Corporate insiders are sending warning signals about the stock market

Corporate insiders are more bearish than they have been in decades.

That's worrisome, since insiders presumably know more about their companies' prospects than the rest of us do. In July, they sold far more of their companies' shares than they bought.

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Consider the measure of insider sentiment favored by Nejat Seyhun, a finance professor at the University of Michigan and a leading expert on interpreting insider behavior. This measure is the number of companies with net buying from corporate officers and directors, expressed as a percentage of all companies that had any buying or selling from those insiders.

For July through Wednesday, this indicator stands at 14.8%. If that turns out to be the full-month percentage, it would be the lowest level in at least 21 years, Seyhun said in an email.

That's ominous enough, but there's more. Seyhun has found from his research that insider selling is an especially bearish signal when it comes in a declining stock market. When that happens, it usually means that insiders on balance are not confident that the market will recover quickly enough to make waiting to sell worth their while. And I need not remind you that the market has struggled in July, with the PHLX Semiconductor Index SOX actually falling into bear-market territory.

Insider sentiment has been trending lower for several years now, as you can see from the accompanying chart. (Data are from InsiderSentiment.com, a website founded by Seyhun's son Jon, who is one of the website's analysts). The Seyhuns' insider-sentiment measure has been below average for a large majority of months during the last three years.

To be sure, the stock market has been remarkably resilient over these three years in the face of above-average insider selling. So at a minimum, the insiders' caution has been premature. It nevertheless seems a good bet that, sooner or later and quite likely sooner, the market will succumb to the gravitational pull of insider bearishness.

One bright spot in this otherwise gloomy picture is the consumer staples sector, in which insiders have recently become more optimistic. But even here there is a fly in the ointment, since consumer staples is a defensive sector that tends to produce its best relative performance when the market is about to decline. The only two other sectors with net insider buying are materials and utilities. Exchange-trade funds benchmarked to these sectors include the State Street Consumer Staples Select Sector SPDR XLP, the Materials Select Sector SPDR XLB and the Utilities Select Sector SPDR XLU.

Insiders appear to be particularly bearish about shares of the largest companies. Among the large-cap companies with any insider buying or selling in July, just 3.2% had net insider buying.

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