In the midst of the extreme market volatility in early August, there appeared to be at least one sign that better days for investors might not be too far off. Corporate insiders voted with their wallets in a big way by purchasing shares of their own company's stock at record rates.
First, let's review the concept of insider trading. We may often recall past cases of illegal purchases and sales by insiders, many of whom ended up serving time in prison for making trades based on information not yet public that could greatly impact the price of a company's stock. It is not illegal for corporate executives to buy and sell shares of their firms stock as long as they are not acting on information which is not yet publically disclosed.
Further, these corporate insiders must disclose their purchases and sales to the Securities and Exchange Commission within a matter of days after initiating the transaction. These reports of purchases and sales are public records and from them we can monitor the activity of these investors who are really in the know about the health of the company they are employed by.
Sales of stock by insiders generally doesn't hold as much weight as an indicator for the market's prospects because there are a lot of reasons to sell stock. Many of these executives receive a large portion of their compensation through the granting of shares of corporate stock. It is normal for them to sell portions of this stock for reasons of diversification, and to pay for personal expenses.
But, when these insiders use cash to buy additional shares it is very noteworthy. After all, there is only one reason for them to buy additional shares – they believe the price will rise in value in the not-too-distant future. These executives are privy to the health of the company they work for, and if a recession was imminent and sales were going to decline, they would put off making purchases of stock until the price was lower.
So, when we see a high level of purchases by insiders across the board at a majority of corporations, it gets our attention. Back around the second week of August, we had just such an event. While the market was experiencing a high level of volatility and a pretty significant correction in prices, corporate executives and other insiders were buying at record levels relative to the amount of stock being sold, at least since we have data on this activity. Over the ensuing four weeks, we have continued to see a high level of purchases.
We take encouragement from this activity because, as a group, these men and women have their finger on the pulse of business and as pointed out above, if things were going to be falling apart, they would not commit capital to buy additional stock. That doesn't mean that their activity is a perfect timing mechanism though. In other words, prices may not to start to rise immediately just because the insiders made purchases. It could still take some time for the fears and related volatility to wane and for the market to make headway to the upside. But, perhaps we can take a bit of comfort from knowing that some pretty smart people have made a large commitment to stocks as an asset class, and perhaps the correction of 2011 may be closer to being over than near its beginning.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.