Just days after Warren Buffett lamented in his latest annual letter that prices for businesses possessing decent long-term prospects are “sky high”, an insider transaction-based model constructed by University of Michigan finance professor Nejat Seyhun predicts that the S&P 500 will be 3.9% lower in one year as a result of a recent surge in insider selling.
Seyhun, one of academia’s “leading experts” on insider transactions, and his trading model were profiled in a recent Barron’s article. Barron’s had previously covered his work back in May 2017. At the time Seyhun’s model was bullish and the S&P has, since then, risen by more than 20%. His model also gave the market “the benefit of the doubt” back in October, during a correction. Since then, the market is about 1% higher.
What is more notable, is that Seyhun’s model has been found to be statistically significant by peer reviewed research. He claims that insider buying and selling data, when researched properly, “does a better job predicting year-ahead returns than almost all of the better-known indicators that are popular on Wall Street.”
His model states that only some of those who are considered insiders are worth following. Specifically, he pays attention to the buying and selling of corporate officers and directors and overlooks transactions by a company’s largest shareholders. Obviously, insiders and directors have more insight as to the health and sentiment of a company than “outsiders” like large shareholders. This can sometimes be a difficult way to perform analysis as, based simply on a size basis, large shareholders transact far more stock than insiders, which can be difficult to ignore.
So why does Seyhun’s model now predict a drop for the market in the coming year? According to the model, insiders – those who by definition have the most insight into the future performance of their own stocks – sold more of their company’s stock in the first half of February relative to buying, than they have in a decade. Five of every six companies for which there were recent insider transactions have experienced net selling.
That said, the model creator is already making excuses about his own model, saying it’s important to not “put too bearish of an interpretation” on the data because it came after a large rally. Insiders have “no choice” but to sell when their compensation comes in the form of equity, he told Barron’s, calling the selling nothing more than “opportunistic behavior”. That remains to be seen.
As far as Seyhun’s reluctant conclusion from the data, he has a simple recommendation: do what the insiders are doing:
“One way of putting this forecast into practice would be to shift your holdings away from companies with heavy insider selling and into those with heavy net buying.”
As Barron’s notes, according to Seyhun’s data among small-cap stocks, energy and financial companies had the most net insider buying. Who was selling? Pretty much everyone else… the good news however was that a willing buyer was always present: companies themselves, because as Bank of America noted recently, stock buybacks YTD are running nearly 100% higher than their already record 2018 pace. Or said even simpler: insiders sold their stock… to their own company.