Mark Hulbert: More Good News From Insiders

[HenryTo]

Some good news for the bulls here:
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More good news from insiders

By Mark Hulbert, MarketWatch
Last Update: 12:05 AM ET May 17, 2005

ANNANDALE, Va. (MarketWatch) -- According to data released on Monday, corporate insiders are now more bullish than they have been at any time since May 2003, when the Dow Jones Industrials Average was trading around 8,500.

Insiders, of course, are a firm's officers, directors, and largest shareholders. Regulations require them to report to the Securities and Exchange Commission whenever they make a transaction in their companies' stock, and various firms collect that data and report it to subscribers.

One such firm is Argus Research, which publishes the Vickers Weekly Insider Report. It reports a number of aggregate statistics based on insider buying and selling at all firms; the one on which it places the greatest importance is a ratio of the total dollar value of all insider selling over the trailing 8 weeks to total insider buying.

As of its latest issue, released on Monday, the 8-week sell/buy ratio stands at 2.52. As recently as last December, this 8-week ratio stood at 6.40.

The last time it was any lower than the current reading was May 21, 2003, when it stood at 2.44. The ($INDU: news, chart, profile) DJIA closed that day at 8,516.

If you're not familiar with the patterns of insider buying and selling, it might not be clear why a ratio of 2.52 is positive. After all, even if the ratio is lower than where it was six months ago, how can it be bullish that insiders are selling 2.52 times as much of their companies' stock as they are buying?

The answer is that insiders always are selling more of their stock than they are purchasing. That's not the issue. Instead, the question is whether they are buying or selling more than the historical norm.

It used to be that the norm was considered to be around 2.5 times as much selling as buying. If that were still the norm today, then the current reading would be no better than neutral.

But as I have written before, the norm today is probably closer to 6.5 to 1 than 2.5 to 1. That's because the ratio of insider selling to insider buying focuses on open-market transactions. Shares purchased pursuant to exercising an option do not qualify. So as options have played an increasingly large role in executive compensation over the last decade, the sell-to-buy ratio has become more and more skewed. (Read archived column.)

Therefore, the current ratio of 2.52 suggests that insiders are selling at much less than normal levels. This is why Argus Research expects the broad market "to improve from their recent lows over the next month or so" - and why its newsletter's two model portfolios currently are more than 70% invested in equities, up from near zero at the beginning of the year.

The newsletter's track record gives credibility to this bullishness. Consider portfolios that switched between the (DWC: news, chart, profile) Wilshire 5000 and T-Bills according to the allocation advice the newsletter recommends for its two model portfolios. Both of these hypothetical portfolios have handily beaten a buy-and-hold on a risk-adjusted basis since January 1993, when the Hulbert Financial Digest began tracking the newsletter.