Market Views on Mr. Market – Bearish Edition
By: Shishir Nigam Sat, Oct 3, 2009
Note: See important disclaimers below article.
Just as there are bubbles of positive sentiment (ie. Manias), there are also bubbles of negative sentiment (ie. Panic) where investors generally believe the end of the world is near and the last thing they want to be caught doing is holding stocks. This, I believe, was the situation in the early days of March 2009, just before the market bottomed.
The situation has definitely improved much since then, but has it improved for the right reasons? Should investors still be bearish? In this second edition, I explore the biggest justifications held out by the “bears”.
Top 5 reasons to be BEARISH
“What’s with the insiders?”
Insiders are those people who have access to non-public information about a company – ie. Employees, senior management, executives. In recent months, insider selling has FAR outweighed insider buying by many multiples. With figures courtesy of TrimTabs (which tracks insider transactions), during August, insiders averaged $210 million worth of shares bought, while they sold $6.3 billion worth. That’s a whopping 30x sell-to-buy ratio! In the last week of August alone, there were $8 million worth of insider buys corresponding to $520 million of insider sales. That means a ratio of nearly 62x! If insiders are selling, and they know more than the market, then what does that show?
“Where is the volume?”
One of the cornerstones of trading wisdom is to follow the volume. Some go so far as to say that a trend holds little meaning if it is not on rising volume. For the rally starting in March, the volume, unfortunately, peaked in March as well. A look at the chart below shows that the ride up has been on declining volume. This makes the rally technically “un-sound”. Even in daily trading, dips have been on high volume, while gains have been on below average volume. And volume usually supports the “correct” trend.
“Show me the money (ie. Revenues)”
While analysts have rejoiced over earnings beats during both Q1 and Q2, the fact is that the beats have been on the bottom-line (ie. Net Income). Companies have had smaller losses than expected, but these have been the result of aggressive cost-cutting, instead of better than expected revenue numbers. Such cost-cutting is not a sustainable solution to maintain better than expected profitability. What’s necessary is revenue improvement which can only result from demand returning to the fore. This has so far not been seen and it remains unclear when it might return as the savings rate in the US shoots up towards 10%, unemployment continues to rise and businesses hold back on investments.
“Rally is stimulus driven”
The start of the March rally coincided with some of the largest aid programs initiated by the US Treasury and the Fed. For example, the Public-Private Investment Program (PPIP) and the American Recovery and Reinvestment Act, initiated by Barrack Obama, both came into play during March. As such, it is easy to postulate that the market rally is the result of excess liquidity provided being channelled into the markets. Following from that, when these temporary programs and government guarantees are rolled back in, the un-natural support for the equity markets might evaporate overnight. Already, the markets have seen a negative impact on the car manufacturers as the cash-for-clunkers program ended with US car sales declining 41% month-on-month in September. With a massively increasing US debt burden, other government programs cannot continue indefinitely.
“It’s all those computers”
Program trading makes up about 70% of the trading volume on the NYSE. Program trading refers to the high-frequency trading that takes place between computers which take advantage of things like liquidity rebates offered by the exchanges, co-location benefits etc. Program trading is rarely motivated by company fundamentals, which leads to the question of whether the direction of the market is even related to fundamentals, since program trading accounts for such a large proportion of trading. In recent weeks, the effect of such trading has been quite obvious with trading in just 5 stocks – Citigroup, Bank of America, AIG, Fannie Mae and CIT – making up roughly 40% of the total NYSE daily volume. This is very unusual, even ignoring the fact that 3 of those 5 companies are already bankrupt. And on several days, the shares of even long defunct Lehman Brothers, were bid up causing them to triple in a few days, showing the huge disconnect with fundamentals again.
Toss a coin?
Where the rally goes from here is anyone’s call. It’s relatively easy to identify the factors that play into setting the direction of a market but close to impossible to ascertain the magnitude of the impact that each will have in determining what that direction is.
