Bearish insiders, bullish investors and global conflict are red flags for stocks

Bearish insiders, bullish investors and global conflict are red flags for stocks

Inflation, Fed policy and the presidential election aren’t the only challenges that stock-market bulls have to worry about. U.S. stocks are vulnerable to a pullback now because of these three major developments that could trigger a market correction:

1. Corporate insiders do not love this market: In its Vickers Weekly Insider Report, the market-analysis firm Argus Research tracks a sell/buy ratio for corporate insiders. We can see how they are trading because executives, directors and shareholders big enough to be considered insiders have to share their trading activity in their stocks.

The Vickers sell/buy ratio is the most bearish it has been since December 2021. Recall that the S&P 500 fell around 26% in 2022. The Nasdaq eight-week sell/buy ratio stands at 6.43. For context, a reading above 2.5 suggests market weakness ahead, while below 2.0 suggests a rising market. A ratio between 2.0 and 2.5 is neutral.

“Insiders remain cautious and insiders at companies listed on the Nasdaq remain particularly cautious,” said Richard Cuneo of Argus Research. Besides tech, selling is strong relative to buying in consumer-discretionary, materials and energy stocks. Note that these are all cyclical groups, so selling in these areas is a statement of caution by insiders about the economic outlook.

Read: These in-the-know investors are more bearish than they’ve been since 2014

2. Investors are quite bullish: If you use just one sentiment measure, make it the Investors Intelligence Bull/Bear Ratio. This service tracks the sentiment of investment advisors and stock-newsletter writers. For context, this ratio historically sits in a range of 0.5 to 5.0. Five is an expression of extreme optimism.

I find it best to use this measure in the contrarian sense — so when the indicator signals extreme optimism, get cautious or even move stock investments to cash. By how I use this gauge, measures below 1.0 tell us the market is a buy.

Conversely, I start to get cautious on the market when this bull/bear ratio goes above 4.0, while above 5.0 means it is time to start raising cash. Two weeks ago, this measure was at 4.53, well within the yellow-flag zone. Last week, it improved by falling to 4.0, but was still a sign that investors are bulled up.

The bottom line: When the general public is bullish and those in the know (insiders) are wary of stocks, it is better to be cautious.

3. Geopolitical risk is rising: People accuse Ed Yardeni of Yardeni Research of being a perma-bull. “Thank you for the compliment,” is his response. It’s a joke, but there is wisdom in it: His point is that, over time, the market always goes up, so being an optimistic investor is the right outlook. But even Yardeni is more concerned now about the U.S. economy and the stock market because of heightened geopolitical risk.

“I don’t see anything suggesting the geopolitical risks are diminishing,” Yardeni said in a presentation to clients on April 8. “Quite the opposite — I see signs that they are increasing.”

The most obvious potential issue is a worsening of tensions in the Middle East. Following Israel’s strike on the Iranian consulate in Syria in early April, there’s now an increased risk that Iran will strike back. Even U.S. President Joe Biden is openly warning about this. In the Ukraine-Russia conflict, there were recently drone strikes on a Ukrainian nuclear plant and on Russian refineries.

Heightened Middle East tensions and damage to Russia’s energy infrastructure could easily send oil above $100 a barrel, Yardeni said. That would fan the inflation worries that shook the market this week.

As JPMorgan Chase & Co. CEO Jamie Dimon wrote in his recent annual letter to shareholders, the world currently faces “risks that could eclipse anything since World War II — we should not take them lightly.”

What to do now

If you are a long-term investor — which should be the case for most people since it is too hard to trade consistently well — don’t sell out of multiyear holdings. It is just too difficult to time exits and re-entries.

Instead, consider selling covered calls against positions. You can generate income in a sideways market by selling someone the right to buy your stocks — by selling them call options. Call options give people the right to buy a stock at a preset price in some limited time frame. Covered calls mean you own the underlying stock they can buy, or 100 shares for each call option you sell. The risk here is that a stock could rocket higher; this would mean you miss out on the gains beyond the price at which you have to sell the stock.

Read: Nervous about stocks? This portfolio security blanket gives you income and a market edge.

Buy gold or better yet, gold stocks. Gold can go higher in times of rising geopolitical tensions, and consider gold stocks because they have not moved up in line with gold.

Also, don’t be on margin. It is always difficult to make money buying stocks using cash you borrow from your broker. It’s even more difficult in an environment where stocks might fall or trade sideways. Stay off margin.

Let cash accumulate. If you dollar-cost average, don’t stop. Otherwise, be judicious in buying. Don’t chase stocks. If there is a pullback, buy it. The U.S. economy remains sound, and this should help avert a bear market.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any securities mentioned in this column. Brush publishes a stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.

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