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Stephen Percoco, CFA
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Steve Percoco founded Lark Research as an independent provider of investment research in 1991. He has been the publisher of the Income Builder newsletter since 2001. He is a generalist, but focuses on several key sectors, including housing (and the homebuilders), real estate, utilities... More
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Risk and Reward
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  • Greece Accedes To EU Requirements (For Now)

    Greece and the EU have reached an accommodation on the bailout program. Greece has agreed to leave the key aspects of the program in place, but will present the points upon which it plans to negotiate new terms to the EU finance ministers today. Greek stocks and especially Greek bank stocks have rebounded sharply, but still remain below levels that existed before PM Antonis Samaras called for the snap election in early December.

    Although there has been significant volatility in trading, the trend in Greek stocks has been up since the election results were announced in late January. I would be surprised if the rebound continues without clearer evidence that a permanent deal will be reached. EU finance ministers would be wise to show some flexibility in renegotiating certain aspects of the agreement. The Greek government, on the other hand, will probably take a tougher stance on those changes that it feels are necessary (and upon which it campaigned). It is possible that a final deal will be reached, but it probably will take some time and the financial markets may hesitate in bidding Greek share prices up, as long as that uncertainty still exists.

    The financial markets will also have to get over what almost certainly will be a setback for the Greek economy in the 2015 first quarter, due to the acrimonious exchange between Greek and EU government officials on the bailout extension. We know that many Greeks pulled their money out of their banks over the past couple of months. Many businesses also put their sales, marketing and investment plans on hold. This could result in another round of finger pointing, but the Greek government will still use the Q1 results to argue that austerity is impeding the recovery in Greece's economy.

    Personally, I think that mistakes have been made on both sides. The new Greek government should have struck a more accommodating tone at the outset to get the time it needs to structure and negotiate a comprehensive plan for reform that differs from the current regime. Similarly, the EU finance ministers should not be pushing for Greece to propose its reforms immediately. (According to press reports, the Greek government's list of proposed reforms is due today.) it would have been better, in my mind, to freeze the current program in place and give the Greek government six months to develop an alternate plan.

    Feb 23 12:21 PM | Link | Comment!
  • More Thoughts On Greece.

    The following is a comment that I posted recently on George Magnus's op-ed in the FT:

    By the figures provided in the article, Greece's annual interest burden is €317B X 2.4% = €7.6B or 4.2% of GDP. By comparison, the interest burden of the U.S. has fluctuated between 1.3% and 3.3%, according to CBO figures. The interest burden of the U.S. is currently at the low end of the range, but is expected to rise above the high end of the range by the end of the decade. As Mr. Magnus points out, that 4.2% interest burden for Greece looks high in an economy still near depression lows. That debt burden may decline as Greece's economy recovers, but the key question is how much of a recovery will we see and what is a reasonable sustainable level for Greece's GDP? The answers will help determine how much debt Greece can afford to carry.

    The standoff between the new government and the EU is likely to come over debt repayments. Greece has €4.3B coming due in March and another €6+B in August. Syriza's posture toward the debt will make it difficult to refinance. Syriza may also draw a line in the sand on debt repayments, since the combination of interest and principal is about 10% of GDP, which is a heavy burden given the current state of the economy. Unless Syriza is able to reassure the financial markets that Greece will honor its current obligations, EU officials will have no choice but to rollover this debt (effectively by extending maturities rather than refinancing).

    Another key issue is whether a Tsipras-led government will show pragmatism by working within the existing austerity framework to nudge government policies toward its vision of reform, rather than rejecting the framework outright. Its freedom to maneuver is limited as long as it stays in the euro. Despite its surprisingly strong showing at the polls, it almost certainly does not have sufficient support at this time to exit the euro. Mr. Tsipras has also said that it will take time for Syriza to implement its programs. He should be careful not to initiate programs that will result in another setback to Greece's economy, which would risk losing the support of those who helped to put him in power. All of this suggests that the new Greek parliament will continue to operate mostly within the austerity framework for now, unless the recovery in the economy stalls and along with it, expectations for improvement in the current living conditions of the lower- and middle-income households that are Syriza's primary base of support.


    Today's WSJ reports that while Greece's interest burden is indeed above 4% of GDP, concessions granted to the country, including profits on loans refunded to Greece and other measures, the net interest burden is effectively just 2.6% of GDP, below Italy's 4.7% and Spain's 3.3%.

