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Corporate insiders are betting that Dow 20,000 will be just a way station on the road to higher levels.
That’s surprising, because insiders normally sell into strength — just as they tend to buy in the wake of weakness. They’re contrarians, in other words.
That they’re not selling into recent strength is therefore quite bullish, according to Nejat Seyhun, a finance professor at the University of Michigan and a leading expert on the behavior of corporate insiders.
This insider trading is the legal kind — that which is undertaken by a firm’s officers, directors and largest shareholders and reported almost immediately to the Securities and Exchange Commission. Seyhun focuses on only a subset of the insider transactions reported to the SEC, since he’s found from his research that transactions undertaken by a company’s largest shareholders tell us little, if anything, about the market’s prospects.
To put the insiders’ recent behavior into context, consider how they reacted a year ago to the market’s steep January-February correction and then equally sharp reversal. Consistent with their normally contrarian tendencies, they turned quite bullish in February 2016; the correction’s low, you may recall, occurred on the 11th of that month. (See chart, above.)
Continuing in this contrarian vein, notice also from the chart that the insiders progressively cut back on their buying last year as the market rallied through the spring and early summer.
This helps us to understand why insiders’ recent behavior is so unusual — and bullish. Far from cutting back in the wake of the market’s strong post-election rally, as would normally be expected, they have increased the pace of their buying.
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To be sure, the message of the insiders isn’t always right. But history has shown that they’re far more right than wrong. The last time I reported on Seyhun’s research, in October 2015, he projected a 15% return for the broad market over the subsequent 12 months. In fact, the S&P 500’s SPX, -0.09% total return over those 12 months was “just” 11%. In the inexact world of stock market forecasting, that October 2015 projection has to be graded as remarkably accurate.
Are there companies and sectors where insider buying is especially concentrated? In an interview, Seyhun mentioned smaller- and mid-cap companies in particular, for which recent insider buying is above the trailing 10-year average. In contrast, recent insider buying is below average among large caps as a group.
David Miller, manager of the Catalyst Insider Buying Fund INSAX, +0.00% , and one of Seyhun’s graduate students at Michigan, draws special attention right now to the financials sector. In an interview, he mentioned four small- and mid-tier banks where there has been noteworthy insider buying: Carolina Financial CARO, -0.50% FNB Bancorp FNBG, +0.29% ; Medley Capital MCC, -0.79% , and Paragon Commercial PBNC, +1.39% .
The other sector that Miller notes for recent insider buying is health care. Five companies in that sector he mentions are: Baxter International BAX, +2.23% ; Edwards Lifesciences EW, +2.25% ; Insulet PODD, +0.92% ; McKesson, MCK, -1.33% and Medtronic MDT, +1.22% .
Be aware that following the insiders is not particularly appropriate for short-term market timing. Seyhun has found that the insider data have their greatest explanatory power at the 12-month horizon. So, even if the insiders turn out to be right in their current bullishness, the market could very well suffer a near-term correction. This is what happened in early 2016, for example, just two months after Seyhun’s bullish forecast from October 2015. But as we now know, insiders have enjoyed the last laugh.