Professor Bainbridge...on law, politics, religion, culture & food

Yes, the insiders are selling. But should you?

The headline of a NY Times article poses the titular question. Heavy insider selling is usually thought to be a bearish signal. The Times, however, relies on work by Nejat Seyhun, a finance professor at the University of Michigan to suggest that the current wave of selling is not necessarily pro-bear.

[Seyhun explains that] the new wave of insider selling has occurred while the stock market has been rallying. His research has found that such selling carries far less bearish significance than selling during a market decline.

To document this difference, Professor Seyhun looked at each publicly traded company on the New York and American stock exchanges and the Nasdaq market from the beginning of 1975 to the end of 2000, identifying all months when the company's insiders were net sellers.

Professor Seyhun found that when insiders sold during a decline, the stocks they sold lagged behind the overall market by an average of 5 percent over the next 12 months. ... In contrast, Professor Seyhun found no discernible pattern in the subsequent performance of stocks sold by insiders while the market was rallying.

As a result, he concludes, the current high level of insider selling provides no signal for the market's direction. He advises investors who base their equity exposure on the behavior of insiders to "sit tight and watch both stock prices and insider trading" in the coming months.

Sounds like good advice to me. (But I have my money, such as it is, parked in no-load low-fee passively managed index funds. Why? Because Malkiel told me to!) Anyway, while I have never met Prof. Seyhun, I have read much of his scholarly output. He is a very close and able student of insider selling patterns, who has done a lot of high quality empirical research on the subject. Seyhun's book Investment Intelligence from Insider Trading pulls that research together in a very effective way.