The New York Times-20080127-An Ear To the Ground On Stocks

Return to: The_New_York_Times-20080127

An Ear To the Ground On Stocks

Full Text (738  words)[Author Affiliation] Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch. E-mail: [email protected].

INVESTOR sentiment suggests that the bulk of the stock market's decline is now behind us.

This conclusion is based on an analysis of two very different groups. The first is investment newsletter editors, who, on average, are usually wrong about the market's direction; they are currently bearish. The second is corporate insiders, who usually get it right, and they are mostly bullish.

The newsletter editors, as a group, have an inglorious track record that makes them excellent contrarian indicators. When they become too bullish, it is generally a bad sign for the stock market, just as it is a positive omen when they become particularly pessimistic. Right now, the average market-timing newsletter is betting that the market will decline.

Consider a subset of investment newsletters that focuses on timing the market's shorter-term gyrations. According to data collected by The Hulbert Financial Digest, which I edit, and which has been tracking newsletter sentiment for 28 years, this subset's average recommended stock-market exposure currently stands at minus 1 percent. This means that the average market-timing newsletter is recommending that its clients allocate 1 percent of their equity portfolios to going short -- an aggressive bet on lower prices.

From the standpoint of contrarian analysis, another positive sign is the speed at which these newsletters have turned bearish. The typical pattern immediately after major market tops is for the editors to cling stubbornly to bullishness, refusing to believe that the market has turned. This isn't what has happened since the market hit its high in early October. At that time, the average recommended equity exposure among the short-term market-timing newsletters was 46.7 percent. That means that in just three and a half months, this average has fallen by nearly 48 percentage points.

To put this rapid retreat in perspective, note that newsletter editors reacted very differently after the bursting of the Internet bubble in March 2000. Three and a half months into the bear market that began then, the average recommended exposure among the short-term market-timing newsletters was actually higher than it was at the market top. That persistent optimism was far from the pessimism we're seeing today.

On the other hand, the insiders in the second group have tended to be more right than wrong about the market's direction. It stands to reason that these officers, directors and largest shareholders of publicly traded corporations have some insight into their companies' prospects. They are required to report immediately to the Securities and Exchange Commission whenever they have bought or sold shares of their companies' stocks.

ONE service that collects and analyzes these reported transactions is Argus Research in New York. According to the firm, insiders are now behaving more bullishly than at any time since November 2002, the month after the end of the 2000-2002 bear market.

One statistic that Argus calculates is a ratio of insider selling to insider buying, which has averaged around 2.5 to 1 over the long term. Insiders often receive shares from their companies as part of their compensation; it is therefore quite normal for them to sell more shares than they buy.

For insider transactions in the week ended Jan. 18, the latest for which data are available, the insider sell-to-buy ratio was 0.89 to 1, according to Argus. Not only is that far lower than the historical norm, it also means that insiders actually bought more than they sold. They wouldn't be likely to do that if they believed that the stock market was about to suffer significant losses.

The week-to-week readings of the Argus ratio are volatile, so the firm also calculates an eight-week moving average, and its most recent reading was 1.44 to 1. The last time it was any lower was for the eight weeks ended Nov. 15, 2002, when it was 1.33 to 1. As David Coleman, editor of the Argus publication Vickers Weekly Insider Report, wrote: Shortly after that was achieved back in 2002, the markets embarked on a five-year bull run.

Needless to say, there are no guarantees that the stock market will perform as well over the next five years. But to bet that the market will fall markedly further from here, one must essentially be betting that the newsletter editors who usually are wrong will have it right this time, and that the insiders, who usually are right, will be wrong.