The coronavirus (Covid-19) pandemic has caused an unprecedented level of disruption to the global economy and the world’s financial markets in 2020. As a result of the economic uncertainty associated with the outbreak, equity market volatility has surged, with many stocks experiencing double-digit declines.
In times of economic uncertainty, insiders are in a unique position in terms of their ability to access, interpret, and act on private information in relation to their businesses, and their actions can provide us with insight into future business conditions and stock price movements.
In an effort to better understand the potential impact of Covid-19 on the global economy and equity markets, researchers at the Simon Fraser University and the Ross School of Business recently analysed the insider transaction activity that took place throughout the first few months of the pandemic – when financial market volatility was at an elevated level – and published an academic paper on their analysis.
Using 2iQ Research’s insider transaction data, the researchers involved in the study were able to analyse over 300,000 insider trades. Below, we highlight the findings and conclusions from their analysis.
An analysis of insider transactions throughout the Covid-19 crash
The researchers involved in the study included Deniz Anginer, Anil Donmez, Nejat Seyhun, and Ray Zhang – all of whom are well known in the insider transaction analysis space. Seyhun, for example, wrote several papers on the topic in the 1980s and 1990s. He is also the author of the book, Investment Intelligence from Insider Trading.
The idea behind this particular study was that insider trading may provide valuable insight into the potential long-term economic impact of the Covid-19 pandemic. If an insider believes there’s a mismatch between their company’s future prospects and its stock price decrease in the wake of Covid-19, you would expect them to buy stock. Conversely, if an insider believes the worst is yet to come in terms of disruption, you would expect them to sell stock despite the large stock price declines. So, the trading behaviour exhibited by insiders, as a whole, could potentially convey valuable information not only about future stock returns but also about the health of the economy.
Overall, the researchers examined 199,030 trades made by 21,499 insiders in the US, and 128,013 trades made by 18,609 insiders in Canada, China, Italy, Spain and South Korea over the period January 2017 to April 2020. All transaction data was sourced from 2iQ Research’s database, which contains open market purchases and sales by all insiders from over 52,000 public-listed companies in 55 countries, with an average history of over six years.
Findings from the insider transaction analysis
There were a number of interesting findings from the analysis of the insider transaction activity.
The main findings are listed below:
- There was some evidence of opportunistic insider selling in January and February 2020 leading up to the Covid-19 stock market decline. Interestingly, insiders with Chinese backgrounds sold shares in higher numbers in January and early February and bought shares in higher numbers after the stock market crash in March.
- Insiders in the US bought stock in record numbers in March 2020. US insiders tend to be net sellers, on average, because a large proportion of executive compensation comes in the form of option and stock grants. For example, over the 36 months prior to the onset of the Covid-19 pandemic, when insiders participated in one or more trades in a given month their firms were net buyers in only 16% of observations. This figure rose to 56% in March 2020.
- Insider purchases in March were more pronounced for larger firms, value (high book-to-market) firms, and firms with high levels of leverage.
- Insider purchases in March were more pronounced for firms in the finance, energy, and consumer nondurable sectors.
- Insider trading patterns in Canada, Italy, Spain and South Korea were similar to those seen in the US. Insider purchases were more pronounced in Italy and Spain – two countries that were initially at the epicenter of the global outbreak and saw greater market declines.
- Insider purchases continued in April, even after substantial stock price increases.
- Firms in which insiders sold stock had significantly lower returns in April 2020 compared to firms in which insiders bought stock.
Takeaways from the analysis
There are a number of takeaways from the analysis of the insider transaction data.
Firstly, insiders’ reactions to the pandemic indicate that they generally did not expect worst-case scenarios, in terms of the economic impact of the pandemic on the global economy, to eventuate. Their trading activity suggests that they believed the impact of Covid-19 on global economic activity and the stock prices of their companies would be temporary.
This is reinforced by the fact that there was a high level of buying at firms with high levels of leverage (which could be more vulnerable than other firms during periods of economic stress). Overall, insiders’ reactions during March indicated that the 35% decline in the US equity market by the third week of March constituted an overreaction to the pandemic. This is consistent with our blog post at the time and our general findings.
Secondly, the sustained insider purchases in April suggest that insiders expected fiscal and monetary stimulus provided by the Federal Reserve and other central banks to be effective in stabilising markets going forward.
Finally, the findings support the view that insider transaction activity can provide valuable insight into the direction of future stock price movements. Examining stock returns in April 2020, the researchers found that firms in which insiders sold stock had significantly lower returns relative to firms in which insiders bought stock. This supports the predictive value of insider trades.
Overall, the analysis shows that insiders’ private information becomes particularly valuable during a period of significant market disruption. Insiders’ trading activity can provide powerful insight in relation to the health of their businesses and the future direction of stock prices.