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Looking beyond the profit warnings: Insiders are selling

U.S. company executives aren't just talking down their earnings expectations. They're putting their money where their mouths are – and they've been pulling it out of the stock market to do so.

The spike this quarter in profit warnings from U.S. companies has been worrisome to many earnings trackers, as the ratio of negative to positive earnings pre-announcements jumped to its highest levels since the depths of the 2008-09 recession. Still, the concerns have been played down in some quarters. Some argue that it's merely caution in the face of some temporary uncertainties, setting us up for yet another quarter of substantial earnings beats or – at worst – one sluggish quarter followed by a rebound in profits later in the year.

But there's good reason to believe this isn't a case of management low-balling the estimates, or that this is a short-lived case of nerves. Company insiders are backing up the pessimistic talk with unprecedented levels of selling of their own companies' stock.

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Insider sell-a-thon

Insider selling has been high throughout the market's post-recession recovery, but it surged even higher – to record levels – over the past few months, Brockhouse Cooper global macro strategist Pierre Lapointe recently noted.

Meanwhile, insider buying – which surged last summer "when insiders rightly saw that double-dip [recession]concerns were overblown," Mr. Lapointe said – slowed to a trickle as the stock market has rallied in the early part of this year. Clearly, company insiders aren't as impressed by this year's rally as the rest of the investing community has been. Rather than playing along, they've been viewing the upturn as a selling opportunity.

"They now have doubts about their companies' earnings power," he said.

Bad omen for market

Regardless of whether their selling is symptomatic of economic or earnings dark clouds that they see on the horizon, it's certainly a bad omen for the stock market.

For one thing, Mr. Lapointe said, it's evidence that equities may be overvalued and that the market has priced too much optimism into many stocks. "If insiders really believed that their companies' stocks were undervalued, we would see more buys and less sells," he said.

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That implies more downside to the stock market than upside – which, indeed, historical precedent bears out.

"History tells us that [when insider selling is high] returns over the next three months are usually lacklustre," Mr. Lapointe wrote. He said the current level of insider selling and price-to-earnings valuation are consistent with markets that in the past have been flat to down 10 per cent over the subsequent three months.

Infographic: Insider selling: A bad omen

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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