    Jan 26 4:40 PM | Link | Comment!
  • Homebuilders: Chart Reflects Uncertainty, But Upside Remains

    Homebuilder stock prices went on much the same roller coaster ride as the broader market earlier in the month of October, falling sharply through support and then climbing back just as quickly to avoid serious technical damage.

    The Lark Research Homebuilder Stock Price Index fell 10.6% from September 19 to October 10, much worse than the declines of 5.2% and 8.2% in the S&P 500 and Russell 2000. During the two week period from October 10 to October 24, the homebuilders rallied back 12.6%, also better than the advances of 3.1% in the S&P 500 and 6.2% in the Russell. Last week, homebuilder stocks fell 2.2%, while the broader averages extended their gains.

    (click to enlarge)

    From the end of 2011 until April 2013, homebuilder shares rallied sharply, right up until the taper tantrum, due to optimism about the recovery in housing. Since then, the stocks have traded sideways, forming a flag pattern, which is characterized by increasing tension as the price converges to the tip of the flag, often resolved with an upside breakout.

    In October, the Index clearly broke through the bottom trendline of the flag, raising concerns that homebuilder stocks could go lower (and possibly much lower), but the stocks rallied back with the market and are now comfortably within the flag. At this point, I calculate that the average homebuilder stock is 2% below its 50-day moving average but 3% above its 200-day moving average.

    The sideways trading pattern presaged slowing upward momentum in housing production. With the steady, but tepid, growth in the economy and rise in employment in 2012 and 2013, buyers came off the sidelines, unleashing a modest amount of pent-up demand. Single-family housing starts increased from 430,000 units in 2011 to nearly 620,000 units in 2013, an average annual gain of 20%. That looks impressive, but coming off of generational lows, such a strong rebound was not entirely unexpected.

    Surprisingly, however, the lift off the bottom was accompanied by a sharp increase in house prices. Despite a still large number of vacant homes, the average price of a new home rose 9% in 2012 and 11% in 2013. Most of these vacant homes have been held off market, so available inventories were actually quite lean. The steady reduction in distressed home sales helped cleared the way for the sharp rebound in pricing. Although this was good news for sellers (and homebuilders), the rise in average prices combined with still tight underwriting guidelines pushed many potential buyers back to the sidelines. No surprise then that housing production has flattened out in 2014 along with homebuilder stock prices.

    The sideways trading pattern reflects uncertainty about the likely direction of home sales (and homebuilder profits). Severe winter weather-driven weakness in housing and the economy in the 2014 first quarter wrecked what should have been a decent spring selling season. Many buyers are still fearful about the direction of the economy and the security of their jobs, but the steady improvement in both over the past few months has raised confidence levels. Mortgage underwriting standards are still a constraint, especially for first-time homebuyers, but the government moved recently to allow Fannie Mae and Freddie Mac to purchase mortgages on houses with downpayments as low as 3%. That along with the elimination of the risk retention requirement for mortgage securitizers should improve mortgage financing availability. In the short-term, this should help boost housing sales. In the longer term, it remains to be seen whether this results in the same excesses that led to the collapse of the housing market in 2007.

    While the decisions on qualified mortgages may have helped lift homebuilder shares in recent weeks, there is still some uncertainty about the current and future performance of the homebuilders. Third quarter earnings have not been great. Although the earnings of one or two builders - Lennar, for example - surprised on the upside, a greater number of builders missed on both earnings and revenues. Yet, all of the builders remain upbeat. In many cases, builders attributed the shortfalls to delays in production or mortgage approvals. Orders remain decent. Backlogs are high. Most builders see improving performance in 2015.

    This expected improvement is already baked into analysts' 2015 estimates. The average analyst estimate for 2015 for eleven large builders anticipates average earnings growth of 22%. Yet, the average forward earnings multiple (for 2015) for the group is around 12, well below the market average and a sign that investors remain skeptical about whether the builders can deliver.

    As long as geopolitical risks remain at bay, however, the economy should continue to grow at around a 3% and add 200,000 jobs per month. Combined with the loosening of mortgage underwriters' purse strings, this should help the builders meet analysts' targets. If so, homebuilder stocks are clearly cheap. It is hard to imagine that the stock market can move meaningfully higher from here without further improvement in the housing sector and greater participation from homebuilder stocks.

    Tags: XHB, ITB, Housing
    Nov 02 7:34 PM | Link | Comment!
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