Whether it’s a bear-market rally or a new bull-market, a minor bubble in a largely imploding market or a new bubble all together, the goal would be to understand the dynamics either way and take advantage of them. Unfortunately for us, we can’t use the “heads I win, tails you lose” formula.
Disclosure: Long the market
Image credit: Jenny Downing
Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.
Just as there are bubbles of positive sentiment (ie. Manias), there are also bubbles of negative sentiment (ie. Panic) where investors generally believe the end of the world is near and the last thing they want to be caught doing is holding stocks. This, I believe, was the situation in the early days of March 2009, just before the market bottomed.
The situation has definitely improved much since then, but has it improved for the right reasons<link words to previous article>? Should investors still be bearish? In this second edition, I explore the biggest justifications held out by the “bears”.
Top 5 reasons to be BEARISH
“What’s with the insiders?”
Insiders are those people who have access to non-public information about a company – ie. Employees, senior management, executives. In recent months, insider selling has FAR outweighed insider buying by many multiples. With figures courtesy of TrimTabs (which tracks insider transactions), during August, insiders averaged $210 million worth of shares bought, while they sold $6.3 billion worth. That’s a whopping 30x sell-to-buy ratio! In the last week of August alone, there were $8 million worth of insider buys corresponding to $520 million of insider sales. That means a ratio of nearly 62x! If insiders are selling, and they know more than the market, then what does that show?
“Where is the volume?”
One of the cornerstones of trading wisdom is to follow the volume. Some go so far as to say that a trend holds little meaning if it is not on rising volume. For the rally starting in March, the volume, unfortunately, peaked in March as well. A look at the chart below shows that the ride up has been on declining volume. This makes the rally technically “un-sound”. Even in daily trading, dips have been on high volume, while gains have been on below average volume. And volume usually supports the “correct” trend.
“Show me the money (ie. Revenues)”
While analysts have rejoiced over earnings beats during both Q1 and Q2, the fact is that the beats have been on the bottom-line (ie. Net Income). Companies have had smaller losses than expected, but these have been the result of aggressive cost-cutting, instead of better than expected revenue numbers. Such cost-cutting is not a sustainable solution to maintain better than expected profitability. What’s necessary is revenue improvement which can only result from demand returning to the fore. This has so far not been seen and it remains unclear when it might return as the savings rate in the US shoots up towards 10%, unemployment continues to rise and businesses hold back on investments.
“Rally is stimulus driven”
The start of the March rally coincided with some of the largest aid programs initiated by the US Treasury and the Fed. For example, the Public-Private Investment Program (PPIP) and the American Recovery and Reinvestment Act, initiated by Barrack Obama, both came into play during March. As such, it is easy to postulate that the market rally is the result of excess liquidity provided being channelled into the markets. Following from that, when these temporary programs and government guarantees are rolled back in, the un-natural support for the equity markets might evaporate overnight. Already, the markets have seen a negative impact on the car manufacturers as the cash-for-clunkers program ended with US car sales declining 41% month-on-month in September. With a massively increasing US debt burden, other government programs cannot continue indefinitely.
“It’s all those computers”
Program trading makes up about 70% of the trading volume on the NYSE. Program trading refers to the high-frequency trading that takes place between computers which take advantage of things like liquidity rebates offered by the exchanges, co-location benefits etc. Program trading is rarely motivated by company fundamentals, which leads to the question of whether the direction of the market is even related to fundamentals, since program trading accounts for such a large proportion of trading. In recent weeks, the effect of such trading has been quite obvious with trading in just 5 stocks – Citigroup, Bank of America, AIG, Fannie Mae and CIT – making up roughly 40% of the total NYSE daily volume. This is very unusual, even ignoring the fact that 3 of those 5 companies are already bankrupt. And on several days, the shares of even long defunct Lehman Brothers, were bid up causing them to triple in a few days, showing the huge disconnect with fundamentals again.
Toss a coin?
Where the rally goes from here is anyone’s call. It’s relatively easy to identify the factors that play into setting the direction of a market but close to impossible to ascertain the magnitude of the impact that each will have in determining what that direction is.
