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I've been asked a dozen times in the past few days about Home Capital Group. My look at it combines some fundamental, technical, and a general understanding of the housing market. Conclusion: Avoid the stock because there are going concern issues.
Speculators love to catch falling knives in hopes of catching the big rebound. A falling knife is a market term for trying to pick a bottom on a stock that has fallen off a cliff. You might catch it, but you'll likely get cut up if you do. This is not value investing, this is pure unmitigated speculation. Most investors should not play this game. There is no prudence whatsoever and even most of the professionals will get this wrong.
The fact that the stock fell below the lows seen in 2008/2009 – it hit $7.50 in November, 2008 – should tell you this reaction is worse than expectations after the Great Recession. The stock traded as low as $5.99 this week.
Read more: The rise and fall of Home Capital
One of the things we should look at is who owns Home Capital shares, besides some of the insiders. The reason we do this is to look at potential supply and demand in the future.
The two biggest holders as of the most recent filings are hedge funds. These guys will likely be sellers at some point if they did not bail in the past few days. Home Capital has been the darling of the "short Canadian housing market" trade. But two of the alternative funds must have liked the long side, as the top two holders own a whopping 17 million shares of the 59 million shares outstanding at last filing, though that could have changed.
The reported short interest is only 2.1 million shares or 3.58 per cent of the outstanding float. Often the stock can bounce as shorts cover their position to take profit. It does not look like the shorts will be much of a positive catalyst compared to the hedge fund longs that no doubt are hurting.
The ETF providers own about 3.8 million shares and those will only be sold when Home Capital gets kicked out of the S&P/TSX composite index. If the price stays where it is and there are going concern issues, it would likely get kicked out at some point. Other holders include pension funds, insurance companies and mutual funds. One big notable is the Canada Pension Plan, which owns 460,000 shares as of last reporting, reminding investors that even some of the smartest investors aren't able to avoid some stock pitfalls.
Technically, there is a huge run on the bank, so to speak. Customers are pulling out their high interest deposits at a breathtaking clip, which is eroding the company's capital base. On Friday, the company said it has $521-million in high interest savings accounts, while that figure was at $2-billion a month ago. I suspect that will continue for some time. The Hospital of Ontario Pension Plan (HOOPP) has come to the rescue leading a $2-billion line of credit. And Home Capital is considering a sale according to a press release on Thursday in which the company said it had hired two firms as financial advisers as it considers its strategic options. That has brought the falling knife speculators out in force.
Will someone buy them? HOOPP came to the rescue with a massive credit line that is punitive. A 5-per-cent non-refundable fixed payment to secure the line, a 10-per-cent interest rate on money drawn, and a 2.5-per-cent rate on money not drawn. That will likely cut earnings to next to nothing. A sweet deal for HOOPP, but according to the records, they do not own any equity. It was not clear if the credit line turns to equity if Home Capital defaults.
They will certainly suspend the dividend if they have to pay that much for capital so I don't think that the 13 per cent dividend yield will stick.
There are only a few things that can break the real estate bubble in Canada. Rising rates are the obvious catalyst. With the amount of leverage (debt) in the system, interest rates cannot rise much at all – the economy would collapse. We need low rates just to grow modestly.
Job losses would mean that some people cannot afford their homes. We have seen some of this in Alberta as energy prices have declined, but it has not been widespread and we do not see that as an imminent catalyst.
Government policy changes can also have an impact. The recently proposed changes by Ottawa and Ontario probably won't matter much, but it should reduce the speculative bid and housing prices should begin to cool. Forecasting how it all plays out is naive, as no one knows for sure. But I manage risk for a living and the signs are evident that there are growing pockets of risk in the economy and many markets globally. Low rates and lots of deficit spending has papered over a weakening global economy.
Catching falling knives is difficult at best. All this makes the case for passive investing with exchange-traded funds and avoiding the emotion of the news of the day. Sure, you pick up some bad companies now and then, but many of the smartest investors in North America got caught holding the bag on this one, too. The benefit of diversification is your only free lunch.
Reducing your emotional quotient when investing will be the best investment you have ever made. Active asset allocation will always be the best way to preserve capital in your portfolio compared to selecting individual securities. I would challenge anyone on that debate.
Do you want to learn more about how to navigate world markets better? I am speaking in Markham on April 29. Registration is free at www.etfcm.com and you can follow me on my new blog www.bermanscall.com or watch me at Berman's Call on Mondays at 11 a.m. ET on the Business News Network (BNN). Follow me on Twitter: @LarryBermanETF Facebook: ETF Capital Management.