Recent insider selling is ominous

By Mark Hulbert, CBS.MarketWatch.com | 12:01 AM ET March 19, 2004

ANNANDALE, Va. (CBS.MW) - Not all insider selling is created equal. We should be much more worried about some kinds than others.

Unfortunately, we may be witnessing the worrying kind right now.

Insiders, of course, are a company's officers and directors as well as its largest shareholders. They are required to report to the Securities and Exchange Commission all transactions involving their companies' stock, and the SEC makes those reports public.

It stands to reason that we pay attention to insiders, since they presumably know more about their companies' prospects than you or I do.

Yet insiders have been extremely heavy sellers over the past 12 months. Those who assumed that all insider selling is equally bearish, and therefore went to cash when insiders became heavy sellers, have missed out on the market's rise of more than 30 percent over the past year.

Yet, as I pointed out in a column last fall, insider selling is not particularly bearish if it occurs in the wake of a rising stock market. I based that column on research by H. Nejat Seyhun, a finance professor at the University of Michigan, who has devoted much of his professional career to studying insider behavior.

Only if insider selling occurs in the wake of a market decline does it foretell likely market weakness, according to Seyhun.

The implication of his research therefore was that investors could draw no conclusions from insider selling so long as the market continued to go up. But, Seyhun told me in September, "if prices begin to decline from [current levels] and insider selling continues and/or accelerates" he would advise getting out of stocks.

Which brings us back to the present: The stock market in recent weeks has experienced its first correction in excess of 5 percent since the market took off a year ago.

And though we only have early precincts reporting - because not all insiders immediately report their trades -- it looks like the pace of insider selling increased during the recent correction.

For data on insider selling, I turn to Vickers Stock Research, publishers of Vickers Weekly Insider Report. Vickers gathers the insider data that are reported to the SEC and, among a number of other things it does with the data, calculates an overall ratio of insider sales to insider purchases.

Take a look at the accompanying chart, which plots weekly changes in this ratio since last summer. The ratio climbed steadily until late last year, when it began declining. But note in particular how that decline came to an end earlier this year, more or less at the same time that the market's correction commenced.

That is not a good sign, especially if this trend were to continue.

The only consolation is that insiders tend to be early. Academic researchers have found that insiders anticipate downturns in their companies' earnings by at least three calendar quarters, and as much as nine calendar quarters.

So, on the assumption that recent insider selling is indeed bearish, we still may have at least until the end of this year before the bad news they are anticipating comes to pass.