Insiders vs Analysts

An interesting, if poorly written article in the New York Times this morning briefly recaps a new study examining the dissonance between analyst recommendations and insider trading. Specifically, the study finds that when analysts downgrade a stock and insiders begin to buy, the stock typically outperforms the market. An abstract of this study, written by Jim Hsieh, Lilian K. Ng, and Qinghai Wang, as well as a link to a downloadable PDF of the full text, can be found here.

The results of this study don't really surprise me much. I've spent the past few months at work trying to learn as much as possible from our research department, as well as examining traditional research techniques. I have to say that, first off, many research analysts don't understand trading very well. Too often they downgrade a stock after it's been hit, or upgrade after a good run-up, and end up being of little value other than as a lagging indicator. Secondly, analysts often run in packs - there seems to be a dearth of unique analysis techniques, causing many of the big banks to come to the same conclusions based on the same methodology. Due to the new restrictions on public dissemination of corporate information, (Reg FD,) it's unlikely analysts can effectively be anything more than laggards.

Corporate insiders, by contrast, have access to information that is not available to analysts or the public. They can see monthly, weekly, and sometimes even daily sales recepits. They know about changes in the supply chain. They know if a major corporate maneuver is about to be initiated. This gives them a unique perspective, and an advantage over the analyst community. If, due to the capriciousness of the market, a stock has been falling despite an insider being aware of strong corporate prospects, of course he'll buy at depressed levels. Of course, this is exactly the same time that many of the banks' analysts are downgrading - it's more important for many of them to not be seen as having an "outperform" on a stock that's down 20% while your peers are downgrading than it is to make the differentiated, gutsy call.

Specialist Unit 949 Is No More

Last Friday I got a call at work from an AMEX broker I used to trade with. I used to stand next to him when I traded Yahoo options, and we became friendly. As it happened, I went to elementary school with his brother, and thus we had a few mutual friends. Anyway, in the process of trying to sell me on some shady transaction that he was involved with, he mentioned my old firm. "You know, the rumor around here is that Charlton book is closing down." Now, I've known for a while that they've been having some problems, and that there was a good possibility of the book closing up at year-end, so I didn't think much of it.

Then Monday, while I was bored, I surfed over to the AMEX website. Scrolling through the floor bulletins, I clicked on a Relocations Of Options list.

Oh shit.

Somebody's book went out of business. There must be 75 options there that were all transferred to LaBranche. Wait. I know those options. I know that book.

Oh shit.

Charlton's done.

Just like that, my old firm closed up shop Friday afternoon. After the initial feelings of relief that I got out before the axe fell, I realized that most of my friends down there probably have no job left. I tried calling Jeff, but no answer. I emailed Yogi. He knew a little more than me - and it sounded ugly.

Finally, Jeff called me last night while I was out. We spoke for an hour, and he gave me the details. It was very ugly. Basically, the 3 senior partners decided to just pull the plug. Most of the junior guys were given jobs trading upstairs, at $30k per year draw. That's it. Jeff and Arnold were told they were not being offered positions. Between the two of them, they probably accounted for 35 years of loyalty and easily $60 million in profit. Apparently, that meant little to the other 3. It just goes to show you - loyalty to your job is overrated. Look out for yourself, since nobody's going to look out for you.