Insiders Cashing in May Hurt Stocks

NEW YORK (Reuters) - Think it's time to buy stocks now the market has stabilized after its spring rally? Many corporate insiders don't.

Executives sold about $32 worth of their own companies' stock for every $1 they bought in July. That is the most bearish they have been since May 2001, and it marks the third straight month that the ratio of selling to buying has topped the $20 level, according to research firm Thomson Financial.

While Wall Street experts say there could be many reasons for employees to trade their own companies' shares, executives' recent reluctance to buy may not bode well for the stock market in the days to come.

``Any time investors stop buying, it signals that they think they will earn better returns someplace else,'' said Charles Elson, a professor of corporate governance at the University of Delaware. ``For us investors, it's not a particularly good sign.''

The last time the market experienced three straight months of such bearishness by insiders was July to September of 2000. Six months later, the Standard & Poor's 500 index (.SPX) had dropped 19 percent, and a year later, the index was down 28 percent, said Lon Gerber, director of insider research at Thomson Financial.

``Is that going to happen now? We don't know for sure, but it's just not a very encouraging signal,'' Gerber said.

Money managers follow trading by employees since insiders often have a close-up view of their company's day-to-day progress and so are thought to have a particularly keen sense of its financial health.

Executives sold $2.4 billion worth of their own companies' stock in July, a number that is right in line with the historic five-year monthly average for selling. But they bought only $73 million worth of stock last month, giving July the lowest monthly level of insiders' stock purchases in two years, according to a Thomson Financial report.

Stocks barreled higher this spring as investors bet on a rebound in the economy and corporate profits in a rally that drove the Standard & Poor's 500 index (.SPX) up about 26 percent from its 2003 low on March 11 to its closing high for the year on June 17.

The S&P 500 is still up more than 23 percent from its mid-March low and up more than 12 percent so far this year.

Among the big sellers over the past six months have been executives at Dell Inc. (DELL.O), Microsoft Corp. (MSFT.O) and Mandalay Resort Group (MBG.N).

Between May 22 and May 27, for example, Michael Dell, the chief executive officer and founder of Dell Inc., sold about 10 million shares worth about $279 million, according to a Securities and Exchange Commission filing. The week before he sold, Dell stock surged over $32, the first time it had seen that level since November 2000. The stock now trades slightly below $32 a share.

Michael Ensign, Mandalay's chairman, CEO and chief operating officer, from mid-June to mid-July disposed of about half of his stake in the casino operator -- selling a total of about 2.9 million shares worth about $95 million, according to data collected by Thomson Financial.

Mandalay Vice Chairman William Richardson, another top shareholder in the company, also cut his stake about in half during that period to rake in about $95 million.

The sales followed a jump in the company's stock price that came after Mandalay said it would pay a dividend for the first time. The shares have climbed further since then.

In May, Steve Ballmer, Microsoft's chief executive and the long-time partner of co-founder Bill Gates, sold shares in the world's largest software maker for the first time in 12 years, getting rid of about $1.4 billion worth of his holdings in the company, federal securities filings showed.

But counting strictly on insider trading to gauge the market's future direction can be a risky proposition, some analysts say.

Just because executives are not buying their own companies' shares does not necessarily mean they are not buying stocks at all. Plus, they are not always as prescient about their companies' futures as one might expect.

``How do we know their sense is good? Maybe they're misjudging it. I can think of examples where you had insiders buying, and the company went broke,'' Elson said.

In addition, employees sometimes receive stocks on a regular basis as part of their pay packages and selling is a way of cashing in.

``Clearly there are individual situations where stocks that have been bruised in the market and an insider will step up and buy stock, that I think can be relevant,'' said Rick Meckler, president of investment firm LibertyView Capital Management.

``But as long as stock is going to be used for compensation, you would expect people to be net sellers over time.''

I would not expect to see, nor have I ever seen, presidents or business leaders predicting the end of the financial world. It is their role to try to support the economy and the markets, not drive them down by forecasting gloom and doom. That is also the role of the Federal Reserve.

For that reason, I'm not surprised at these quotations.

What I try to work with is logic. So, if you were a corporate exec and part of your compensation package is in the form of stock options, and your company’s stock has just appreciated by anywhere for 50% to 500% (lots of tech stocks have done just that) from the trough of the collapse, what would you do?

Well, I don’t know about you, but my reaction would be to sell some of that stock and created a diversified portfolio so that if the worst happens, I would not be caught in the same situation I was in when my entire net worth was tied up in my company stock and it cratered.

