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!

Short term opportunity after PAIN

SGP Schering-Plough Corp:

Dropped 25% today to $14 and change due to a negative RCT on SGP's novel cholesterol drug Vytorin. This is a huge over reaction, leaving SGP one of the cheapest big Pharma players around. The forward P/E multiple is just 8. It has a bit more debt than I'd like to see with the recent $14 Billion Organon acquisition (D:E almost 1); however, the pipeline looks healthy for the future and there is a potential blockbuster anaesthetic drug called Sugammadex nearing release worldwide. A new anti-platelet agent called TRA (for Acute Coronary syndromes) is also promising.

Morningstar has indicated that it feels the FMV of SGP as of today is $31, giving a greater than 50% margin of safety.

Fred Hassan is a CEO with an excellent track record. He has introduced a much leaner infrastructure which should continue to improve operating margins down the line.

I already own a few shares of SGP and have put in a bid to double my stake today.

Addenum:

Summary of Morningstar's take: "Despite our reduced expectations for Vytorin and Zetia, we continue to believe Schering-Plough SGP holds much potential. Outside of what we believe to be an overreaction to the Enhance data, Schering-Plough offers a robust new pipeline of drugs and relatively minimal patent exposure."

Status/Strategy Report

BAM.A Brookfield Asset Management--> I think the market deeply misunderstands this company as a REIT. A relatively small share buyback of 1 million shares was just completed this month (remember the market cap is $17 Billion). I have put in a standing bid for more shares at $25, hoping that this bear market rally will collapse soon and drag BAM down with it to even cheaper levels. It is definitely possible that BAM may find it more difficult to find other equity partners to make their multi-billion dollar deals with in the current environment-- without such a catalyst, I doubt that this stock will take off any time soon, so I'm biding my time to acquire shares in small increments, slowly.

BBSI Barrett Business Services--> Remains debt free despite acquisitions. I went over the annual report in detail and barring one accounting irregularity, the company's prospects appear solid. The irregularity was an internal control problem with the IT dept regarding the cash management and reporting of cash flows between offices and the head office in Vancouver, WA. The remediation procedure was well covered. I'm surprised that the analysts didn't bring it up in the Q4 conference call but it may be possible that this information wasn't available to them at that time. Accounting irregularities of any type do make me nervous so I may wait for another quarter before adding to my position as I previously planned. I doubt that this issue will make a material impact on the company's financial health and it is the only big question mark/vunerability I can find to date. This company is maximally exposed to the turn down in the local California economy, so we are seeing the company remain profitable and debt free during adverse times, something that strongly suggests a large margin of safety despite being a small cap security. I think that the management is top notch.

KMX CarMax--> Wall St. is not enamored with this stock but its customers and employees certainly are. I've been hard pressed to find any negative feedback about it, even on the Motley Fool discussion boards. It's not dirt cheap at a P/E multiple of 20; however, the following issues add to the margin of safety: EPS growth exceeding 16% p.a. over the last 5 years, the lowest leverage in the industry D:E 0.12, a current ratio of 2.4 and committed management with considerable insider ownership (7%) and let's not forget that Berkshire is a major holder (10%). Their business plan (discussed previously) is solid and difficult to replicate.
Like BAM, I don't expect the share price to appreciate much in the next 18 months and I think recession has been already factored into the share price. Despite small-mid cap status, I think it is another good long term hold that I will add to on dips. Morningstar has reaffirmed its fair market value at $32/share recently and since its currently trading at about $19 this gives a P/FMV ratio of 60%. I would buy at any price less than or = to $19.

CKI Clarke Inc--> Definitely not a boring company. Armoyan (the CEO/President/Chair all in one) is aggressively buying back shares personally and through Geosam, a holding company owned by his family. He is still buying up small Canadian trusts and although I can see the strategy he is using paying off over the long term, I am concerned about debt. The annual report suggested a current ratio of over 6; however, recent investments (and share buy backs) will have consumed this readily available cash. It's difficult to estimate CKI's total short and long term debt with the information I have available. The last D:E ratio was 0.67 and I'm guessing it's closer to 1 now. I plan to hold tight with my fairly large stake until the next financial report. Unfortunately, Clarke doesn't host conference calls so the tough questions don't get asked. Armoyan is no dummy and he has a massive stake in this company, so I think that his interests are still aligned with the shareholders--- definitely more so in Clarke Inc that in the trusts he's swallowing up.

Quantitative Investing-- Sorry, you DO have to still use your brain

Fool me once...

by Todd N Kenyon He's back. Back to his old tricks, just not quite as bad. And only because people were willing to give him Billions to play with AGAIN.

No, not Donald Trump. John Meriwether, the infamous founder of the even more infamous Long Term Capital Management, (which strangely enough made highly-levered short term bets on a variety of fixed income and other securities). Of course LTCM lives in infamy due to it's $4B implosion in 1998 which forced a coordinated bailout to avoid a financial market train wreck (ironically, Bear Stearns was the only big investment bank that declined to participate in the bailout).

