Are Insider Stock Sales a Bad Sign for the Market?

Investors and analysts sometimes view large amounts of insider selling as an indication that executives lack confidence in their companies or are generally downbeat on the economy. And sometimes that’s the case. What’s more, there’s more of it going on at the moment than normally.

Insider Selling Is Different This Time

According to the Financial Times, U.S. corporate executives are selling stock of their employers at the highest level since 2000. Data from Britain-based Smart Insider, a firm that tracks insider stock activity, and strips out sales for tax purposes, ownership limits and other non-market factors. This year, through mid-September, combined insider sales of stock reached $19 billion, trending toward $26 billion by the end of the year, surpassing the post-crisis summit of $25 billion in insider selling in 2017.

Of course, the rise in stock prices plays a role in the insider’s decision to sell a stock. Most corporate executives’ compensation packages include stocks or warrants, and this component is sometimes higher than their cash pay out.

So it makes perfect sense they would want to participate in the price gains by selling stock. On the other hand, 2019 will likely be the most active year for insider stock selling since the disastrous dot com bubble selloff sent the market plunging in 2000, when insiders sold $37 billion worth of stock just before the correction.

Are We in a Stock Bubble?

Is that what we’re seeing with the current insider selling?

Perhaps; but it’s not likely. For one thing, from a relative value perspective, it doesn’t appear that the two periods are comparable. Today’ stock market valuation is more than twice than it was then. The billions in insider selling then become much less relative to the total market than it was in 2000.

Also, the dot com bubble was truly an instance when companies with zero revenues were given outrageous valuations based primarily upon speculation about future valuations. That’s often a risk that accompanies first generation technology companies and their world-shaking impact. If that is the case today, it is mostly in the unicorn private equity space, outside the public stock market.

Furthermore, both investors and analysts in today’s market have a much deeper understanding of risk and rewards of internet companies, with known and observable key metrics. Also, neither new, digital technology nor fraud seem to be driving market valuation nor are a factor with regard to some of the largest insider stock sales events.

Retail Weakness

For example, some of the major insider sellers today are in the retail industry. That’s a much less frothy sector than technology or biomedical ones. It’s the Walton family and executives, owners of the retail giant Walmart, along with cosmetic company Este Lauder and women’s athletic wear leader Lulumon Athletica who are leading in insider stock sales. That just doesn’t have the same reckless feel like the dot com bubble.

What’s more, today there doesn’t seem to be a comparable investment climate for speculation within the markets that there was in 2000. And, our economy is arguably stronger now than it was then. As much of the world’s economies struggle with recessions or near-zero growth, the U.S. economy continues to grow and attract investment.

Federal Reserve Can’t Be Overlooked

Another huge factor in the growth and stability of the market is the Federal Reserve. From 2008 through 2015, its policy of quantitative easing injected much needed liquidity into the economy, with much of it supporting the stock market.  Quantitative easing had the direct effect of raising asset prices in the markets. Starting November, the Fed will once again begin quantitative easing. Whether it impacts stock prices as it has in the past, however, remains to be seen.

Of course, the unknown outcome of the U.S. trade war with China may also be a reasonable factor driving insider stock sales. As the optimism-to-pessimism cycle continues without an end in sight, doubts about pricing and supply chains increase. Doubts about the global economic outlook as a whole are pervasive.

That may, in fact, explain why retail is leading the insider selling. Slower global growth and rising costs due to moving factories and other related expenses may reduce profit margins for the next year or longer for some companies who rely on Chinese manufacturing. Locking in stock gains now makes sense.

Do Insiders Show Us When to Buy and Sell?

These factors all impact selling decisions of insiders, but don’t necessarily point toward a market correction, or more narrowly, even a correction in a company’s stock price. Other, more salient indicators, such as forward price-earnings (a forward look at expected earnings) and cyclically adjusted price-earnings (typically over a rolling 10-year period) ratios, cashflow, debt,  and other business metrics are better indicators of a company’s near-term price.

Bearing all this in mind, should investors be tracking and mimicking buy and sell actions of insiders? How well do insider sellers – or buyers – do in their actions? Are they making money or losing it?

According to the American Association of Individual Investors, insider buying and selling have been “fairly good predictors of future stock performance” but “not foolproof.”

James Gorrie is a writer and speaker based in Southern California. He is the author of “The China Crisis.”

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Author: James Gorrie