A Risky Moment
Insiders aren't buying... Private equity is selling... Russell 2000 losers are rising... Risky debt is expensive... Investors are buying everything... A wider range of outcomes... What I'll say in Vegas...
When insiders buy stock, pay attention...
If you're the CEO of a company, you should know more than anyone about the company's stock valuation versus its future prospects.
And when you can see that the market is undervaluing your company, it's a natural time to load up on shares... a transaction an insider must report to the U.S. Securities and Exchange Commission ("SEC").
SEC filings about insider buying are a bullish sign. It means insiders believe the business is a great investment and that the stock price will rise. And they're not just saying it on a rosy conference call... but putting their own wealth on the line.
Now, insiders sell for many different reasons...
Insider selling is not a clear signal of insider sentiment and doesn't mean you should sell the stock. It can be a contributing factor in making a bearish case for a stock, but that's usually only true if there's also a potentially serious problem with the business.
The same applies to sales from a top investor like Warren Buffett, who also must disclose the transactions of his holding company, Berkshire Hathaway (BRK-B).
Still, while sales from these folks aren't inherently bearish, they're certainly not bullish...
And lately, I (Dan Ferris) have been reporting on all the ways big investors and insiders are selling...
That includes Buffett selling big portions of Berkshire Hathaway's stakes in Apple (AAPL) and Bank of America (BAC). We also mentioned that Buffett's top insurance guy, Ajit Jain, has sold most of his stake in Berkshire Hathaway.
Then, a couple weeks ago, I reported that Michael Dell sold 45% of his publicly traded Dell Technologies (DELL) shares, though he and his wife still control the company via private shares. We also reported that the Michael & Susan Dell Foundation reduced its position in Broadcom (AVGO) by 66%.
We reported on Buffett selling Apple and Bank of America not because he's an insider in those companies. We simply thought it was important that Buffett had reduced his firm's largest position by 60%. Same with Bank of America, also a large position for Berkshire.
Coincidentally, Barron's recently estimated that Berkshire's cash hoard could be as large as $300 billion. So the most famous and influential investor of the last several decades – who has been telling us to buy U.S. stocks the whole time – is selling stocks and piling up cash.
The simultaneous selling of large insider stakes by Ajit Jain and Michael Dell seems to add fuel to the fire.
Though we don't have more selling news this week, we do have evidence that insiders are sitting out the current market rally...
It comes to us from our friend Jason Goepfert at SentimenTrader.com. Folks at his firm crunch historical market performance numbers like nobody else, and they can tell you how stocks have tended to perform after just about any type of event.
He recently posted on social media platform X:
You know who's not chasing stocks here?
Insiders.
Corporate executives among S&P 500 firms have some of the least open market purchases in 13 years.
And remember, Goepfert isn't talking about one particular sector or industry. He's talking about the entire group of corporate insiders, from all 11 sectors in an index that makes up 80% of the market cap of all U.S. stocks (which account for nearly half the market cap of global equities).
So you can't say this record low in insider buying is about some particular development in one industry. It's everywhere. All those insiders like buying their company's stock less than any time in at least 13 years.
This trend isn't limited to the stock market...
The Financial Times recently reported that private-equity ("PE") investors are selling in record amounts...
Big institutional investors like pension funds and university endowments are disappointed in the returns they've been getting from their PE investments and want to sell.
Under normal circumstances, PE investors would simply hang on to their investment for the agreed-upon term (usually 10 years). Along the way, the private-equity firm extracts cash from the companies it invests in – either by selling the company or, in some cases, by borrowing against it to pay itself and its investors a big dividend.
Private-equity firms use a lot of debt financing. It's virtually their entire strategy. They buy a company, lever it up, and sell it. That was easy when interest rates were scraping 5,000-year lows. But when using a lot of debt is your whole schtick, high interest rates can ruin your business.
Higher interest rates make every aspect of private equity harder...
It's harder for PE firms to finance investments.
It's harder for them to lever up their own balance sheets and those of their invested companies.
It's harder for them to extract cash from the companies they invest in, which have to spend more cash servicing debts.
And it's harder for PE companies to sell companies, which become less attractive to prospective buyers.
