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Stock Market Insiders are Running for the Exits, Should You Follow?

Stock-Markets / Stock Markets 2010 Nov 04, 2010 - 02:40 PM GMT

By: Q1_Publishing

Stock-Markets Best Financial Markets Analysis ArticleThe Federal Reserve announced its going to pump more than $800 billion of new cash into the economy.

Financial assets, as they’ve done for the past two years, have responded strongly to the pump.

There is, however, a lot of causes for concern. One of the big ones that recently grabbed a lot of headlines is record levels of insider selling.

There’s nothing that spooks investors like insider selling.

The premise is a simple one. Insiders know their company best. They know how well the company is doing. They can see problems months before the markets do.

So when they buy, conventional wisdom views it as a good sign. When they sell, it’s a bad sign. And when they all sell, it’s a bad sign for the overall markets.

That’s why when a recent CNBC report found insider selling has reached record highs, a lot of people are taking note.

This could be the exact wrong move to make right now. Here’s why.

3,177-to-1: Insiders Running for the Exits

There are a lot of “leading indicators” out there. The proverbial canaries in the coal mine are sectors which are directly tied to consumer activity and business investment.

Two of those are technology and retail - technology because it’s highly correlated to business investment and retail because it shows how much consumers are really spending.

Lately, insiders of companies in these bellwether sectors have been dumping shares at an astonishing rate.

John Melloy in CNBC reports in Insider Selling Volume at Highest Level Ever Tracked:

The largest companies in three of the most important leading sectors of the market have seen their executives classified as insiders sell more than 120 million shares of stock over the last six months. Top executives at these very same companies bought just 38,000 shares over that same time period, making for an eye-popping sell to buy ratio of 3,177 to one.

That’s an absolutely astonishing ratio for sure. But we’ve got to remember, CEOs and CFOs of Fortune 500 companies are, as a group, just as terrible investors as most everyone else.

The Insider Selling Fallacy

The table below on insider selling shows how poorly insiders have done over the past eight years:

The chart reveals two clear trends about insider buying and selling.

First, insiders buy most heavily on “dips.” They tend to view a decline in the overall markets as a time to buy. Whether that’s a 5% or 10% correction or more, they’re buyers when the markets are headed down.

Almost every time the market fell, they bought over the past few years. They really started buying in 2007 when the markets felt the first whiff of the subprime meltdown. It turned out to be the worst possible time to buy stocks in the past decade.

Second, insiders sell most heavily when the markets are doing well. While the markets were rallying from 2003 lows to a peak in 2007, their selling was about equal with buying. The markets went up and up while insiders sold and sold.

These two tendencies show insiders are terrible investors. They buy every dip – whether stocks are headed lower or not – and they sell every rally – whether stocks are eventually headed higher.

That’s why it’s no surprise, given the market rally, to see insiders selling so much. Its further proof that insider selling as a whole is nothing to be concerned about.

Wait for the Turning Point

Massive insider selling will be just another “warning sign” to keep the majority of investors on the sidelines.

The Fed’s free money policies will likely keep stocks headed higher and create asset bubbles of enormous proportions.

It was a Fed injection of liquidity during the currency crisis and Russian debt default of the late 1990s that created the tech bubble. The Fed’s response to the tech bust created the housing bubble. The Fed’s current unprecedented response to the housing bust that preceded response to the housing bust will inevitably create an unprecedented bubble in many financial assets.

In the next Prosperity Dispatch, we’ll look at which assets the money will likely flow to, why, and look at how much higher those bubbles can go.

Good investing,

Andrew Mickey

Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2010 Copyright Q1 Publishing - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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