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Investor Alert

Feb. 6, 2021, 4:42 p.m. EST

Code red — here’s what it means for the stock market now that company insiders are selling shares

By Michael Brush

Now that WallStreetBets’ 15 minutes of fame is over, it’s all clear in the stock market, right?

Maybe not.

Right before the GameStop (NYS:GME) trading shenanigans dinged the market, company insiders were flashing a warning sign. Their selling was exaggerated compared to buying, and the negative skew hit code-red warning levels.

What’s more interesting was the dichotomy among two major exchanges. Selling on the Nasdaq was flashing an outright red alert. But selling on the New York Stock Exchange was more of a yellow flag, according to a sell-buy indicators tracked by Vickers Weekly Insider from Argus Research.

The Nasdaq signal improved a bit when the market weakened last week. But as the market nudges higher, I expect the heavier selling to return in the Nasdaq. After all, insiders — higher-level executives who are in the know — are not whimsical. A little temporary “gamestonk” trading mayhem won’t check their caution.

So, it’s worth drilling down on their code-red selling to learn more about what insiders are telling us. Judging by the kinds of companies where insiders are selling, here are four key lessons for investors.

No. 1: The market looks vulnerable to a pullback, and it may be overvalued

Valuation is a big debate right now. Bears warn that the 21.8 forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is well above the 10-year average of 15.8. Bulls respond that valuations are often high coming out of recessions because forward earnings estimates are so beaten down. This increases P/E ratios based on forward earnings.

Tech insiders are siding with the cautious types. There’s been a flood of selling at tech companies like Ciena (NYS:CIEN) , Facebook (NAS:FB) , Marvell Technology (NAS:MRVL) , Medallia (NYS:MDLA) , Workday (NAS:WDAY) , Zoom (NAS:ZM) , Twilio (NYS:TWLO) , Datadog (NAS:DDOG) , Dell (NYS:DELL) and Equinix (NAS:EQIX) .

“They may be feeling the market is priced to perfection,” says Richard Cuneo, of Vickers Insider Weekly.

True, these are mostly preplanned sales. But that doesn’t explain the warning signal. There were a lot more of these pre-arranged sales, too. Preplanned sales on the Nasdaq were up 39% recently compared to the same time last year, according to data that Cuneo compiled for me. Besides, the insider sell-buy signal is a ratio, so it’s in warning mode because of declines in buying, too.

Not only are insiders cautious, but sentiment is fairly rich. Together, these indicators suggest a market vulnerable to a correction. Be careful about getting caught up in the hoopla, putting on too many trades, or using margin. One of the biggest mistakes people make is to go full in on margin, when exuberance is contagious. Then as the markets retreat, brokerages increase margin requirements. That makes payback (margin calls) even worse.

No. 2: Too many people are piling into the reopening play

As a contrarian investor, I was big on reopening stocks in March last year when everyone hated them. A portfolio of them suggested in my stock letter, Brush Up on Stocks (the link is in the bio, below), was up 108% compared to 48.5% for the S&P 500 (S&P:SPX) by the end of 2020, from when I suggested them on March 17. I put several of these names in this MarketWatch column . The 20 stocks from that column were up 64% by year-end, compared to 52% for the S&P 500 and 44% for the Dow Jones Industrial Average (DOW:DJIA) .

Now I see a lot of chatter on Twitter about reopening plays. This is a potential negative sign that the crowd has arrived. It’s time to be more cautious on the theme now. That is what insiders are telling us. They have been big sellers at reopening plays like Carnival (NYS:CCL) , Walt Disney (NYS:DIS) , Caesars Entertainment (NAS:CZR) , Shake Shack (NYS:SHAK) and Yum! Brands (NYS:YUM) .

No. 3: The rush to cyclicals may be overdone

Cyclicals have done well since I suggested them last summer and fall. I’m not surprised. There has been so much stimulus put in the economy, we are likely to have rip-roaring growth by the summer, predicts Leuthold Group economist and market strategist Jim Paulsen. Don’t get distracted by the noise in the employment data. The bullish forward indicators are there.

Corporate sentiment has jumped to record highs since 2004, according to content analysis of earnings calls by Bank of America’s Predictive Analytics team. Thanks to a combination of government stimulus and lockdown restrictions on consumer spending, the U.S. personal saving rate has nearly doubled to 13.7%, notes Capital Economics.

Now it might pay to take a breather and wait for the economy to catch up. That’s what Nasdaq company insiders are telling us. The insider selling on Nasdaq is heavily weighted toward companies in cyclical sectors. There’s been significant selling in banks and financials like Goldman Sachs (NYS:GS) , Interactive Brokers (NAS:IBKR) and Morgan Stanley (NYS:MS) . We see it in construction and materials names like Construction Partners (NAS:ROAD) , Masco (NYS:MAS) and U.S. Concrete (NAS:USCR) .

Selling is prevalent in industrials like Agilent Technologies (NYS:A) , Jabil (NYS:JBL) , Navistar (NYS:NAV) , Mercury Systems (NAS:MRCY) and Patrick Industries (NAS:PATK) . And at retailers like 1-800-Flowers.Com (NAS:FLWS) , CarMax (NYS:KMX) , PriceSmart (NAS:PSMT) , SelectQuote (NYS:SLQT) and Wayfair (NYS:W) .

No. 4: Interest rates are going up

We think of the Nasdaq as technology, but a lot of the heavy insider selling has happened in biotech. The selling makes sense if you think interest rates are going up, which will be the case, in my view. What do biotech names have to do with interest rates?

Biotech earnings are heavily weighted into the future. To value the stocks, you have to discount those earnings back to the present using net present value models. The discount rate used is typically the 10-year Treasury yield. So as that continues to rise, the present value of future earnings decline, because they are being discounted more heavily, cautions Jefferies  biotech analyst Michael Yee.

Of course, biotech bulls think the developments in their companies will offset the damage. There are so many interesting breakthroughs playing out in biotech right now in areas like gene editing and the manipulation of how cells communicate with each other, they may be right.

But it is hard to ignore the prevalent sector selling in names Adaptive Biotechnologies (NAS:ADPT) , Arena Pharmaceuticals (NAS:ARNA) , Crispr Therapeutics (NAS:CRSP) , Fate Therapeutics (NAS:FATE) , Jounce Therapeutics (NAS:JNCE) , Moderna (NAS:MRNA) and Replimune (NAS:REPL) .

The bottom line: You need to choose your biotech names very carefully now. Go with ones that have enough developments coming to power through any sector weakness caused by rising interest rates. One I’ve recently suggested in my stock letter around current levels is AbCellera Biologics (NAS:ABCL) , a cutting-edge company that uses artificial intelligence to help discover therapies.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned CCL, BAC and ABCL. Brush has suggested DELL, FB, CCL, DIS, CZR, BAC, GS, MRCY, FATE and ABCL in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.

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