Insider Insights

Inside The Market


We may be in the summer doldrums for stock market trading volumes and the number of Form 4s insiders are filing at the SEC, but there is little sense of calm when it comes to lingering macro events that could yet cause a break out or break down in equity prices.

The volume of insider filings are solidly in a seasonally low state, resulting from most companies closing their trading windows to insiders until a couple days after their June quarter results are released. Even so, we didn't expect our intra-day monitoring programs to set off alarms last week about a potential problem with our Form 4 processing systems. We have our system programmed to alert us if there is an unusually large time lag between filings reaching the insider database subscribers screen and analyze during days the SEC is open. But our systems were fine. It was just an intra-day dry spell of Form 4s unusual even for this seasonally slow time.

Specifically, last week there were just 113 companies with insiders buying their shares in the open market versus an also small 232 firms with insiders selling. That total of 345 companies with open-market activity is a fraction of the 855 companies that had similar combined insider activity during the peak Q2 filing week ended 5/18/12. If seasonal trends hold, this coming week will be an even slower filing period for insiders. Form 4 volumes will then trend higher as the number of companies releasing financial results increases. Filing volumes should reach their next crescendo during the second week of August.

Forever blowing bubbles

Despite the present slow filing period, we still pay attention to our proprietary insider buy/sell ratios-which are calculated differently than the simple dollar-value insider ratios that tend to go to extremes too quickly. The four week average of our insider buy/sell ratios (aka our Insider-Based Market Indicator) is now at negative 78%, representing that there's been an average of 78% more firms with insiders selling their shares in the open market versus buying over the past four weeks.

That absolute level is actually quite interesting. In our weekly InsiderInsights Newsletter we present Charts each issue that graphically present the long and short-term meanderings of our Insider-Based Market Indicator. For nearly two decades before the bubble-generating, loose-money years got going in earnest in 2003, our Indicator tended to bottom out at around negative 80%. That was our bullish signal that the stock rally prompting insiders to sell more heavily was reaching exhaustion.

At the end of 2003, however, our Indicator fell to the unheard of depth of negative 284%, and it stayed remarkably negative for months! Back then we heard commentators on insider data opine that things were different this time. The insider ratios were suddenly not as relevant, they said, due to stock options and other technical matters having to do with the filings.

That didn't seem right to us. We recalled that there was no shortage of insiders exercising options in the late 1990's in the run up to the Internet bubble bursting in March 2000. Yet our Indicator managed to generate unmistakable buy signals in the fall of both 1998 and 1999. Long story short, after publishing a study on the odd movements of our Insider-Based Market Indicator in the (now antiquated looking) February 28, 2005 issue of InsiderInsights, we concluded that:

"all the accommodative monetary and fiscal policies of 2003 and 2004 merely postponed the inevitable fixing of numerous economic imbalances that could cause a shock to equities. Which is to say that insiders may be absolutely correct to be fearful right now, even though their fear has not been a good tactical tool for investors this time around."

At the dividing line

Our further take on the use of our Insider-Based Market Indicator in the lead up to what we now all know as the financial crisis was that we wouldn't really trust a market rally until our Indicator once again inflected downwards after rising to at least positive 40%--as it did before the bubble years began in 2003. (It has since done so three times: in January 2009; March 2009, and; September 2011.) But that didn't stop us from recognizing that our Indicator was still generating useful market signals. It was just doing so at a much lower level. Interestingly, the new level that our indicator began topping out at was around, drum roll please…negative 80%!

So what was the bearish floor for our Insider-Based Market Indicator before 2003 ended up being the bullish ceiling during what we came to call these "Bubble Normal" times of too-loose-for-our-own-good policies out of the Beltway. Go figure. And as we relay above, our Indicator is once more approaching that "dividing line" of sorts from above.

So whether we interpret our Indicator as presently being in bullish or bearish territory depends on whether we believe we are still in a period of loose monetary and/or fiscal policy (which should force our Indicator lower as stocks trade higher), or whether we think central banks and governments are finally out of real or effective ammo to battle the economic downturn (which should make our Indicator reverse bearishly upwards from here in reaction to stocks falling).

The concept of stocks needing more loose policies to rally higher is hardly a ground-breaking conclusion. But it is a valuable sign that our Insider-Based Market Indicator appears to be confirming that widely held sentiment on its own. The level of our Indicator is also absolutely a useful bit of knowledge for developing tactics. We have and do make definitive market calls (sometimes contrarian ones) at InsiderInsights when the data dictates. But the fact that our Indicator is not even close to a bullish or bearish extreme right now tells us that this is no time to go "all-in" or "all-out" with our clients' portfolios. That's an important conclusion too, and one that will likely keep us out of trouble.

Up or down, or down then up?

We obviously have market opinions over and above our insider-based work, though. We are fundamental analysts at heart and by training, with a tertiary degree or two. And with the U.S. and European economies still far from being healthy, we think another loose money barrage is in the offing.

But that unfortunately still doesn't mean that right now is necessarily the time to buy, buy, buy. While we presently expect a further rally in stocks some time this year in reaction to a coordinated central bank loosening effort of a magnitude not seen for at least four years (sarcasm intended), we unfortunately also expect central banks' efforts to only be grudgingly made after deteriorating economic fundamentals cause a further decline in the value of risk assets.

That's also hardly a news flash of a scenario. It may even be the most common one being bantered about at this time. But there is a difference-a huge difference-between thinking it will happen, and preparing for it to happen. We've spent the past couple months making forced sales in order to raise our cash level up to between 20% and 35%, depending on the week.

The sales are consistent with the conclusion we reached (albeit belatedly) in our June 8th issue of InsiderInsights, when we started our latest round of raising cash in preparation for a better buying opportunity. Insiders have done their job at supplying us with a large number of solid new stock ideas with significant, company specific trades. We're now spoiled for choice for insider-approved and (more importantly) fundamentally sound investment ideas in the energy and biotech sectors, as well as stocks considered income plays and special situations.

We expect to put more money to work on the long side this week, but not enough to bring our cash below 20% again. The odds of a better buying opportunity in the not-so-distant future remain too high not to hold onto some dry powder. And as far as we're concerned, cash is a valid asset to hold in the short term, despite the low return it offers.

That's our call going into this week, though we reserve the right to change our opinion as quickly as market realities mutate. "Better nimble than dogmatic" remains our motto in this tricky market.

TAGS: Equities
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