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Smart Money Is Selling, and You Should, Too

It won't be an apocalypse, but a needed pullback is surely coming


Early in my career, I discovered one of the most valuable truths I’ve ever learned about investing. You don’t have to be the sharpest knife in the drawer to succeed at this stuff. What you do need to do is find out who the smart players are, and emulate them.

Right now, the folks who typically get it wrong at important turning points are buying like crazy. And the people who typically get it right when it counts most are dumping — with almost equal urgency.

Insiders Are Selling

The smartest of the smart are the insiders — officers and directors of America’s publicly traded corporations. They aren’t stock traders, at least not in the ordinary course of business. However, they understand the internal workings of their companies far better than any outsider, including the most highly paid Wall Street analysts.

In recent weeks, insider selling has picked up sharply — and may soon turn into a tsunami once earnings season passes. (Company regulations often restrict insiders from selling their own stock shortly before, or after, earnings reports.)

According to data from Vickers, insiders have executed 4.79 sell transactions for every buy over the past eight weeks. That ratio exactly matches the high from last fall, recorded as the S&P 500 index was in the process of shedding 7.7% from mid-September to mid-November.

Avoid the Extremes

In contrast to the insiders, we’ve got the professional market timers. Collectively, they’ve compiled a less-than-glorious record: boundless enthusiasm at the top, utter panic at the bottom, just like the unwashed public.

Alas, the latest poll from the National Association of Active Investment Managers, released yesterday, shows that the average market-timer is 104.25% invested. In other words, these ne’er-do-wells have not only invested every dime in their possession but they’re also borrowing money (on margin) to buy even more stocks.

It’s the highest reading in the survey’s seven-year history. The only other 100%+ number came in January 2007, shortly before the trap door opened and trillions of dollars fell through.

I’m not expecting such an apocalyptic result this time. In fact, I think there’s a strong chance the headline stock indexes will break out to new all-time highs later this year.

However, the market is now clearly overextended and in need of a rest. A pause, followed by perhaps a 3% to 4% pullback during February, would refresh the bull. Whereas a continued rush for the skies would set us up for a much more severe decline later.

Act Defensively

Consider selling stocks and mutual funds that haven’t touched a new high for the cycle during the past 18 months. This advice applies even to investments I’ve recommended, as long as you own the stock or fund in a taxable account and you won’t incur a significant tax liability by selling. Sometime this spring, I suspect you’ll be able to buy back most of your value-rich laggards at lower prices.

Among the few stocks still worth buying at these levels are dividend-rich Coca-Cola (NYSE:KO) and Microsoft (NASDAQ:MSFT). Even here, though, I recommend building a position gradually over the next six to eight weeks. Place your orders on days, like yesterday, when these “royal blue” chips uncharacteristically drop by a much larger percentage than the S&P 500 index.

From yesterday’s close, I’m projecting a total return of at least 15% for Coke in the next 12 months and at least 20% for Microsoft.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.

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