Have Insiders Turned Bearish on the Market?

This article is published with permission from InvestmentU.com.

The average bull market lasts 4-and-a-half years. This one just had its fifth birthday.

And nervous stock market investors have had more to chew on in recent weeks: Fed tapering, soft earnings news, slowing growth in China, geopolitical tensions with Russia, newfound enthusiasm for equities among small investors (a famous and well-founded contrarian indicator known as "the odd-lot indicator," since small investors are often unable to buy in round lots of 100), and—oh yeah—the fact that the Dow has returned approximately zero so far this year.

And there's more. In a recent column in The Wall Street Journal, Mark Hulbert offers "The Inside Scoop: Officers and Directors Are Bearish." He declares that corporate insiders "are more bearish than they have been at least since 1990."

That doesn't sound good. Is this the time to bail on stocks?

What insiders know

Hulbert rightly points out that corporate insiders "know more about their companies' prospects than the rest of us." How could it be otherwise? They have access to all sorts of material, nonpublic information that is unavailable to the rest of us.

They know the direction of sales since the last-quarter report, whether there are any new products or services in development, whether the company has gained or lost any major customers, whether any pending litigation is about to be settled, and so on.

This gives them an unfair advantage, so Uncle Sam requires that they file a Form 4 (electronically) with the SEC any time they buy or sell their own company's shares, detailing how many shares they bought, at what price and when. This helps level the playing field.

But do they know whether the market is about to go up or down? Of course not. No one can know that. And you can't devise it from their buying and selling patterns either.

Hulbert urges caution because in recent weeks corporate officers and directors have sold an average of 6 shares of their company's stock for every one that they bought—double the average ratio since 1990.

No need to bail

But I would urge caution about exercising caution. Insiders often sell for reasons that have nothing to do with the outlook for their business. For i

nstance, option grants today are a big part of executive compensation. These insiders may be selling to simply take advantage of the discrepancy between their option price and the market price. Or they may be selling to diversify their portfolios. (Bill Gates, for instance, has been a regular seller of Microsoft shares not just for years, but decades. It's not that he doesn't like the company. It's because—like the rest of us—he has an overhead.)

With dividends reinvested, stocks have nearly tripled in the last 5 years. Wouldn't a reasonable investor take some profits, regardless of their outlook for the economy or the market?

Academics will point out that when the ratio of selling to buying is this high it has sometimes preceded trouble for the market. But there have been other times when it hasn't. The insider ratio was virtually the same as it is today in early 2007 and early 2011, for example, and stocks continued to go up.

In short, insiders know an awful lot about their own companies' prospects. When they buy a significant number of shares with their own money at current market prices that should get your attention.

But insiders don't know what the market is about to do. So you can safely disregard indicators based on their aggregate behavior.

As an investor, the important issue is what insiders are buying and why … not how many are selling and when.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.