Company Executives See Opportunities In Their Stocks
In a market crash, investors or trading firms sell for numerous reasons. Forced selling to cover losses in underperforming assets, margin calls in leveraged funds, the need to withdraw cash for living expenses, and just plain panic. None of the reasons for selling in an environment like today are dispassionate. And most sellers getting out of these relatively low levels already recognize that raising cash at this point will not prove to be a wise portfolio decision in a year. Between today’s levels and the absolute lows (whenever they occur) now falls into the domain of market timing, not a portfolio allocation decision.
Of course, actually buying at these levels requires conviction that most of us just don’t have. We don’t have a good vision of each company’s future and can only speculate on a firm’s future business post coronavirus. It is at moments like today that company insider buying activity offers the greatest information about a company. Those in the C-suite have the best vision of their company’s prospects and ability to generate revenue post coronavirus. Remember, company insiders may sell their stock for numerous reasons (portfolio re-balancing/diversification, put a kid through college, or to buy a new house/big-ticket item) but they only buy their stock for one reason: they are optimistic on their company’s future business.
We track data covering both the number of company insiders buying or selling their companies’ stock, as well as the dollar amount, for over 4,000 listed companies. We standardize the dollar amounts of insider buying or selling relative to the market cap of the company, then create an Insider Composite Score along with the number of executives buying/selling. A purchase of $10,000,000 of Tesla (NASDAQ:TSLA) shares by Elon Musk receives less weight in our scoring than a purchase of $100,000 in shares of Armstrong Flooring (NYSE:AFI) by its CEO, due to the differences in market caps ($78B vs $45M). We track our Insider Composite Score each week to generate a list of off-the-radar companies that may soon be on the move.
For the week ending March 20, the worst week for the stock market since 2008, we can report that more companies saw Insider BUYING activity rather than selling activity. Within our coverage universe, only nine companies saw deterioration in their Insider Composite Score (that is, net insider sales). Again, as we don’t know the reasons for these executive stock sales, we won’t pass judgment on the companies. Below are the nine companies seeing insider selling last week.
On the other side of the ledger, a whopping 57 companies in our universe saw improving Insider Composite Scores, or net Insider buying. We share the full list of companies at the end of this Commentary.
Our first observation is that Financial stocks saw the greatest amount of Insider Buying. Of the 57 companies with net Insider buying, 22 were in the Financial sector, well ahead of the second place Energy sector with 7 companies seeing net Insider buying. We think that this is instructive for investors and portfolio allocators. Financial stocks have seen the most blood among the 11 sectors since the market peak. The popular Financials SPDR (XLF) is down -39% while the SPDR S&P Bank Index (KBE) has been decimated, -45%. The S&P 500 by comparison is down -30%. We know the principal reason for the selling. Interest rates across the yield curve have plummeted to near 0%, killing the net interest margin (NIM) business of banks. What the Insider buying within Financials tells us is that stock prices now reflect the lost NIM revenue AND have priced in additional negativity which Insiders don’t see. At current price levels, we see the Financials stocks as most attractive. The banks were the big losers in the last stock market cycle. Today bank balance sheets are nothing like under-capitalized banks we saw in 2008. Moreover, we can’t remember an example in history in which a sector/industry which provoked and/or led down equity markets in the prior cycle was again the underperformer in the subsequent cycle. For these reasons, investors should look to dip their toes into bank stocks to begin with.
Our second observation is that, amid the carnage in the Energy space, seven companies are seeing Insiders buying their stock. News alert: not all Energy companies will go bust, and we now know seven of them that won’t likely go under. Among these Energy companies, our quantitative fundamental rankings place Sunoco (SUN) on top. We post our summary boxes for Sunoco below.
Looking at charts (as technicals seem to matter most in this market), all these Energy stocks have been wiped out with the whole sector. Everything in Energy is deep value. One idea that we like for trading Energy names is running a long/short pairs trade, buying Energy companies seeing Insider buying while shorting the S&P Oil & Gas ETF (XOP). This removes the near-term timing bet on the direction of oil prices. Holding a small basket of companies more likely to survive, while shorting XOP (with many drillers that will go under) would provide a decorrelated, non-directional position for investor portfolios.
As with all trading strategies, there are potential risks to our long Financials and long/short Energy trade ideas. Notably, in this case, the main drawback is that company Insider buying is not a precise timing tool. Insiders recognize value in their stock and are constructive on their company’s future. They don’t know when the market will also recognize the value in their stock.
Finally, a general note for investors, we believe now that the coronavirus situation in the U.S. is still, unfortunately, in the crescendo phase. We see what is happening in Europe and we must expect the same rate of infection to prevail in the U.S. Italy, Spain, and France are under full lock-down and citizens may not leave their homes without a specific justifiable reason. Yet the number of cases is still surging. In the U.S., college students on Spring break are partying on Florida beaches. This is not going to play out well. Until the number of cases peaks in the U.S. and tests are readily available for everyone, that is, markets have a handle on what we are dealing with, we do not expect a sustainable rally in equities. Nonetheless, we are bullish on a portfolio allocation basis (not attempting to time what may be an elusive bottom) and are systemically hedging short-term trading positions.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.