. (RITM) and Ready Capital Corporation (RC). These REITs are focused on mortgage origination business:

As can be seen in the chart above, PMT is under-performing its mREIT peers as well. Its ROE has consistently printed negative for multiple quarters now. This gives me further confidence that PMT’s operational momentum is also subpar, thus adding confluence to my bearish view.

A Contrarian Take

My bearish thesis on PMT seems to be a contrary one since recent Seeking Alpha analysts have not gone so far as to rate this a sell:

Wall Street as well does not have a sell rating yet on this Mortgage REIT:

I believe the price and volume prints of the charts, combined with the macroeconomic backdrop makes a strong case for bearishness on PMT. I like getting in before the institutional crowd as it provides an opportunity to add onto positions when the Street joins in on my idea. For example, in some of my previous articles, Wall St has often upgraded their ratings and price targets a few weeks after me, for the same reasons I had outlined.

Shorting Considerations

Currently, 4.7 million out of the 88.9 million shares outstanding are sold short for PMT. This implies a short interest of 5.3%, which I deem low. Accounting for only 81.5% free float, this implies an effective short interest of 6.5%, which is also low. Usually in my experience, short squeeze risks kick in when the short interest is in the double-digits.

The annual borrowing costs for a short position is currently 0.80% for PMT. Regarding time horizon, I am thinking the bearish move will be effective for a quarter (3 months).

Another Shot at 2008?

A lot of us missed being aligned to the housing market downturn in 2008. Jobs were lost, budgets were cut, hopes were shattered and lessons were learnt. I believe we may have another shot to play a similar theme right now via a short or puts on PMT.