EDITOR NOTE: Small caps began surging in November last year, having underperformed the S&P 500 in all of 2020. Now it tops the broad-based sector, and perhaps its performance is enough to give investors a reason to feel bullish. But according to a recent MarketWatch article, corporate insiders--those required by the SEC to report their holdings--are more bearish now than ever on small-cap stocks. With the energy, finance, and utility sectors seeing the most bullish activity, what does this say about the market and economy as a whole, as the largest segment in both is composed of smaller businesses and small-cap stocks? Should investors seriously consider hedging their exposure? If so, toward what, considering that investment-grade bonds are barely yielding anything, and the value of the dollar is sinking. The only thing left of real value toward growth and preservation is gold and silver.
Corporate insiders are more bearish today than they’ve been in more than a decade.
That’s bad news for the stock market, since it stands to reason — and this is backed up by the data — that insiders have greater insight into their companies’ prospects than the rest of us. Insiders include officers, directors and the largest shareholders. They are required to report more or less immediately to the SEC whenever they buy or sell shares of their companies’ stock, and many on Wall Street pay close attention to trends that emerge.
Research conducted by Nejat Seyhun, a finance professor at the University of Michigan and a leading expert on the behavior of insiders, has found that the insiders whose behavior is most revealing are officers and directors. In contrast, Seyhun has found that the largest shareholders do not on average have any special insight into where their companies are headed. Since the dollar volumes of outside shareholders’ transactions typically dwarf those of officers and directors, it’s important to ignore their purchases and sales when analyzing the underlying trends.
Seyhun at my request did just that a few days ago, and the accompanying chart summarizes what he found. The chart plots the percentage of companies with any director or officer transaction in a given month in which there were more purchases than sales. For the month of January to date this proportion is just 10.8%. That’s the lowest level of the past decade.
To put the latest data in statistical perspective, it is 2.2 standard deviations below the 10-year average. The current reading is something we’d expect to see just 2% of the time.
Also evident from the chart is the extraordinary shift in insider sentiment over the past year. At the March lows, the proportion of firms with net officer or director buying rose to an extremely high 62.5%. Since then the S&P 500 SPX, 1.15% has risen more than 70% while the Nasdaq Composite COMP, 1.30% has almost doubled.
Nowadays, in contrast, insiders with the most insight collectively are almost as bearish as they were bullish then. Bulls should definitely take note.
Bulls still control these 3 market sectors
While officers and directors are bearish across all market-cap categories, according to Seyhun’s data they are most bearish for small-cap companies. In that cohort, the percentage of companies for which net buying is positive is 3.4 standard deviations below its 10-year mean — something you’d expect just 0.1% of the time.
Among the midcap stocks, the percentage of companies for which net officer and director buying is positive is 2.2 standard deviations below its 10-year mean, and for large-caps it is 1.1 standard deviations below. Those are still bearish readings, but not as bearish as for small caps.
Among industries, the sectors in which the proportion of firms with net officer and director buying is highest are energy, financials and utilities. The first two of these sectors were also the ones for which insiders were most bullish last August, which is when I last devoted a column to Seyhun’s analysis. Since then, the Energy Select Sector SPDR ETF XLE, 2.92% has gained 18.8%, according to FactSet, and the Financials Select Sector SPDR ETF XLF, 2.94% has gained 22.9%. The S&P 500 meanwhile is up 12.2%.
Originally posted on MarketWatch