The Shocking Truth About Insider Selling

|
Includes: SPY
by: Lou Basenese

Riddle me this, Batman…

In the last week, the Dow hit an all-time high. Yet corporate insiders are selling shares of their own stock at the fastest pace in over a decade.

As of late February, the ratio of the number of shares that insiders sell in a given week to the number they buy almost hit 10 to 1, according to Vickers Weekly Insider Report.

That must be a sign that a turn in the market is imminent, right? Or, at the very least, that company executives don’t feel optimistic about the economic outlook.

After all, corporate insiders always know best.

Or do they?

Since Tuesday is as good a day as any to bust a Wall Street myth wide open, let’s put this one to the test.

Newsflash: Insiders Don’t Possess Superhuman Investing Skills

The rationale for following an insider’s lead couldn’t be more straightforward: No one knows a company better than a corporate insider.

So, if insiders are buying, then they must be optimistic about the company’s outlook. And if they’re selling, well… not so much.

Unfortunately, though, the data doesn’t back up such simple logic.

As Jim Stack of Investech demonstrates with his annotated chart of the Dow, insider selling has been a terrible indicator of when this bull market is going to end.

More specifically, since 2009, every time insider selling ramps up, the mainstream financial headlines predictably urge caution. But the stock market ends up charging higher and higher.

Click to enlarge

Insiders: The Most Unreliable Stock Market Indicator?

Lest you think the chart above is some rare anomaly related to the current bull market – and that insiders are otherwise capable of predicting market turns – consider a more comprehensive history of insider buying and selling, courtesy of Stack…

  • In late 1982, as the Dow approached a level it couldn’t top in 17 previous years, insider selling hit its highest level in a decade. Did stocks fall shortly thereafter? Nope. They kept rallying for another five years.
  • One week before the infamous 1987 market crash, insider buying ­– not selling ­– reached a record high level. So they were completely caught off guard, too.
  • In 1991, as stocks rallied out of the 1990 recession, insider selling spiked – indicating that the market would eventually plummet. But the bull market lasted another eight years, without a single 10% correction along the way.
  • In May 1999, insider buying hit an eight-year high right before the peak of the dot-com bubble. Again, insiders proved terrible at predicting a market turn.

Add it all up, and as Scott Wren, Senior Equity Strategist at Wells Fargo Advisors, says, “[Insiders] react to fear and greed and are just as uncertain as to what is going to happen in the future [as every other investor].”

Accordingly, we shouldn’t blindly follow their lead.

Lies, Damn Lies and Statistics

If you’re still not convinced that you should ignore the latest bout of insider selling, chew on this:

According to Nejat Seyhun, a professor at the University of Michigan, insiders actually aren’t that bearish after all.

Instead, the headline figures are being heavily skewed by “mega sales” – a large number of shares being sold by a handful of insiders.

Or, as Mark Hulbert of MarketWatch puts it, the headline insider sales numbers don’t “tell the whole story.”

Forget the whole story, Mark. They don’t tell the true story!

It turns out that the overwhelming majority (90%) of shares sold by insiders in February were mega sales. And if we subtract them out, Seyhun says the ratio of insider selling to buying is actually 10% below its average level of the past 12 months – and right in-line with the average level over the last decade.

In other words, even if you want to put your faith in insiders, there’s nothing to worry about based on their latest activity.

Bottom line: Don’t ever take financial headlines at face value. They seldom tell the whole (or true) story. And you definitely shouldn’t rely solely on insiders to govern your investment decisions. They’re just as unreliable.