Remember Dionne Warwick? She was the once-popular singer who was reduced to touting for US television’s Psychic Friends Network, which recently went belly up. The joke is why Ms Warwick, an insider with the psychic community, failed to see the demise of her cash cow coming?
Well, there are a lot of Dionne Warwicks on Wall Street. In fact, with the advent of 401k plans, fully half of Americans have a vested financial interest in the continued good health of the world’s financial markets. But novice investors have a decided disadvantage in discerning the mystic tea leaves that portent good fortune or ominous times ahead for the markets.
The investment professionals – the traders, brokers and others who make their living on Wall Street, along with investor relations executives and CFOs – know better. And what they’re seeing in their crystal balls these days is enough to make the heartiest soul wonder if the end of the decade-long roaring bull market isn’t finally at hand.
What are the pros seeing that is souring their stomachs so? For starters, an unparalleled rash of insider selling that transcends simple profit-taking. Also visible on the near horizon is a slowdown in the once-frenzied pace of corporate buy-backs, signifying that skittish companies today are buying less and selling more.
Cash shy
Finally, some industry observers say that the recent rash of bank megamergers is an omen of dark times ahead for the financial markets, and not just for the potential price controls and near-monopolies that will result from the big M&A activities of late. They’re looking at the books and walking away scratching their heads, wondering why so little cash has changed hands in all the hoopla. Could it be that big banks only want to sell their own stock, and not hand over fistfuls of cash, because they know something the rest of us have yet to find out?
Okay, maybe we’re beginning to sound a little like Oliver Stone and one of his conspiracy theories. Some observers think so. ‘If you look at the fact that the stock market is up substantially, it would make sense for anyone to take some profits and diversify,’ cautions Marilyn Capelli Dimitroff, a Bloomfield, Michigan-based financial planner. ‘The recent trend toward insider selling might just be a case of smart business people making smart business decisions.’
There again, it might not. ‘On the other hand, we are seeing an increase in insider selling, and we are seeing a slowdown in corporate buy-backs,’ Dimitroff adds. ‘And we’re also seeing an increase in the volume of short sales. So maybe it’s best to take a closer look at that kind of activity.’
Aha, now we’re getting somewhere. Let’s open the floodgates. ‘We’re seeing red flags everywhere,’ says Johnnie Johnson, president of IR consultancy Johnnie D Johnson in New York. ‘In Canada profits were rising with the TSE 300 in mid-1997 and then they dropped like a rock. The same is true for the US, where profits have flattened out while the market keeps spiraling upward. You’d be remiss in not paying attention to that.’
Then there’s the little guy. You know, the one who saved Wall Street’s bacon during last October’s market correction, following the Asian stock price crash, by keeping a steady hand when the big boys were jumping ship. ‘Actually, the little guy is scared,’ notes Harold Evensky, a principal at the Coral Gables, Florida financial advisor Evensky Brown & Katz. ‘For about a year now I’ve noticed the number of calls from smaller investors about the market dwindling. My daughter has stopped asking me about Microsoft and Intel. Even the guy who waters the plants in our office has stopped asking me about the market. Now those are red flags.’
Insider’s game
So there is some concern out there. Now let’s turn the white-hot media spotlight in the direction of those corporate buckaroos who are selling stock at the frenzied pace of a ticket scalper at a Spice Girls concert. Some estimates put total unexercised stock options out on the market at $1 trillion. That’s a powder keg and a lit match waiting to happen.
First, inside sellers are often a fickle and disingenuous lot. Take Walt Disney chairman Michael Eisner. His recent exercise of 7.3 mn options (with 5.7 mn shares actually being sold) drew a crescendo of oohs and ahhs in the media. The spin from Disney investor relations was that Eisner was actually increasing his common stock stake by 1.6 mn shares. Unless Eisner hired Goofy to run the numbers, the spin doesn’t make any sense. Actually, he decreased his combined stock and options holdings by 53 percent.
Then there’s Oakley’s chairman, James Jannard. The company’s investor relations staffers would have us believe that he saved the day for shareholders by buying 1.9 mn shares (for $20 mn) when the stock sunk in 1997. But what about the fact that Jannard had quietly taken $220 mn in stock sales prior to 1995? Nobody wants you to know that.
But guys like Eisner and Jannard are hardly alone. According to a recent article in the Wall Street Journal, the ratio of insider sales to purchases rose as high as 3.34 in the fourth quarter of 1997 – the highest level of the 1990s. The number fell to 2.25 in the first two months of 1998 before rising back to 2.8 in March and April. According to insider selling tracker Bob Gabele of CDA/Investnet, a ratio of 2:1 is historically normal for inside sellers. Anything over that is decidedly bearish. Unlike the Psychic Friends Network, corporate insiders have a track record of getting out while the going is good: the ratio of sellers to buyers was very high prior to the October 1997 market collapse.
One technical analyst, Frank Ponticello of Prudential Securities, says that he looks for three or more company insiders buying or selling more than 1,000 shares of stock within a three-month period. Others look for two or more executives in the same industry selling more than 10,000 shares during the same month. That could be a sign that their faith in the market is weakening.
Stormy market bellwethers
Another big indicator of potentially declining markets is the rate of corporate stock buy-backs. In the first quarter of 1998, companies announced plans to repurchase $39 bn of their own stock, down from $52 bn during the same period last year.
At the same time, companies are loading down the market with new stock: $34 bn in the first quarter of this year versus $28 bn last year. The evidence is plain: they’re buying less and selling more.
Merger mania in the banking industry is another cause for alarm for some stock market watchers. The absence of cash in the mega-billion dollar deals in favor of company stock is a big red flag. Would so many big bank mergers have been consummated if any of the parties had to lay out real money?
Others say that the revenues generated from the big M&A deals in 1997 and 1998 aren’t being earmarked for company growth, but instead going to buck up the fortunes of company stock. ‘There are a lot of senior managers who are absolutely alarmed over the fact that big chunks of M&A money aren’t going to company research, training, technology, or to increase head count – the things that drive company growth,’ says Susan Kaplan, a Wellesley, Massachusetts-based financial planner. ‘Instead, the money is going straight to the bottom line to artificially support the company stock. That strategy could easily backfire on these companies, and negatively impact the stock market as well.’
Sure, you’ve probably read or heard about the market dangling off the precipice for five years now, yet it still keeps chugging along, blissfully unaware of the rocks strewn over the track down the road. It’s managed to crunch some of those smaller rocks under its mammoth wheels, but the red flags we’re talking about here are not just rocks, they’re boulders – the kind of boulders that can so easily derail oncoming locomotives. That’s why so many people in the engineer’s cabin are leaping off the train. Can the rest of the crew and passengers be far behind?