One more thing, the 144 reports that show insider selling only show selling. There is no rule requiring the purchase of substitute securities (unless you are buying your own company’s stock). What would be interesting to me is to see what is being done with the money. My educated guess is that it’s going into managed equity portfolios, hedge funds, and bond portfolios. Diversification, it’s a beautiful thing.

Sorry to disagree, but I must. The rationale for diversification is that different asset classes act in different ways. The technical term for it is correlation factor. For example, large cap value stocks and small cap growth stocks are not perfectly correlated and will perform differently. That is why a well-diversified portfolio will hold as many as 10 different asset classes.

Since it is not possible to consistently predict which asset class will outperform in the next year, portfolios are diversified so as to own some of each. This will absolutely guarantee that the portfolio will not outperform any individual asset class during any one period, but it will guarantee that the owner of that portfolio will not get caught in the same situation that Enron or Worldcom employees were.

We can always tell each other where we should have been to make a fortune if we could go back in time. Unfortunately, my “wayback machine” is acting up.

It is important to note one thing: the only 144 reporting that is required is INSIDER buying and selling. It is not reported if the president of Exxon Mobil buys shares in IBM.

When an insider buys, he is probably adding to an already large position of his company’s stock., creating a situation where a dangerous part of his net worth is tied up in one stock.

In the lifetime of the modern executive we have never had a market melt-down like the one of 2000-2002. Many tech executives went from multimillionaires to poverty (some owing more in taxes than their stock positions were worth).

THAT is a lesson that they will never forget.

I would be surprised if anyone with half a brain would expect people who are already over-concentrated in a single stock to repeat the mistakes that got them - and their neighbors - into trouble just a few years ago.

I confidently predict that we will see much more 144 selling than buying for years to come. Their wives, friends, neighbors and financial advisors will all tell them to diversify.

TrimTabs is also reporting more selling than buying and concludes the market will decline or remain weak until companies stop expanding supply and begin buying back their own stock. You can listen to last weeks Jim Puplava's interview with Charles Biderman here:

Charles Biderman Interview

Biderman says the trend is flashing a warning signal. Good interview.

Richard W.

”TrimTabs is also reporting more selling than buying and concludes the market will decline or remain weak until companies stop expanding supply and begin buying back their own stock.”

I don’t wish to be disagreeable, but do wish to disagree. I contend that insider selling is natural in view of two facts: first, the run-up in the stock market – in some stocks hundreds of percent since the bottom of the market in 2002. Second, as I noted in my posts 21 and 24, corporate executives will not soon forget the lessons of the crash of 2000-2002. They are diversifying, and doing it at a time when the market has paused and the run up has stalled. That makes a lot of sense.

I would be surprised to see net insider buying for years.

In my own case, while not an insider and not subject to Rule 144, I own a lot of my company’s stock as the result of the award of stock options. My company’s stock recently hit an all-time-in-the-history-of-the-universe high. I have been selling the stock and will continue to do so until I reach a level where it does not represent more than 10% of my net worth. Under Rule 144 you would have concluded from my selling that I believed that my stock was going to decline. I believe no such thing, but I have also absorbed the lessons of 2000-2002, seeing the value of high quality companies like GE and Microsoft decline by over 50%. I will not allow my own family’s finances be exposed to a singe stock, a few stocks or even a single asset class.

WARNING - This is certainly for advanced investors only.

I too was raised on the sacred doctrine of diversification.

And yes, there is always something good happening in one of a diverse group of real estate, resources like metals and energy, technology, health-care, interest bearing securities and businesses, etc.

From what I have read and experienced, the most successful do not 'cut the flowers and water the weeds'. They ride a winner for as long as possible, and the more leverage they carry on the winner, the better.

Now, if we are wanting to retire in 40 years on a modest but stable base, we should highlight safety, keep working at a steady job, invest $100 per week in a solid mutual fund, etc.

Or, if not, open your eyes wide, spot the fundamentally-sound trend in vogue, for example, investment real estate, and just go for it with both barrels.

What you will do in a single year will humble your entire past efforts, including your job income however honorably earned.

When the fundamentally-sound trend becomes momentum only, get ready to bail.

Then, shop wisely, and invest in the next fundamentally-sound trend.

I have leap-frogged entire generations of wealth because of this amazingly-safe philosophy.

The key is finding fundamental value (i.e. backed by defineable earnings and income), and having your entire focus on making it work.

Repeat - never let your eye off the ball.

They are diversifying, and doing it at a time when the market has paused and the run up has stalled. That makes a lot of sense.

So you are saying that the insiders are trying to reduce risk by buying shares of other companies -- one's that have already risen to nose bleed areas of valuation. If it makes sense to you, then maybe there is something I'm missing.

Richard W.

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