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UPDATE: As stock markets skidded early this month, company insiders boosted their buying

Today 5:18 AM ET (MarketWatch)

By Mark Hulbert, MarketWatch

Share of firms for which net insider buying from officers and directors is positive climbed as the Dow industrials skidded more than 1,000 points

CHAPEL HILL, N.C. -- Corporate insiders have reacted to the stock market's recent selloff by increasing their buying, and that's an encouraging sign.

This suggests they think recent drops in benchmarks like the Dow Jones Industrial Average and S&P 500 index are only temporary, and that their companies' shares will soon be trading for higher prices.

Insiders, of course, are a company's officers, directors and largest shareholders. They presumably know more about their firms' prospects than do us outsiders, which is why it pays to pay attention to them. Fortunately, since the Securities and Exchange Commission requires them to report almost immediately whenever they buy or sell their companies' shares, that is relatively easy to do.

Nejat Seyhun, a finance professor at the University of Michigan who is one of academia's top experts on analyzing the behavior of insiders, believes that the insiders whose transactions are most worth following are officers and directors. He told me that's because the third category of insiders--a company's biggest shareholders, which almost always are Wall Street's largest institutional investors--have not exhibited any historical stock-selection ability, on average. So even though institutional selling has been in abundant evidence this past week, as waves of their selling have sent the market averages plunging, that tells us relatively little about the market's prospects going forward.

The particular metric on which Seyhun instead focuses is the percentage of firms for which net insider buying from officers and directors is positive. He calculates this by first measuring for each firm whether total purchases from officers and directors in a given month exceed total sales--positive net insider buying, in other words. He then reports the percentage of all firms with insider activity that had this positive net insider buying.

It would have been particularly worrisome if this percentage had fallen, according to Seyhun, since that would indicate that insiders on balance had so little confidence in their companies' shares that they were eager to sell at almost any price. Fortunately, however, that's not what they did. For the first four days of August, for example, during which the Dow industrials were plunging more than 1,000 points, this percentage rose to 29.5%, according to Seyhun, from 20.7% in July.

To be sure, the August percentage reflects only the first four trading days, whereas the July percentage (as well as the percentages for all prior months as well, as plotted in the accompanying chart) reflect transactions over entire months. Nonetheless, Seyhun believes the August number is still revealing, indicating insiders' immediate reactions to the market's plunge.

"Had they sold into the prices declines, that would have been a bearish signal," he said in an email.

The August number is encouraging from another perspective as well: It is above the 10-year average, which stands at 27.3%. Seyhun has developed an econometric model that translates a moving average of recent monthly insider buying percentages into a forecast of the S&P 500's gain over the subsequent 12 months. That forecast currently is for a return of 14.1%, slightly above the stock market's long-term average.

The insiders' recent behavior is reminiscent of how they reacted to the market's correction last autumn, when they also increased their buying. Though that correction still had further to go when I reported this good news last October (http://www.marketwatch.com/story/corporate-insiders-are-taking-the-stock-markets-big-selloff-in-stride-2018-10-12), the market nevertheless soon bottomed and commenced on one of the most powerful six-month stretches in recent history.

To be sure, because the forecasted 12-month S&P 500 return of 14.1% is not much above the market's long-term average return, an overweight equity position can't be justified on the basis of insider behavior alone. Still, given the doom and gloom scenarios that accompanied the market's turmoil over the last couple of weeks, most of us would be entirely happy, thank you, with the next 12 months being an "average" year.