Less cash extraction and fewer company sales mean PE firms are distributing less cash to clients. Private-equity funds have paid out less than half the average amounts they've paid in the past.
So now PE investors are getting frustrated with the lower cash payouts and want to sell their stakes. Executives at investment banks Houlihan Lokey and PJT Partners expect secondary sales of $145 billion to $150 billion, beating the previous record of $132 billion set in 2021. The PE industry is holding $3 trillion of unsold investments, also a record level.
But just like in the stock market, valuations are soaring. In 2022 and 2023, FT reports, investors were selling stakes at 80% of their reported value. Today, prices are between 93% and 98%.
So just like Buffett and all those insiders we've been talking about for weeks now, PE investors are using a rally in valuations to head for the exits.
By the way, those PE companies aren't the only ones wrestling with higher debt costs...
You've certainly heard of the Russell 2000 Index, the most popular small-cap stock index. These days, the Russell has companies with market caps as high as $14.5 billion and as low as a few million dollars.
The Russell 2000 has a well-earned reputation as a junky index. It's the only major stock index that hasn't eclipsed its 2021 highs. Many Russell 2000 companies lose money. And many of them have loads of debt.
Apollo Global Management chief economist Torsten Slok reports that 42% of the Russell 2000 companies now have negative earnings. That's higher than the 41% high notched at the end of the 2008/2009 financial crisis. Data charted by Slok shows that the figure has risen steadily since the mid-1990s, with sharp upward spikes during recessions.
Rising interest rates have hit the Russell 2000 hard. The total interest expense of all Russell 2000 companies is now at 7.1% of their total debts.
That's the highest level since 2003 – in the wake of the dot-com junk-bond rout. Lots of Russell 2000 companies have junk credit ratings. Junk bonds started 2003 priced at a spread of about 8.9% above Treasurys of comparable maturity. They finished the year at a spread of about 4.2%.
And yet, investors don't care...
Despite obvious signs of distress, they're paying high prices for junk bonds, right along with any other asset today. Today, junk bonds are as expensive as stocks, PE stakes... and just about everything else.
Today, according to the ICE Bank of America U.S. High Yield Index Option-Adjusted Spread, junk bonds are priced at 2.9% above Treasurys. That's the lowest spread since 2007 – just before the great financial crisis, when spreads blew out and reached 20% in late 2008.
In other words, junky companies like the ones you find in the Russell 2000 are showing obvious signs of stress like near-record numbers of them losing money with the highest interest expense in 21 years...
And the market is in love with them, paying the highest prices relative to Treasury bonds since June 2007.
It's a risky moment...
People are more excited about taking risk in the stock market than they were in late 2021, just before the S&P 500 Index lost 25% of its value and the Nasdaq fell 36%.
They're more excited about the riskiest bonds in the market than they've been since 2003... even though a greater percentage of the companies issuing them are losing money than any time since the mid-1990s (except for early 2021).
At the same time, gold is hitting new highs.
And we know what they're all so excited about. It's not hard to figure out at all.
Central banks around the world are cutting rates. Last month, they did it 21 different times, the highest number since March 2020 – when pandemic lockdowns shut down the entire global economy.
So everyone figures that they should just... buy...
Everything.
It's not a stupid bet. But it's not the bet most folks think it is...
Most folks think they're buying everything because lower interest rates make stocks and other asset prices go up... even though the history of rate-cutting cycles shows that they often accompany recessions and bear markets.
But what they're really doing is overpaying for risky assets because low yields make safer ones unattractive.
In other words, people think they're buying a more benign environment for equities. But they're really just selling a less attractive environment for bonds.
They think they're buying a "sure thing," but they're really getting high on speculation and risk-taking.
They think risk assets are safer, but they're not. They're riskier than ever.
And let's not forget what risk means: the width of the range of likely outcomes...
For example, historically, short-term Treasurys have delivered a very narrow range of outcomes. They preserve your principal and pay you a yield that has ranged in the last decade from microscopic to (currently) reasonable.
Historically, stocks have delivered a wider range of outcomes, from losses of 50% or more in bear markets to periods of 20%-plus annual gains. Over the long term, they've done great.
The widest range of outcomes you can expect is in something like biotech or exploration mining stocks. You could make 100 times your money... or you could lose it all. And losses are more likely than gains.
