Protect Yourself From the Economic Downside

 | Aug 26, 2013 | 3:00 PM EDT
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That was a lovely durable-goods report this morning, wasn't it? If you put that together with relatively weak retail earnings and the surprise drop in new homes last week, it is not really a great economic picture as we head into the fall.

I sent out my crack team of retail observers this past weekend, and my wife and daughter reported that stores were not overly busy during what used to be the big back-to-school shopping session. The so-called economic recovery continues to sputter along at a very low level. We aren't creating enough jobs to get a real recovery going, and I don't see any vast improvement in the near future.

Of course, in the wacky world that is Wall Street, some folks take this as good news, as it means the Federal Reserve is not as likely to turn off the pump of bond buying just yet. The central bank will need to see some more positive reports before it can deprive the stock market of its regular fix of cheap money and liquidity. Somehow, this is good for stocks, at least in the short run.

I think this is a special form of insanity, and the growing disconnect between the economy on Main Street and the everlasting rally on Wall Street is going to be a huge problem at some point. As I have said it several times, this disconnect makes for a very scary stock market. I have no idea when the reality of the economy and the illusion of the "wealth effect" will collide, but I can take steps now to make sure I don't get crushed if and when it does happen.

One good way to make sure you do not get caught owning the wrong stocks at the wrong time is to follow the insider selling lists. An isolated insider sale here or there is not a cause of concern, as it could be someone diversifying or doing estate planning or even building a dream house. However, when you get a cluster of open-market sells, countless studies have shown us that there is a substantial chance the stock will decline over the next year. Given this information and an increasingly cloudy economic picture, it just makes sense to avoid or sell any holdings of economically sensitive or consumer-oriented companies that are seeing substantial insider selling.

I thought I was a real genius for buying Conn's (CONN) a few years ago, doubling down below $5 and selling in the mid-$20s. The stock laughed at me by climbing up into the high $60s as the Texas economy rebounded faster and farther than the rest of the country, driving strong earnings for the electronics and appliance stores.

Since April of this year, analysts are finally falling over themselves to upgrade the stock, but now we are seeing insiders sell stock at a fairly rapid clip. In the last month, officers, directors and a beneficial owner have combined to sell more than 1 million shares of stock for more than $65 million. The stock now sells for more than 4x book value and 30x earnings, and I am clearly not the only one who thinks it may be a little overvalued here. It is time to take profits along with the insiders, and I certainly would not be a buyer here.

Dividend chasers have been buying shares of Procter & Gamble (PG) for a couple of years now, and the shares got an additional lift when William Ackman took a stake in the company with activist intentions. The stock is trading at crazy levels, given the anemic sales growth and weak economy.

A few weeks ago, when I ran intrinsic-value calculations in large blue chips, I found that only by plugging in ridiculously optimistic assumptions could I get a number above $50 a share. Since Procter & Gamble currently trades at around $80, I cannot think of a single valid reason to own the stock. Apparently, a few insiders have some questions about the price of the stock as well, since seven insiders have combined to sell more than $2 million of stock in the past month.

Stocks that show clusters of insider selling have a large statistical probability of declining, and economically sensitive stocks are exposed to what looks like increasing risk. If we get a selloff related to Federal Reserve tapering, these stocks will decline with the market, and if the economy stays weak enough to prevent tapering, these companies will have poor sales and earnings results. It makes little to no sense to me to own these types of stocks right now.



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