What Retail Investors are Telling Us, Once Again
(November 17, 2005)
Dear Subscribers and Readers,
In our commentary over the weekend, we discuss two indicators that were potential "thorns" for the bear's case - namely the NYSE Specialist Short Ratio and the current bullish liquidity indicators as discussed by TrimTabs, such as the amount of cash acquisitions, company buybacks, the lack of primary and secondary offerings, and relatively low insider selling. In the process, we managed to discredit the NYSE Specialist Short Ratio as a bullish indicator. But dear readers, the bullish liquidity indicators as presented by TrimTabs - however short term they may be - should be respected. Using the same indicators that TrimTabs has been using, one would have gotten out of the market right before the March 2000 top, as well as gotten into the market during September 2001. Sure, the major market indices did make lower lows during the June to July 2002 period, but that was preceded by a huge spell-binding rally that pulled in many investors and that presented many profitable opportunities. While we are not asking our subscribers to go long in the stock market in a major way, we are definitely not advocating shorting in general.
But of course, while the TrimTabs headline data may look extremely bullish from a stock market liquidity standpoint, readers should keep in mind that the effects of M&A and buybacks can wear out relatively quickly, as was demonstrated during the months after September 2001. Readers should treat this data from TrimTabs as purely short-term in nature, and not use it for any long-term planning.
Moreover, and this is something new: It is important to keep in mind that many recent cash acquisitions have been done by private equity firms via the leveraged buyout (LBO) process. These include firms such as Hertz, Neiman Marcus, MGM, Toys R Us, as well as Warner Music. Readers who are interested in more details should read the most recent NY Times article entitled "The Great Global Buyout Bubble" but here is the gist: According to the NY Times article, buyout firms have spent more than $130 billion this year acquiring many well-known names in Corporate America. Thanks to the lowest borrowing rates in 50 years, buyout firms have been able to borrow a large amount of money to fund their acquisitions. According to the NY Times: "If you figure that the firms can borrow three to five times that amount [the $491 billion that buyout firms have in their coffers thanks to big institutional investors]- a conservative assumption - the industry has more than $2 trillion in purchasing power." That is, even though buyout firms still have plenty of buying power at their disposals, the "low hanging fruits" have already been picked, and many buyout firms are now faced with the dilemma of having to sell their holdings (approximately $500 billion in total) in the next few years in a period of rising borrowing costs. The author is now wondering: Who are they going to sell to? Certainly not the baby boomers, and certainly not to international investors - simply because of the sheer size of these holdings. My guess is that the current cyclical bull market will end with the "popping" of this great LBO bubble. Readers should continue to keep track of the actions of private equity firms going forward.
I now want to take this opportunity and re-ask the question that I asked our subscribers in our November 6th commentary: "Did the Retail Investor Just Show His Hand?" In that commentary, I had discussed the widespread bearishness on bond prices as recently exhibited by retail investors - and how this may provide a good buying opportunity in bonds in the near future. With the most recent release of the "Equity Ownership in America, 2005" survey from the Investment Company Institute and the Securities Industry Association, it is now again time to ask that question.
Let's start with the following chart (courtesy of the ICI and SIA report) showing the number and percentage of households who are owners of equities from 1983 to 2005:
As shown on the chart - despite the 2000 to 2002 cyclical bear market, equity ownership in the United States has continued to increase - topping 50% of all households for the first time in U.S. history this year. While most equity holders are not as complacent as they were in 1999 (please read the full report for details), the virtual majority of equity holders in the U.S. still claim to follow the philosophy of buy-and-hold and "stocks for the long-run." Readers should know, however, that equity out-performance (when buying index funds such as an S&P 500 fund) is very much dependent on two things:
- What your starting point is. Buying equities in an undervalued of fairly-valued stock market (P/E of 15 or under) should ensure equity out-performance over time. That is, if one was buying equities during the 1997 to 2000 period, chances are that there will be other assets who have outperformed and will continue to outperform equities for the foreseeable future.
- The dividend yield. Over time, the majority of stock returns come from the reinvestment of dividends and inflation. Little of it comes from real appreciation. Growth stocks are the exception - but history has shown that being able to buy successful growth stocks in the early stages and then holding for the long-run is a more of a pipedream than reality. For most investors, value investing is still the way to go - unless you are Philip Fisher, of course. The current dividend yield of 1.7% in the S&P 500 is historically low - and should ensure continued equity underperformance for the foreseeable future.