Whether it’s a bear-market rally or a new bull-market, a minor bubble in a largely imploding market or a new bubble all together, the goal would be to understand the dynamics either way and take advantage of them. Unfortunately for us, we can’t use the “heads I win, tails you lose” formula.
Disclosure: Long the market
Last 3 posts by Shishir Nigam
- The Era Of Unintended Consequences - June 13th, 2010
- First Dose Of Moral Hazard Delivered - April 18th, 2010
- Two Big Issues - RIM’s Future Hangs in the Balance - April 3rd, 2010
Tags: bear market, bear-market rally, insiders, low volume, market
Great article Shishir, along with the previous one. I look forward to future ones.
Great article Shishir! I am hoping that you would be sending alerts for all new ones as well so that I can keep up with the reading!
Like the article Shishir. Its simple and well articulated. I actually would dispute the insider trading conclusion. As much as its easy to say all the insiders are trading because they see a downturn, it could just as easily be the insiders cashing out what is part of their salaries. Most of the insiders have probably lost a whole bunch of money in the past couple of years on their investments and most of their options would be worth something now that some of their companies are going up. What do you think?
I actually enjoy the part about the automated trading causing a lot of the volume in the market. Would actually like to see an article in more detail about what the triggers are for automated trading etc… hint hint.
Will be reading these more often. If I was a betting man (and short-term trading in a volatile market driven by emotion is a complete gamble), I’d go with the trend heading to the end of the year was down but with the volatility there’ll be a lot of volatility along the way. Lets see if I’m close or not
Thanks for the feedback everyone, you can subscribe to the RSS feeds for this blog over here: http://feeds.feedburner.com/youngandinvested , it’ll send you updates on the blog as they come!
Mohamed, thanks for your comment. I agree with your point partially. Insiders cashing out or for that matter buying in will make up what is the regular churn in insider trading numbers. But when we’re talking about the ratio of insider selling to buying, that ratio should be relatively close to equal if it’s just normal churn in a neutral market. The point is that with insiders selling more than 60x more, that is a reflection of the additional information they have about the true state of their company, and not just its stock price. Agreed that cash needs due to the last year could increase insider selling but I don’t believe that factor by itself can justify a 60x ratio. Let me know your thoughts.
I actually agree the ratio is way out of whack but frankly I don’t see insiders being able to predict what their stock is going to do even with the extra info. I’m not the expert but recently earnings have not been the best prediction of stock movements and stocks beating estimates haven’t always got the big bump up. That goes the same for companies giving average to weak numbers not always dropping like we’d be used to seeing (except for RIMM
but lets not go there). Add to that the additional volatility from fairly low volumes, insiders probably figure now is a good time to cash out while the market has sustained a rally and not risk the possibility of a dip.
Overall, the only way a market rally can be maintained is if revenues start to drive profitability and not bottom line cuts like you mentioned. For the US that simply means increasing consumer spending to get the wheels rolling which can only happen when unemployment decreases which isn’t going to happen while companies are cutting back. Economic black holes are a pain to get out of and continuous stimulus packages with monster deficits aren’t the answer either. Barack sure has his hands full
What do you think?
Shishir, good article. I will be a reader going forward. On the insider trading, while I agree the ratio of selling to buying is high, i dismiss its relevance because the amount, $6 billion is immaterial relative to the total amount of transactions in the market in August.
Awesome article Shishir.
I have to agree with Mohamed about the insider positions. Ratio of selling-buying currently is quite high, but their stocks, options, and warrents are really their main source of salary, especially if its a junior company and I would assume that the majority of them loss quite a bit in their accounts with the downturn. Also I would assume that just like many others (i.e. David Rosenburg) would like to take some cash off the table because the markets have rallied substantially based on…
All in all, I for one would keep an eye out for when insiders start loading but in terms of selling, I wouldn’t give a lot of thought to it, unless, of course all insiders start killing their positions =/.
I look forward to your future articles.