Right now, it's as reasonable to expect a "Melt Up" as it is to expect a meltdown. Either would make sense, given the current state of things. (My subscribers to The Ferris Report will hear more on this theme, including a stock recommendation to take advantage of the situation, in the October issue that will publish one week from today.)
It's foolish to manage your money (or anyone else's) based on your ability to predict markets. That's a skill nobody has.
But it's especially foolish to rely on predictions at a moment like this, when financial markets seem to be pointing in opposite directions at the same time, signaling a potentially wide range of outcomes.
That's where I am today...
I see a higher-risk environment, and I'm trying not to be surprised about what happens next... whether markets keep soaring, go sideways, or plummet.
A year from now, most folks will look back with 20/20 hindsight and say that they knew markets would soar or they knew they'd go nowhere or fall or whatever.
But that's never true. Nobody invests anything because they know the future. In fact, a good investor invests for nearly opposite reasons: because he knows nobody can predict the future, but that a good investor can find an asset trading at an attractive price.
Right now is always the hardest time to invest, and this moment is no different. But still we must proceed. So we maintain our discipline, make the best investments we can make, and stand ready to correct them if we're wrong.
We hold more cash than usual at risky times. And we're happy we own gold at times like this. Cash is the true diversifier, while gold is the time-honored store of value and hedge against genuine financial chaos. Holding both is a great way to prepare your portfolio for a wide variety of outcomes.
Next week at our annual conference in Las Vegas, I'll touch on some of these points and give a lot more evidence of the risky environment we're in right now. And I'll tell the audience what I think you should own right now (it won't be a huge surprise to readers of Extreme Value or The Ferris Report). If you haven't already booked your livestream conference access, ticket sales close today... Click here to learn more.
Finally, at our annual Alliance meeting on Wednesday, I'll give attendees a small-cap stock pick. This stock has already been performing well the past couple of weeks, and I'll make a very bullish case for it over the next several months. (It's not the usual sort of thing you expect when you hear the words "small cap." I bet nobody else at the conference is even thinking about it.)
It's a risky moment. But if you know how to prepare for a wide variety of outcomes, you will not merely survive whatever is coming. You'll thrive and grow wealthier through it.
New 52-week highs (as of 10/17/24): Automatic Data Processing (ADP), American Express (AXP), Brown & Brown (BRO), BWX Technologies (BWXT), Cameco (CCJ), CME Group (CME), Pacer U.S. Cash Cows 100 Fund (COWZ), Cisco Systems (CSCO), Cintas (CTAS), CyberArk Software (CYBR), Gilead Sciences (GILD), SPDR Gold Shares (GLD), W.W. Grainger (GWW), Houlihan Lokey (HLI), HealthEquity (HQY), iShares U.S. Aerospace & Defense Fund (ITA), Jack Henry & Associates (JKHY), Kinross Gold (KGC), Linde (LIN), Lumentum (LITE), McDonald's (MCD), Motorola Solutions (MSI), Newmont (NEM), Pembina Pipeline (PBA), Sprott Physical Gold Trust (PHYS), Royal Gold (RGLD), RenaissanceRe (RNR), Snap-on (SNA), Cambria Shareholder Yield Fund (SYLD), Toast (TOST), Travelers (TRV), ProShares Ultra Gold (UGL), ProShares Ultra Financials (UYG), Vertiv (VRT), and W.R. Berkley (WRB).
A quiet mailbag today, so we'll offer one final reminder... Our annual Stansberry Research conference starts on Monday in Las Vegas. In-person tickets are sold out, but if you're interested in taking in our biggest event of the year, you can still get a Livestream Pass, but through today only.
Things get going at the conference on Monday morning with a sit-down interview between our founder Porter Stansberry and acclaimed author Michael Lewis. They'll be followed by dozens of presentations featuring insight on all the hot topics in finance and investing today, and exclusive recommendations from our editors and invited guests (who include Rick Perry, Dave Barry, and many more).
We'll have reports here next week from Vegas, but if you want to experience the conference, again, your best bet is a Livestream Pass. And, as always, if you have comments or questions, send them to feedback@stansberryresearch.com.
Good investing,
Dan Ferris
Eagle Point, Oregon
October 18, 2024