Moreover, it is interesting to note that while equity ownership in the U.S. continues to increase, the growth has drastically decreased over the last 10 years, as opposed to the growth during the 1980s and early 1990s. Quoting from the ICI and SIA report: "While household ownership of equities has increased in recent years, the growth rate of equity ownership has slowed considerably since the 1990s. For example, the number of households owning equities rose 24.5 percent between 1995 and 1999, but was followed by a more modest 8.6 percent increase between 1999 and 2002, and 5.2 percent between 2002 and 2005. Several factors seem to have contributed to the slowdown in the growth of equity ownership during the past decade. First, the growth in the number of workers enrolled in defined contribution plans has slowed. In the 1980s and early 1990s, a large portion of the increase in equity ownership occurred through these plans as an increasing number of businesses began offering them to their workers, particularly among the nation's largest employers."
Again, we pose the question: Did the retail investor just show his hand? Retail investors continue to be relatively complacent about buying and holding equities, even after the popping of the technology bubble during 2000 to 2002. History has shown that the beginning of a secular bull market coincides with severely bearish sentiment among U.S. equity investors. That is, the "hand" of the average retail investor is telling us to be cautious, and that most likely, the secular bear market is not even half-over yet.
For those who are following the demographic issues with a keen eye, I believe the following chart should be of interest:
While the percentage of households owning equities have increased consistently since 1983, that is not the case with young households - namely those where the decision maker is under age 35. In fact, equity ownership among these households has been declining since 1999. As the baby boomers retire, who are they going to sell to? Not only are younger households lacking in number on a historical basis, their affinities for buying equities continue to decline. It is going to be an interesting ride.
On a more immediate note, it is also interesting to see (and readers should not be surprised if they have kept track of our commentaries and the weekly releases from amgdata.com) that the amount of foreign equity ownership has been rising substantially:
It is doubtful that most retail investors in the U.S. know what they are getting into when they are, for example, buying a mutual fund that invests in foreign equities. When the average retail investor buys a mutual fund that invests in foreign equities, he or she is basically betting on two things:
- That foreign earnings growth will exceed U.S. earnings growth for the foreseeable future
- That the U.S. dollar will continue its downtrend from 2001
We have argued that except possibly for Japan (who may be in the midst of emerging from its 15-year old slump) earnings growth in foreign and emerging markets will most likely underperform earnings growth in the U.S. for the foreseeable future. We are also at the point in the economic cycle where U.S. earnings growth (a non-manufacturing and thus relatively non-cyclical economy) should outperform those of other countries - especially in energy-intensive countries such as China or manufacturing-intensive countries such as Germany. In fact, while GDP growth in China has been skyrocketing over the last ten years, earnings growth has been relatively dismal as margins have continued to be squeezed from all sides.
On the second note, readers should recall that we first became "officially bullish" on the U.S. dollar in our May 1st commentary - when the U.S. Dollar Index was at 84.44. Yesterday, it closed at 92.41 - a near 10% appreciation from the April 29th close. Even though the U.S. Dollar Index has risen very quickly in a very short time (and thus, I would not rule out a consolidation phase), this author is still bullish on the U.S. dollar. The continued bullishness in foreign equities from retail investors is not only telling me that the U.S. dollar definitely has more upside, it is also telling me that foreign and emerging market equities are now generally the worse asset classes to invest in.
Finally, I would now like to take this opportunity and ask our readers to respond to two recent issues by either e-mail or in our discussion forum:
- The concept of Peak Oil; and
- Their response to the recent abandonment of the reporting of M-3 by the Federal Reserve
Questions, concerns, and explanations are provided in their respective threads in the discussion forum. I feel that both these exercises will add tremendous knowledge - useful for both us and our subscribers. After all, these two issues will not be going away any time soon.
Okay, this author is not done yet, as I want to extend our weekend discussion on the energy sector, namely natural gas. For readers who are interested, you can obtain historical monthly demand statistics (broken down by the type of user) from the following EIA webpage. It is interesting to note that consumption from industrial users have historically ranked number two among all types of natural gas users - during both summer and winter months. What most analysts have not discussed over the last six months is the fact that industrial demand has been severely tanking - anywhere from 5% to 10% on a year-over-year basis. That is, for some industrial users, the recent high natural gas costs represented the final nail in the coffin - and they are either moving their operations overseas or shutting down their operations altogether. If this downtrend in industrial demand continues, then this author would not be surprised to see a 60 BCF (billion cubic feet) per month decline in industrial demand this winter. Combined with the fact that natural gas production in the Gulf of Mexico should continue to recover, my guess is that the January 2005 natural gas contract - currently trading at over $13/MMBtu - is at best, fairly valued, even assuming a colder-than-expected winter.
Henry K. To, CFA