ALBERT HERTER

‘CORPORATE INSIDERS BETTING ON RALLY CONTINUING,’ Mark Hulbert at Marketwatch via fidelity.com.

In Uncategorized on November 18, 2009 at 15:18

Most investors expected the stock market’s October correction to be much deeper and last much longer.

 

Not corporate insiders, however. Soon after that correction began, they markedly picked up the pace of their buying. And this trend has continued since then.

 

The stock market neatly obliged, by almost immediately bringing that correction to an end. The Dow Jones Industrial Average  is now trading comfortably at a 52-week high.

 

Consider the ratio of insider selling to insider buying that is calculated each week by the Vickers Weekly Insider Report, published by Argus Research. In the week ending last Friday, according to the latest issue of the service, this ratio stood at 1.96-to-1. Three weeks ago, in contrast, this ratio stood at 4.52-to-1.

 

As David Coleman, Vickers’ editor, wrote earlier this week, “Insiders … seem to think that there is long-term value still to be found in the shares of their companies.”

 

You might wonder why a 1.96-to-1 sell-to-buy ratio is considered to be bullish, since it means that insiders sold 1.96 shares for every one that they bought.

 

The answer lies in the reasons why insiders will sometimes sell their companies’ shares, which not infrequently have nothing to do with their opinions of those shares’ prospects — such as paying a down payment on a house, or a child’s college tuition. As a result, the insiders’ historical sell-to-buy ratio has averaged between 2-to-1 and 2.5-to-1, according to Vickers.

 

In relation to that historical average, therefore, the current 1.96-to-1 ratio is slightly below average — and to that extent bullish.

 

Furthermore, according to research conducted by University of Michigan finance professor Nejat Seyhun, the average sell-to-buy ratio in recent years has been closer to 6.5-to-1. This can be traced in large part to the increasing share of insider compensation that has come from equity grants from their companies.

 

Since the insiders did not acquire these shares by purchasing them, they will never show up in the sell-to-buy ratio. But insider sales of those shares most definitely will show up, skewing that ratio towards increasingly negative readings.

 

In light of Seyhun’s findings, of course, the current sell-to-buy ratio of 1.96-to-1 is even more bullish.

 

Regardless, Vickers is most definitely not using the recent positive trend of insider behavior to throw caution to the winds. Its two model portfolios on average currently have a healthy 50% cash position, in fact.

 

This also is consistent with the recommended equity exposure of the other insider-oriented newsletter monitored by the Hulbert Financial Digest: Jonathan Moreland’s Insider Insights.

 

The bottom line for those inclined to follow the lead of the insiders: Don’t give up on this rally yet.

 

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