With merely $5B in capital, Long Term had borrowed about $125B and had off balance sheet positions with notional values of over a trillion dollars. LTCM employed up to 50x leverage because its trades, by design, only returned very small percentage gains, and its roster of rocket scientists and Nobel Prize winners believed that it was impossible for many of their bets to go against them at once - the diversification was too great (hmm - sounds familiar...). History has shown again and again however that so-called diversification works until it doesn't. When things get bad, EVERYTHING correlates. The Russian financial crisis provided another example of stress-induced correlation, and as essentially all of LTCM's trades started going against them, Wall Street vultures piled on and that was that.

The Russian Crisis was one of Nassim Taleb's "Black Swans" - an unprecedented and unlikely event that nonetheless was possible. Mr. Taleb described LTCM's strategy as akin to "picking up pennies in front of a steam roller" - a fairly certain series of small gains with the unlikely but real possibility of a fatal event.

The WSJ featured an article yesterday entitled "A Decade Later, John Meriwether Must Scramble Again". Amazingly, only a year after the LTCM disaster, Meriwether started another firm with LTCM alumni. Once again, investors gave him billions to manage. As the WSJ reports, until this year the funds have had mediocre but positive performance. They have performed well below peers and their benchmarks, but haven't lost money. Now, it is starting to look far worse as one fund is down 28% YTD. Meriwether has told investors he learned his lesson, and hence he now only employs a "mere" 15x leverage. Mere that is, until another black swan shows up. And show up it has in the form of the credit crunch. If investors all decide to bail and his bets continue to go against him, he's finished. Again.

This all begs the question as to why investors would give this guy billions shortly after he precipitated a major financial crisis. Not only that, they pay him 2% of assets + 20% of gains (i.e., $46 million last year just for the management fee!), only to have him underperform an index fund for years and then possibly implode yet again. Here he is back in the same sort of pickle as the one that killed LTCM, albeit with less capital and leverage. Thankfully, he likely won't cause a financial crisis (other than for his investors) this time. Will two times be enough to finally teach investors a lesson? Fool me twice, shame on me, fool me three times...?

Dr. Paul Price's analysis of Cintas CTAS

Caution-- I've still got to do my homework on this one so please don't accept the analysis at face value:

Too Good not to Mention Again - Cintas Corp. - CTAS

by Dr Paul Price Unformly Cheap – Cintas Corporation

Cintas Corporation [Nasdaq:CTAS] March 26, 2008 close: $28.82
52-week range: $27.41 [Mar. 17, 2008] - $41.04 [Jul. 13, 2007]
Yield = 1.60%

Cintas designs, manufactures and distributes uniforms mainly through its rental division (73% of sales). They also rent cleaning equipment. The remaining 27% of revenues comes from distribution of first-aid supplies, fire protection products and document management services.

EPS in their fiscal third quarter [ended February 29] were up 10.4% at $0.53 versus $0.48 year-over-year. Cintas lowered its guidance for the FY ending in May to $2.12 - $2.16 due to the weak U.S. economy. That revised figure still represents all-time record earnings on the highest sales in the company’s history. Current estimates for FY 2009 are now at $2.30/share.

The recent market sell-off has pushed these shares to < 13.5x current earnings – less than half the 10-year median P/E for Cintas. In fact, CTAS shares have only had an average annual P/E of less than 20 once since 1992.
Value Line is assuming a very conservative 18 multiple for CTAS for their
3 – 5 year projections.

Cintas has shown outstanding and consistent growth. Every year since 1992 has seen increased sales and earnings. The dividend has risen in each year during that period also.

Over the past 10 years:
[All figures are split-adjusted]

…………….Sales/share……….EPS………..Annual Dividend
FY 1997……..$5.80…………..$0.64…………….$0.10
FY 1998……..$7.64…………..$0.77…………….$0.12
FY 1999…… $10.64………….$0.99…………….$0.15
FY 2000…….$11.30………….$1.14…………….$0.19
FY 2001…….$12.76………….$1.30…………….$0.22
FY 2002…….$13.36………….$1.36…………….$0.25
FY 2003…….$15.75………….$1.45…………….$0.27
FY 2004…... $16.42...…. …...$1.58…….……….$0.29
FY 2005…….$17.97………….$1.74…………….$0.32
FY 2006…….$20.86………….$1.94…………….$0.35
FY 2007…….$23.36………….$2.09…………….$0.39

10-year CAGRs for all the above were between 13.5% - 15.5%.

As of November 30, 2007 Cintas had only 24% LT debt and total debt coverage of > 11x. Value Line assigns them a B++ financial strength rating and places them in the top 1% of their 1700 stock universe for earnings predictability.

Chairman Richard Farmer holds 11.4% of the shares and other officers and directors held another 3% of the outstanding. They have been actively buying in their own shares since 2004. The common share count has been reduced by over 10% [from 171.4 MM to around 153.5 MM] since then.

