Panic Sellers Want Cash

18 Aug

The recent market selloff, led by financials and consumer discretionary stocks, looks very much like a panic. By mid-day Thursday, the S&P 500 was down 10% – an unofficial “correction” level. The last couple weeks have been one of the best times to invest new money in a very long time.

Over the past few weeks, we’ve seen indiscriminate selling across the board. For instance, one company I watch very closely was down as much as 50% since the end of June, a result not of its own operational problems but of being lumped into a broad category along with American Home Mortgage (AHM), a just-bankrupted mortgage REIT. Yet its business model and risk profile is very different than the typical “mortgage REIT.” It has now rebounded 50% from its lows and the indiscriminate selling offered a great opportunity to add to positions. This situation is not isolated only to this one stock; I’ve seen it with many others.

Countrywide Financial (CFC), a company I’ve mentioned here as a reasonable value at higher prices, is down 50% year-to-date on concerns the company doesn’t have access to enough liquidity to continue funding its operations. I’ve read all the recent filings and press releases, but what has been reported in the media based on those communications has amounted to “spin.” In the most recent example, the widely reported news that “Countrywide is forced to max out its credit line” was an exaggeration. True, CFC did max out one of its credit lines, but has access to quite a bit of additional short-term liquidity that will allow it to continue making loans. And now, with the Fed cutting the discount rate Friday to 5.75% and the borrowing term now 30 days renewable, CFC now has access through its bank to highly-available, reasonably-priced capital.

As of June 30, CFC was paying its depositors a weighted-average rate of about 5.15% on deposits and is now offering 12-month CDs at 5.65%. Discount window loans won’t cost them much more. Countrywide is continuing to make loans and take market share. They bought five branches from HomeBanc a few days before it entered bankruptcy and are hiring workers from American Home, previously mentioned. Year-over-year through June 30, market share rose to near 19% from under 15% last year, and funding grew despite an overall mortgage market that was down 10%. I cannot summarize the entire investment case here, but I (still) believe CFC shares are an excellent value at current prices, but are not for the faint of heart because the road will be very bumpy until the dust settles.

As Ben Graham said, “In the short term, the market is a voting machine; in the long-term, it is a weighting machine.” And in the past few weeks people have “voted” by taking their capital out of the market, and especially certain sectors. During just the past week ended Thursday, $585 million was pulled from the Select Sector SPDRs Financial fund (XTF), which was nearly 20% of its assets. Money market funds reported net inflows of $41.484 billion, the largest year-to-date. The week prior to that, money markets had net cash inflows totaling $36.229 billion, the largest inflows since 12/7/05. Investors are selling stocks (and bonds) and going to short-term funds to “wait out” the storm. As a value investor, I am happy to turn over some of my cash for the undervalued assets they’re selling.

The best time to get in is when everyone else is getting out. Analyze well, consider worst-case scenarios and downside risk, and if your reasoning and analysis are good market prices will eventually reflect economic reality, regardless of the irrationality of Mr. Market.

Full disclosure: Long CFC.

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