Insider Selling Picks Up…As Expected

We remain fully invested going into next week, but that doesn’t mean we’re complacent about this fabulous months-long stock market rally continuing uninterrupted. So we feel it time to go over some of the basics of how we use insider transactions to try and gauge where we may be in a market trend.

Insiders continued to increase their selling activity into the current market rally. This week’s insider buy/sell ratio was –147%, meaning that over the past five market sessions, there have been 147% more companies with insiders selling their shares in the open market versus buying them. This is also the most negative weekly ratio we’ve seen since July of last year, and it pulled the rolling 4-week average of our buy/sell ratios (which we also refer to as our Insider-Based Market Indicator) down to –110%.

But this is as expected. As longer-term clients of our weekly InsiderInsights Newsletter know, insider buy/sell activity tends to skew more towards sales as the market climbs, and more towards buys as the market falls. Which just makes sense, really. It’s perfectly logical that there are more compelling values for insiders to buy as stocks fall. A market well off its highs also generates less stock profits for insiders to logically take. The opposite is true when the market rises. There tends to be fewer insiders buying after their stocks have popped, and more reason for execs to take profits in their suddenly dearer shares.

So it is that the plots of our Insider-Based Market Indicator (Click Here to see Charts) trend more positive as the market falls, and negative as the market climbs. More specifically, the Charts below clearly illustrate that—as expected—the recent near-term peak in our Indicator in September of last year corresponded very well with the bottom of last fall’s pullback for the markets. The trend in our Indicator since then has been down, and the market’s trend has been up.

That’s all as it should be. But it is fair to ask just when we should start to worry about when a dreaded inflection upwards in our Indicator will occur since it will invariably correspond to another pull back in the markets?

We all know the macroeconomic issues that could yet derail any global economic recovery, but acting on such fears before they actually matter to stocks is far too easy to do, and a recipe for underperforming the market. It may surprise new readers to hear, but we don’t view the goal of the top-down insider analysis as telling us when the market is going to change trend in the future.  Instead, our goal is to determine if a change in trend for the indices has legs after it occurs. Trying to call a peak or trough ahead of time is the proverbial “sucker’s game”. We have found it much more profitable to rationally analyze insider sentiment (among other factors) just after a sudden market shift occurs.

Sure, this approach guarantees that we will not get bearish enough at the absolute short-term top for the market, or bullish enough at a short-term bottom. But in our experience, it is far too easy to turn too bearish 10% or more before a market actually tops by being too-clever with one’s market analysis. Same goes for getting back into the market too soon after a sharp pull back. We’d rather be 5% too late to act on a trend change after determining that some pullback or surge is likely to continue, rather than end up being a head fake.

This approach has helped us maximize profits and minimize losses any number of times over the decades. Most recently, we pounded the table last August that it was too early to get fully invested into that market swoon, On the flip side, we confidently bought the market dip in the wake of the Japanese earthquake and tsunami disaster last March, after determining the resultant stock pull back was a buying opportunity, and not the beginning of a longer downtrend.

We’ve explained all this to point out that, even given our approach of not attempting the sucker’s game of calling a change in market trend before it occurs, we absolutely do monitor other factors as a market trend plays out to try and be prepared for possible inflection points. One warning flag popped up this week, and it is not the aforementioned fact that the absolute level of our weekly buy/sell ratio is the most negative it’s been since last July. Heck, as the Charts behind the link illustrate, we’ve seen ratios and our Indicator trend much lower in the recent past before a rally fizzles.

What we find of more acute concern is that the number of stocks that hit our Bearish New Finds table in this week’s InsiderInsights Newsletter is much larger than the number of names that made it on our Bullish New Finds table. Our New Finds tables list all the stocks that met the threshold of having significant bullish and bearish insider activity over the prior week. Considering that we use these tables as determining what stocks are qualified to make it on our Recommended List (if fundamental and technical criteria confirm the insider signal), that means we have more potential short positions to research in the coming week than potential new long positions.

This warning light for the rally also seems consistent with the individual stock research we’ve been undertaking on our existing positions, which has led to stepped up profit taking and a smaller number of buys on our Recommended List. We also find it interesting that this warning light has lit up as rallying indices start to face some technical resistance at the highs hit last July.

To be clear, we are not throwing out this bearish insider stat to suggest that a pull back is imminent. And the larger-than-expected supply of Bearish New Finds in this week’s Newsletter could turn out to be an outlier. But if we continue to have good fundamental and technical reasons to take profits in our longs even as the supply of potential insider-inspired short ideas increases, we could well start to ease into a more defensive position even before any official bearish inflection point upwards in our Insider-Based Market Indicator generates an actual red “sell” bar on our Chart of our Insider-Based Market Indicator.

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