How cheap are these shares right now? They trade today dollars below the lows at any time between 2001 and 2007. In that whole period, when fundamentals were nowhere near present levels the absolute low hit in those seven years was $30.60 [and the trailing P/E at that multi-year low point was then over 21x].

A return to even 18x expected 2008 calendar year earnings of $2.20 would bring these shares back to $39.60 or plus 27.4% from today’s quote. Add in the 1.6% current yield and a 29% total return within 12 – 16 months looks to be quite predictable.

Is that crazy? Nope. CTAS shares have peaked at $42.90 and higher in each year since 1998.


Disclosure: Author owns shares and is short puts on Cintas Corp.

The Stingy Investor's Stock list for 2008

Norm Rothery's modified Graham criteria read it here

Ken Fisher's comments on the credit crunch

Other than Walmart, take his stock recommendations with a grain of salt. Arcelor Mittal is very highly leveraged, even by steel industry standards and has grown so much in the past 2 years that the law of large numbers will apply. C's fate remains to be seen. Why speculate when you can invest in known quantities such as Wells Fargo and US Bancorp that have been unfairly dragged down by C's poor stewardship?


Financial Columnists
Portfolio Strategy | Crunch Mythology
Ken Fisher 03.24.08, 12:00 AM ET

If you believe the popular economic myths of the day, you think there's a credit squeeze--less total credit available. This is nonsense. There's indeed less credit available to poor risks, individual and corporate. But that just means there's more for the good borrowers. Blue-chip companies are flush with capital and borrowing power. This is bullish, both for the economy and for stocks, especially stocks of big companies.

Fact: The largest firms have much more credit access in all forms than they did 12 months ago. These are the very firms that can spend it the most and the fastest.

Fact: Total corporate borrowing--that is, total U.S. corporate debt issuance--was higher in 2007 than in 2006. In January 2008 U.S. corporate borrowing was $101 billion, up slightly from the same month a year ago. The majority of this debt was of investment grade, meaning that it was rated BBB or better; within this segment the borrowings were up 12% from a year ago. Some credit crunch!

If there were a squeeze, interest rates would be shooting up. They aren't. Over the past year the yield on investment grade corporate bonds has gone down. At the superprime end, debt rated AAA, the yield is down from 5.18% to 4.63%. Globally, there are only 14 corporate borrowers with that rating (among them ExxonMobil and Novartis). But there are more than 350 A-rated or higher. Recently rates are down, a little, on AA, A and BBB bonds, too.

A parallel myth is that corporations have stopped doing takeovers and stock buybacks. Tell that to Microsoft. It's just that we've changed from a lot of small deals to fewer bigger ones. By the fourth quarter "credit crunch" headlines were ubiquitous, yet fourth-quarter 2007 announced takeovers were $478 billion, the fourth-largest quarter ever. The volume was a $116 billion gain from the third quarter. Share repurchase announcements in January totaled $59 billion, up 16% from a year ago. That's a $700 billion annual rate. The prior four months were also up--collectively, by 63.5%, to $276 billion ($828 billion annualized).

Where do we get all these myths about crises and collapses? From pontificators. The sort of folks who frequent Davos.

Yahoo will cost Microsoft $40 billion or more if it goes through--essentially half cash. It will issue long-term debt for the first time in its existence. Surprise, it will be AAA rated. In one bite, IBM announces a $15 billion stock buyback. Some credit crunch. Think big.

As I detailed last month, the market has shifted, as it did in the mid-1990s, into a period where the biggest stocks do best. We're in the first full correction of the new leg of the bull market. The Asian debt contagion then is the American debt contagion today. This debt crisis is, like the last one, a false alarm. By midyear we will awaken to an ever shrinking supply of equity and a growing economy. The market will be led by big companies.

If you think we're moving toward recession, you might expect steel prices to weaken. So many expect this to happen that recession is already built into the prices of steel shares. Since I see no recession, I expect steel to do well. Hence I like Arcelor Mittal (79, MT), domiciled in Luxembourg but spread across the globe. It operates in 60 nations. Its 115 million tons of annual capacity give it 15% of the world total and three times as much as its largest competitor. Arcelor mines coal and iron, makes coke, has both integrated mills and minimills and has top-notch distribution. In an industry selling at two times annual revenue Arcelor is at just one times. It goes for ten times likely 2008 earnings and two times book value. A little price increase from here could go a long way for this $115 billion market-cap producer.

Still worried about a recession? Then buy Wal-Mart (51, WMT), which retails affordable consumer staples in good times and bad. The world's dominant retailer at a market multiple of earnings isn't a bad way to go when the biggest stocks are doing best. Market capitalization, $204 billion.

It's going to take years for the financial sector to recover from its excesses, just as it took years for energy to recover from the 1980 collapse and for technology to recover from 2000. Still, I like Citigroup (25, C). The stock costs less than half of what it did last year. The market value of $129 billion looks high against earnings of $3 billion. But those earnings reflect the subprime writeoffs. These writeoffs have simply nothing to do with the underlying business. Take them out of the equation and you find Citi going for four times operating earnings. I think this is a $40 stock by mid-2009.