In his budget for fiscal 2015, President Obama assumed courageously or just conveniently that the US economy would grow 3.1% in 2014, quite a jump after having lumbered along at 1.9% in 2013, and given what looks to be a soft start for the year. But according to the budget proposal, the economy would boom. It would be the fastest growth rate since 2005. It would be the most exciting economy in nine years.
That level of growth would solve a lot of problems. Citing the rebound in housing – the price bubble, apparently, though sales are plunging – along with strength in manufacturing and oil production, the budget statement claimed that there were “encouraging signs emerging across industries.” And so the economy “is moving forward and businesses are creating jobs, but our top priority must be accelerating that growth….”
Given this sizzling economy, companies would finally see some revenue growth beyond the rate of inflation that would support some real earnings growth, rather than the masterfully doctored earnings growth of late, and their stocks would soar. And corporate insiders, who can see all this better than the White House because they have their boots on the ground and are involved in the nitty-gritty of their operations, should be the most bullish in nine years.
Corporate insiders can be divided into two groups: the company’s executives and directors; and large shareholders who own at least 10% of the outstanding shares. When any of them sell or buy the company’s shares, they have to report it to the SEC – and by extension, to the public. How they voted with their wallets – not the hype that they dish out – is studiously tracked and scrutinized and transformed into a sell-to-buy ratio to gain more insight into what’s really going on, which is usually impossible.
So in 2007, these very insiders as a group, the smart money that gets the inside scoop, had no clue what was coming, based on their buying and selling patterns, had no clue with regards to their own company, and had no clue with regards to the markets or the economy. In October 2007, at the very peak of that bubble, they didn’t see that a tornado was forming right in front of them. According to Mark Hulbert, who watches this sort of thing, the sell-to-buy ratio at the time was more bullish than the historical range.
Blow these insider geniuses off because they don’t know any more than the huddled masses?
Not so fast, says Nejat Seyhun, a finance professor at the University of Michigan, cited by Hulbert. He determined in research conducted before 2007 and validated on two occasions since – in the crash of 2008/09 and in the 20% downdraft of 2011 – that some of the insiders are the smart money who know where their company’s share price is going. and they act on this knowledge by buying or selling; and some insiders are just the dumb money with big wallets.
Seyhun figured out that if you remove the largest shareholders – the dumb money with big wallets – from the pool of insiders, you end up mostly with executives and directors – the people who really know. And he consolidated their behavior into his adjusted sell-to-buy ratio. “In the summer of 2007, for example, his adjusted insider sell-to-buy ratio was more bearish than at any time since 1990” when the data series began, Hulbert points out. True insiders – the executives and directors – were quietly dumping their company’s shares during the last months of the bubble while spouting off hype for public consumption.
And once again, we’re inundated with hype. Obama’s forecast of an economy that’ll grow a glorious 3.1% this year is part of it, but served up on an official, gleaming White House platter. And Wall Street screams buy, buy, buy.
But Seyhun’s adjusted sell-to-buy ratio is now once again at the same extreme bearish level as in the summer of 2007, and as in 2011 just before the 20% market plunge, Hulbert reported. The executives and directors as a group knew when to get out back then. And they’re once again quietly dumping the shares of their companies, acting on their boots-on-the-ground knowledge of things to come, and trying to get out before the shares of their companies – and the markets overall – once again swoon.
Meanwhile, small investors are finally having fun in the stock market again, after years of sitting out the most phenomenal rally. They’re leveraging up their portfolios. Margin debt is spiking beautifully. Alas, spiking margin debt has a nasty habit of ending in a crash. Read…. Small Investors Exuberant, Margin Debt And Risk Of Crash Soar
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.