Everybody's selling!!! Should you?

No way: swim upstream from the herd.

Fed Data Shows Large Household Selling of Equities

March-31-2008

If you like tables (not the kind you can throw your junk mail on), the Federal Reserve Flow of Funds Z1 publication may be up your alley.

Link: http://www.federalreserve.gov/releases/z1/Current/z1.pdf

Because I’m somewhat of a “numbers nerd”, it is up my alley.

The Z1 report is a quarterly summary of all financial flows within, and to and from, the United States . It shows the aggregate of all money flows made by the household, business, and government sectors each quarter.

Although it is hard to make money by studying economic data, some data is useful to understanding what’s going on.

One thing I find very interesting in the Z1 report is that the household sector has been selling their holdings of U.S. stocks for several years. Net holdings of individual stocks (not including mutual funds or pensions) by households has decreased at an accelerating rate.

The public is selling stocks (net yearly investment in individual stocks by households):

2003: -$86 billion
2004: -$269 billion
2005: -$467 billion
2006: -$761 billion
2007: -$989 billion

While households have been selling their individual holdings, they have been adding an average of $623 billion to deposit and money market accounts, and an average of $257 billion to mutual fund holdings, in the past 3 years. Meanwhile, net foreign acquisition of U.S. stocks has increased from a mere $5 billion in 2003 to $182 billion in 2007. The largest net buyer of stocks in 2007 were companies themselves, who bought $837 billion net stocks. The total value of all stocks in the U.S. is approximately $16 trillion.

If you add together foreigners and companies, they absorbed nearly all the household sector selling in 2007.

Since 2003, household direct ownership of U.S. stocks has fallen from 43% to 33% of the total stock market, while foreign ownership has increased from 12% to 17%. U.S. households have been net buyers of foreign stocks and mutual funds, though.

Adding together all this data one thing that stands out in my mind is that individual investors are, for the most part, becoming less and less interested in holding individual U.S. stocks. They are holding more and more cash, foreign stocks, and mutual funds. As a percentage of total assets, households now have only 7.6% of their money in individual U.S. stocks, down from 10.7% in 2003. Households have 31% of their assets (and 73% of their liabilities) in real estate.

The first quarter of 2008 looks like more of the same, with individual investors selling stocks (and now mutual funds) at a furious pace.

Clearly, the headlines have been bearish. Economic woes are front page news. Yet if the pace at which they have been selling continues, households will not directly own ANY U.S. stocks in another 5 years. While anything is possible, this is completely implausible. The very idea is wacky. Wacky, I say!

So, what good is this information? I theorize that there will be an abatement of selling pressure by households at some point in the not-too-distant future.

First, it is mathematically impossible for direct household selling of stocks to continue at the same rate of 2007 for very long. Directly held stocks by households totaled $5.4 trillion at the end of 2007. Assuming declines in market value have taken that total to around $5 trillion as of this writing, net selling of another $1 trillion by households this year would take the total down to $4 trillion. This would be a 20% reduction in net ownership in 1 year! Even if you think that is possible, another $1 trillion the following year would be a 25% net reduction (from $4 to $3 trillion). The following years would be a 33% and a 50% reduction if the trend continued. No households would own stocks directly by 2012. That isn’t going to happen. There will always be some people in the U.S. that own shares of U.S. companies.

Second, households ended 2007 with $8.3 trillion in bank deposits and money market funds, enough money to buy fully half the U.S. stock market. With yields on deposits declining to sub-inflation rates, a few people will decide enough is enough and start buying stocks for income if nothing else. Rather than putting more money in the bank, I expect them to start looking at blue chips like GE with a 3.7% yield and saying “What the heck!”. GE has paid annual dividends going back over 100 years.

Third, while it is true that retiring baby boomers will need to liquidate some securities for living expenses, the selling period is extended over a long time. A 62 year old baby boomer born in the first “boomer” year of 1946 and retiring in 2008 can expect to live another 20 years or more. It is unlikely that any selling pressure from retiring boomers, who already hold a diminished percentage of the total stock market, will exert much influence over market prices.

Also, I expect some time soon, many U.S. investors will start to understand that their old domestic Dow 30 blue chips such as Coca-Cola, IBM, Hewlett-Packard, 3M, GE, Johnson & Johnson (among others), achieve half or more of their business outside the United States. Why sell Coke to buy a foreign stock when Coke IS a foreign stock for all practical purposes? 70% of Coke’s revenues are earned outside the U.S. In fact, some of these companies are better investments than foreign stocks simply because they are headquartered in the U.S. and as such pay many employees in devalued U.S. dollars. It’s sad but true!