Stock markets have been shown to be reliable predictors of future changes in underlying economic activity and there’s no mystery as to why this should be.
If you know your company is starting to lose business and job losses, perhaps yours included, lie ahead you might chose to lighten up your equity portfolio. You do that ASAP of course; you don’t wait until the axe starts swinging. Conversely, if you’re a manufacturer and your order book starts to lengthen, long before you have to build new capacity, you can buy stock today in either your own firm or one of your listed peers.
However, this knowledge isn’t very helpful to investors because, as we frequently discover, when we reach the point in time where real economic activity has accelerated/decelerated Mr. Market has more than discounted this. This process may be the root of the advice to rookie investors to always ‘buy the rumor, sell the fact’?
What would be of more use would be to find some activity that predicts aggregate stock market behavior in advance and in the paper I’m highlighting this week Mr. Francois Brochet, Visiting Professor at the Sloan School of Management of the Massachusetts Institute of Technology, appears to have pulled off a unique double. He’s found an indicator that not only reliably predicts stock market performance, it predicts (some) GDP shifts as well. Yeowza; but how?
In his own words “Using data from up to 39 countries, I find a significantly positive association between country-quarter aggregate net insider purchases and future market returns. Furthermore, purchases (sales) exhibit a significantly positive (negative) association with future returns, and purchases are positively associated with future growth in GDP.”
In plain English; insiders may not give reliable signals via their purchase and sales activity about their own stock’s performance but they do, when their actions are studied together, provide a guide to their respective stock market and economy’s future. Mr Brochet further notes “..insider sentiment is more significantly associated with future market returns in countries with lower investor protection and a less transparent information environment.” Remind you of anywhere in particular [Er, China? Ed.]?
The following link will take you to the paper in full http://mitsloan.mit.edu/events/asia-conference-in-accounting/pdf/Insider_Sentiment_and_Market_Returns_Around_the_World.pdf
So, keep an eye on insiders’ trading activity not because of what it may tell you about a particular stock’s progress but what it may indicate, when taken together with others activities, about the outlook for the market in general. Handy, huh?
Happy Sunday.