Insider buying is one of the most telling market indicators you have at your disposal.

When company insiders (CEOs, CFOs, major shareholders, directors, etc.) are bullish enough to spend millions of their own dollars to buy stock on the open market, it means they think stocks are cheap and worth owning.

However, when those same insiders are selling stocks en masse, the market is generally overextended and stocks (on a whole) are expensive. That’s when you want to exit stage left. Or at the very least, you want to sit on the sidelines and observe from a distance.

Now is one of those times when you should either be a seller or sitting on the sidelines in cash. Take a look at the chart below. It shows the ratio of insider buying to selling compared with the performance of the S&P 500:

Notice insider buying inversely correlates to the general market’s performance. In other words, when the market plunges, insider buying peaks. And when the market peaks, insider buying dries up. For instance…

During the crash of 1987, the number of firms with insider buying almost doubled. While the mainstream was panicking (and selling for massive losses), the smart money was piling in.

The same thing happened during the collapse in 2001.

The ratio of insider buying to selling spiked twice between September 2001 and September 2002. During that time frame, the S&P 500 fell from 1,155 to 800. That was a good buying opportunity. The S&P 500 is at 1,250 today.

By comparison, insider buying has been all but nonexistent lately. This is no big surprise when you think about it. On May 8, the S&P 500 hit a new five-year high. So there aren’t many bargains on Wall Street. And as you would expect, the insiders are selling stocks at a greater pace than anytime in the last six years. The ratio of buying to selling is approaching 0.2 today, compared with well over 1.4 in 2001-2002.

This is a very telling sign.

The people who are running the companies you and I are investing in are selling their own stocks right now. These are the guys who know about future orders coming in. They know specifics market trends long before you and I have a clue. They know everything about their own balance sheets, income statements and cash-flow situations. Armed with all of this information, the insiders are saying, “Screw this, we’re getting the heck out of Dodge.”

Yet retail investors keep buying.

Even after the recent correction from early May to mid-June, the market immediately rebounded. Your average investor was (and is) convinced that we are still in a raging bull market and that stocks (even really bad ones) will keep rising.

This is a classic sucker’s rally. And I can say it is a sucker’s rally with a high degree of certainty because the smart money has been eerily absent from the equation. Only fools are buying now. They bid the prices up, and the people in the know sell out for a nice profit.

This situation can only end badly for the fools.

Now is a good time to take profits — especially on speculative stocks that are selling way ahead of their underlying fundamentals.

Of course, there are still a handful of stocks that the insiders think are very attractive. Insider buying has not dried up completely.

This morning, I discovered an ambulance company that does business in some of the fastest-growing states in the country. It has growing sales, healthy net income, above-average profit margins and very strong cash flows. The company is paying down debt ahead of schedule — which caused Moody’s to upgrade its credit rating. And the CEO of the company recently bought nearly 30,000 shares at market prices of well over $200,000.

As it turns out, this stock is down 29% from its highs last year. So it is already beaten down. It is exactly the kind of stock that should outperform the market — even as most stocks crumble.

As an investor, I’d much rather put my money in stocks the insiders are bullish enough on to invest in alongside of me — especially in this ugly market.

Best regards,

James
July 13, 2006

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