Warning: Stocks Get Popular

Individual investors are moving into stocks. And the smart money is moving out. This new popularity of equities is a warning sign.

With the Dow Jones Industrial Average pushing past 14,000, individual investors jumped back into the stock market. Unfortunately for them, insiders are betting that the rally is already over. They quietly sell their stocks for what they believe is the best price they can get.

When average investors pour money into the market, it’s a sign that a correction, or even a bear market, is coming. Likewise, when corporate insiders sell their shares, look out below.

Individual investors pulled more than $150 billion out of U.S. stock mutual funds since 2009, but they returned in January with a net investment of $10.3 billion. Including exchange-traded funds, a record $77.4 billion flowed into stock funds in January, according to TrimTabs Investment Research.

Conversely, there are more than nine insider sales for every buy lately, among insiders whose stocks are listed on the New York Stock Exchange.

“Insiders are waving the cautionary flag in an increasingly aggressive manner,” wrote David Coleman of the Vickers Weekly Insider report.

For example, Google (GOOG) Chairman Eric Schmidt revealed in a regulatory filing that he plans to sell off 3.2 million of his Google shares – 42% of his total stake in the company – over the course of a year. As his spokesperson told CNET, this move has more to do with Schmidt’s personal portfolio diversification than a short bet on the company.

But think about his timing. Google rallied nearly 20% in the past three months. It is possible that Schmidt doesn’t see the shares increasing in value much more. It also doesn’t bode well for hopes that Google someday pay investors a dividend.

Executives have not sold their company’s stock this aggressively since early 2012 – just before the Standard & Poor’s 500 corrected by 10% to its low for the year. If you look at charts of the major stock indexes, you see that the stock market is following a similar pattern from the November to February period a year ago. We could follow the same path now.

Of course, there are plenty of legitimate reasons for a stock market rally.  Aside from a disappointing gross domestic product report for last year’s fourth quarter, data on manufacturing, consumer behavior and the housing market suggest that the economy is steadily improving. We should see stronger economic growth and lower unemployment just ahead, right?

Well, not so fast.

Initial forecasts predicted that fourth quarter earnings might reflect the economic growth taking place. Instead, fourth quarter earnings were down 1% from the year-earlier period and 8% lower than analysts’ pre-earnings season forecast.

So what about the recent market gains during earnings season?

As Zero Hedge noted, just 10 companies contributed more than 90% to the S&P 500’s upside in aggregate earnings. Microsoft (MSFT) and JP Morgan Chase (JPM) account for half of that.

Individual investors pulled out of the market in droves just as the market was recovering from the 2008 bear market. Now they’re jumping back in. Join the herd at your own risk.

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Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass.  
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