Why private equity is a buy now

By Jon Markman

They don't let teenagers into the operating room to perform lung transplants. They don't let Little Leaguers climb into the batter's box to face Roger Clemens. But in the stock market, anything goes: Your average butcher, baker and candlestick maker can punch a "buy" button online and trade any day of the week against the canniest pros of Wall Street.

Most of the time, the competition is a total mismatch, so when you see situations in which the pros and amateurs are at extreme opposite ends of a trade, it grabs your attention. And right now, my friends, it's Godzilla vs. the Baby-sitters Club as retail investors flee the U.S. stock market at a time when corporations and insiders are stealthily scooping up equities left and right.

Maybe the amateurs will get it right this time -- who knows? But the odds favor the pros, and unlike in the movies, this is a game where underdogs have a terrible record.

Bad timing

How much do retail investors hate American stocks? Let me count the ways. In July alone, U.S. equity mutual funds saw $11.6 billion pour out of the door, the highest one-month outflow since September 2002, according to California research firm TrimTabs. In the past three months, outflow from U.S. equity funds has totaled $24.7 billion, the greatest draining of market capitalization since the third quarter of 2002. Most of it is not going under the mattress: $9.7 billion piled up in global equity funds last month, while $7.76 billion went to bond funds.

The investors who make these kinds of decisions -- moms and dads, teachers and doctors -- may be great people, but they have proven themselves in cycle after cycle to be horrible market timers. So the stunning skew in their decision making, away from U.S. stocks and toward foreign stocks and domestic bonds, could be an indication that U.S. stocks are on the verge of a period of serious outperformance.

If this sounds to you like déjà vu, you are right on the mark. TrimTabs points out that when the U.S. stock market topped out in 2000, mutual fund investors had just completed a 12-month period in which they poured a record $260 billion into U.S. equity funds while yanking $50 billion out of bond funds -- loading up on exactly the wrong asset class as shares were about to plunge. And then by the time the U.S. market hit bottom in October 2002, retail investors had gone fully in reverse, draining $25 billion from U.S. equity mutual funds and dumping $141 billion into bond funds. Whoops.

Companies and corporate insiders appear to be doing just the opposite right now. Federal regulatory data show that insider selling totaled only $240 million daily from July 20 through late last week, down almost 50% from the annual average. This means people who actually run companies and know how well they're doing are not betting that the market is on the verge of a wipeout.

• Video: Blackstone disputes story in The New York Times

Corporate buyback activity and mergers show the same, as the market's capitalization was reduced by $567 billion in the first seven months of 2007, according to TrimTabs data, and you can add another staggering $81 billion in announced buybacks so far in August. That includes the massive $15 billion reported by Procter & Gamble (PG, news, msgs) last week. In other words, companies are much more enthusiastic about U.S. stocks than the public, and they are buying at a record pace that could total $1 trillion by the time the year is out.

A post-IPO bargain

Companies are taking a long-term view at a time when they can still borrow money relatively cheaply.

To be sure, there is more pain to come in the shares of bombed-out home builders and banks, as a constriction of lending to even the best credits in the market will crimp home sales and the vast constellation of retail that revolves around them.

But bottom-fishers are taking the view that these risks are mostly discounted by now, and that their investors pay them to make these kinds of tough decisions.

So what should you buy in these conditions? Strangely enough, I am very attracted to the companies that started it all -- the private-equity firms. Organizations such as Blackstone Group (BX, news, msgs), Fortress Group (FIG, news, msgs), Leucadia National (LUK, news, msgs) and Brookfield Asset Management (BAM, news, msgs) live for these kinds of moments, so that they can sweep in like vultures and buy assets for dimes on the dollar. These are the cream of the crop in U.S. finance, and they will beat the amateurs at their game every day of the week.

Continued: A closer look at Blackstone

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