Insiders’ Caution May Be Warning Worth Heeding

A lot of people think stocks are too expensive at these near-record levels. And that group now includes some folks who should know best how to value shares: Company insiders.

The pace at which corporate executives have been buying their own companies’ shares has slowed sharply since spring, and in recent weeks the number of insider buyers has crashed to what some analysts consider ominous levels.

Wall Street’s fear is that the insiders are foretelling that the market’s rally is running out of gas, and that it’s better to wait for lower prices to buy. Corporate executives’ market timing isn’t foolproof but historically has been quite good.

Insiders’ buying and selling of their own companies’ shares is public information because key executives are required to report their trades to the Securities and Exchange Commission. A number of investment newsletters track the trades, on the theory that insiders are the best judges of their own companies’ prospects and thus of the true value--or lack thereof--in the stocks.

Of course, executives often can make stock purchases at below-market prices via options. Analysts ignore those trades when trying to judge insiders’ bullishness or bearishness. Instead, the insider-trackers focus on open-market purchases, meaning transactions made at the same price the public would pay for the stocks.

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What has happened since spring is that insiders’ interest in paying market prices for their own stocks has dwindled significantly:

* Insiders newsletter in Deerfield Beach, Fla., says its “Insider Indicator” index has slumped to 36% currently, meaning that only 36% of reported insider stock transactions over the past five weeks have been purchases, and 64% have been sales.

In contrast, the index registered 58% purchases in early February, an extraordinarily bullish reading that coincided with the sharp acceleration of this year’s stock market rally. The Dow Jones industrial average was at 3,900 back then, compared to 4,620 now.

* A “flash” index tracked by the Insiders letter is even more bearish. It looks at insider transactions that occurred over the past 20 days. That index now shows just 23% buyers and 77% sellers.

* The number of industries in which insider selling is swamping purchases has soared in recent weeks, according to the CDA/Investnet Insiders’ Chronicle newsletter in Ft. Lauderdale, Fla.

Measuring insider activity over the prior 90 days, 47 industries currently are ranked “sell” by the Chronicle, up from 28 three weeks ago. And the number of industries ranked “buy” is 11 now, down from 27 three weeks ago, according to Chronicle editor Robert Gabele.

“The numbers are getting increasingly bearish,” Gabele says. “The [bull market] tide is going out, from the insiders’ perspective,” he says.

George Shirk, analyst at the Insiders letter, agrees. The number and dollar-value of insider transactions can be extremely volatile from week to week, he notes, and in general you expect more insider selling than buying--because shares purchased via options don’t count as open-market purchases, but are of course part of open-market sales when let go. Even so, Shirk says, “What we’ve really seen is a cessation of buying here.”

Although it can’t be proven, the assumption is that if insiders are far more interested in selling their own companies’ shares than buying, they must believe that prices are unsustainably high.

“I think it boils down to insiders’ expectations” regarding corporate earnings, Shirk says. Wall Street is widely anticipating that the robust earnings growth of the past 18 months will continue into 1996, but “it looks like insiders really don’t believe those numbers,” Shirk suggests.

Because SEC rules require insiders to hold any stock they buy for at least six months, executives must look at least that far ahead when judging whether their shares are bargains at current prices. If an insider figures the stock will be lower in six months, there may be little sense in buying now.

Both Gabele and Shirk caution that heavy insider selling, and/or a low level of buying, don’t necessarily mean the market is doomed to collapse. Historically, aggressive buying has been a much better predictor of a rising market (as earlier this year) than aggressive selling has been a good predictor of a plunging market. And sometimes the insiders’ timing, overall, is dead wrong.

But with the U.S. market already up more than 20% this year, insiders’ growing caution about their own shares may be a warning worth heeding.

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Losing Their Appetite

Corporate insiders’ purchases of their own companies’ shares have slumped sharply since the beginning of the year, as the stock market has soared. Percentage of open-market insider trades that were purchases (as opposed to sales), bi-monthly readings of a five-week moving average:

Aug. 1995: 36%

Source: The Insiders newsletter