January 03, 2023 | Jon
Just as market sentiment refers to the overall attitude of investors toward the stock market, insider sentiment refers to the overall attitude of corporate insiders towards the stock market. Insider sentiment is another way of saying aggregated insider trading, in which the purchases and sales made by corporate insiders of their own firm's stock is analyzed for the market as a whole. By examining the trading of corporate insiders of their own stock in the aggregate, we can get an indication of their attitude towards the broader market.
To understand how insider sentiment, measured through aggregated insider trading, acts as a broad market indicator, we have to understand the position of the insiders themselves. In fact, the proposition that insider trading can predict market returns can seem implausible at first. After all, the information that insiders possess is related specifically to their own firms. They do not have crystal balls and are not able to predict interest rate movements, aggregate employment, or GDP growth any better than you or I.
What they do have better insight on is information that relates to the operation of the company they oversee. This includes things such as whether their company is controlling expenses well, the health of the sales department, and upcoming developments from competitors. None of this information relates to macroeconomic conditions directly. So how could insiders use this information to predict market returns?
The answer is, while the information insiders observe does not directly pertain to the macroeconomy, the signals they receive are affected by macroeconomic developments. As an example, while insiders cannot foresee changes to interest rates, they do know how recent changes to the interest rate will affect their firm's ability to borrow, sales figures, and profit margins going forward. In fact, they observe these firm-level changes before other market participants do. Hence, they can buy before other market participants realize positive developments of the company, and vice-versa. This is what allows them to trade their own firm's stock profitably. In the aggregate, this translates to a highly informative leading economic indicator for the market as a whole.
At InsiderSentiment.com, we publish the Insider Sentiment Tracker for our active subscribers, which measures insider sentiment by calculating net insider buying and selling on a firm level over time. However, it is not enough to just provide raw data regarding insider buys and sells - what other services provide. Insiders' actions must be interpreted in light of broader market narratives and movements. Only by combining insiders' actions with developments occurring in the business, political, and monetary world are you able to maximize the value obtained from insider sentiment.
As Professor Nejat Seyhun has been a leading expert on insider trading for over 4 decades, he has developed the ability to interpret insiders actions in the larger market setting. This is why we provide Professor Seyhun's regularly updated interpretation to the Insider Sentiment Tracker in addition to the data itself.
The best example of insider sentiment acting as a leading economic indicator occurred in late March 2020. The stock market had recently plunged into a bear market on news of the accelerating pandemic and unprecedented lockdown orders that grinded economic activity to a halt. Governors in the United States took turns demanding non-essential businesses close their doors and for employees to move to remote work where possible. Suffice it to say that uncertainty was as high as it ever has been. The Federal Reserve slammed the fed funds rate to as close to zero as possible. Were you to have asked 100 Americans how they thought the situation would unfold over the next year, you probably would have gotten 100 different, highly emotionally charged answers.
In the midst of this uncertainty, it would have been easy to sell your stock holdings and hunker down in a shelter to wait out the ensuing pandemonium. However, as hindsight would later reveal, this would have been the exact wrong thing to do, as March 2020 turned out to be the bottom of the bear market. The rebound wasn't delayed by even a week. You can see this in the graph below:
So how was your typical investor supposed to anticipate that the market wouldn't continue to worsen? It would have been very difficult to remain optimistic at the time. But insider sentiment would have provided the answer. As you can see from the Insider Sentiment Tracker below, insiders anticipated how the huge monetary and fiscal stimulus moves would have positively benefited their firms. As a result, March 2020 ended up marking the highest level of net insider buying, as revealed by insider sentiment.
This means that had investors been aware that insider sentiment was in fact peaking as the stock market was bottoming out, they could have had the necessary ammunition to resist selling or even to buy at the exact trough. That is how powerful insider sentiment is. You can see this in the below data from Morningstar which shows that most investors were not able to do this in 2020. Instead, they sold as fear spiked in March and fled to cash, which you can see as the rising blue line.
In doing this, they missed out on much of the market gain, and their portfolio performance suffered as a result. Investors that were aware of insider sentiment could have better timed the market and avoided this mistake.
While the past does not have a monopoly on uncertainty, we must arm ourselves with knowledge to prepare for what the market will throw at us. Our and our family's livelihood is on the line. We do not know exactly what the future will hold, but we believe we can be ready for it most effectively by knowing what the insiders are doing and how their actions fit into the bigger stories at play. After all, they are the most informed when it comes to navigating their own companies.
We invite you to join us by subscribing to insidersentiment.com so you don't miss out on the next signal, as it could be a big one. You can also check out this free blog where we post about interest finds from the world of insider trading, and fundamentals about insider trading. If you liked this post, you may also like our post about the relationship between insider trading and stock prices.