These company insiders are the only ones to watch — and right now their buying is bullish for U.S. stocks

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US stock market will give marginally positive returns over the next 12 months. You don’t think it’s particularly newsworthy. But it comes as, as it currently is, some Wall Street people are claiming that insiders have never been more bearish than they are now. If this is true then it would be worrying, because insiders have more information about the prospects of their companies than the rest of us.

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But, fortunately, that’s not true—at least not for insiders who have historically been worth following.

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This is the conclusion I draw from research conducted by Nejat Sehun, a finance professor at the University of Michigan and one of the leading experts in academia interpreting the behavior of corporate insiders.

According to Sehun, there are three categories of insiders, and only two are important to investors: corporate directors and executives. Right now, according to their latest data, on balance these two categories of insiders are very close to being in the middle of their historical range between extremely bullish or extremely bearish.

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Their current currency translates into an expected US stock market return over the next 12 months that is only marginally below the historical average.

The third category of insiders, which Cehun’s research found not to be eligible for the following, includes the companies’ largest shareholders. Because their transactions are typically several orders of magnitude higher than those of executives and directors, overall insider data will be dominated by this category of insiders who have the least amount of insight. This is why Sehun ignores these largest shareholders when analyzing insider behavior.

The chart below tells the insider that Sehun has found significant predictive power. It is the six-month moving average of the percentage of publicly traded companies for which there is a net purchase from officers and directors. Companies that have no insider buying or selling are ignored for the purposes of calculating this figure. Its latest value is 18%.

This may leave many of you thinking dangerously low, so it’s important to note two distinct features of the chart. First, note that the indicator was at a very low level in 2013, and that year and subsequent years have been very good for equities. Second, note that this insider indicator has never risen above 50% in the past decade. For example, in the wake of the fall in the February-March 2020 waterfall, which was when insiders on the balance were as close to bullish as before, the indicator rose to 43%. Its long-term average is in the low 20s, only slightly above the latest reading.

The reason most companies have net insider selling experience is that both corporate officers and directors receive a substantial portion of their compensation in the form of their companies’ stock. Although the acquisition of those shares would never appear as a purchase in insider data, the eventual sale of those shares would. So it makes sense that insider data would lean more towards selling than buying.

Another reason not to be alarmed is what might otherwise appear to be excessive insider selling: Many insider sales are done for reasons that have nothing to do with their opinion of their companies’ prospects. For example, they may need to pay for a child’s college tuition or make a down payment on a home.

This is very different from when an insider uses personal assets to buy more company stock. That’s why you should look at the percentage of companies that have a net insider buy. Currently, this percentage is slightly below its historical average.

Mark Hulbert is a regular contributor to Businesshala. Their Hulbert Ratings track investment newsletters that pay a flat fee to be audited. he can be reached here [email protected]

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