According to Charles Biderman, CEO of TrimTabs, an independent research firm, the average insider selling ratio, that is, number of sellers divided by the number of buyers, is around 7. That means there are typically 7 times more sellers than buyers on any given day. There are a number of reasons the number is so high, one being that many employees are paid in stock, and sell immediately when the stock vests, but that’s not really all that important.

What is important is that the average is 7, and that in November of 2008, before the panic sell-off, the number had spiked to 24. What’s even more important is that right now, that number is 30. Insiders are selling off more than they did just two months after Lehman Brothers collapsed. We were still looking into the abyss at that point.

Even though I am bearish on the overall economy for the next few quarters, I was shocked to see such a high ratio of insider selling. It’s probably time to start taking profits off the table and moving towards a more conservative portfolio, with a large swath in cash.

Read this article from CNBC (owned by General Electric [NYSE: GE]) carefully: Durable Goods in Surprise Jump; Jobless Claims Dip.

Then read the article again with my emphasis in bold and my analysis in between the sections:

“New orders for long-lasting manufactured goods saw their biggest gain in 16 months in April and fewer workers filed for new jobless benefits last week, according to official data on Thursday that suggested the deep recession was abating.

The Commerce Department said new orders for durable goods rose 1.9 percent, the biggest percentage advance since December 2007. However, March orders were revised sharply lower, falling 2.1 percent from the previously reported 0.8 percent decline.“

March orders were revised down significantly to nearly 3x the level they were reported previously. How can we possibly believe the Commerce Department’s 1.9% estimation when they got it so very wrong last month? I promise you the April numbers will be revised in June, and they will not be pretty. But it sure makes a good headline for CNBC, right?

The article continues:

“A separate report from the Labor Department showed initial claims for state unemployment insurance dropped by 13,000 to a seasonally adjusted 623,000 in the week ended May 23, falling for a second straight week.

However, the number of people staying on benefit rolls after drawing an initial week of aid increased 110,000 to a higher-than-forecast 6.79 million in the week ended May 16.“

To put it another way, people who are losing their jobs are not finding new ones and the number was, of course, higher-than-forecast. But that would be too negative to put in the title of the article; instead they’ll simply bury it in the text.

“U.S. stock index futures pared gains after the data. Treasury debt prices briefly pared gains, while the dollar was flat.

‘The data is consistent with the view that the rate of contraction is slowing, but we are still working our way through a recession. We haven’t hit a bottom yet,’ said James Masi, chief fixed income strategist at Stifel Nicolaus in Baltimore.

The reports were the latest in a series that have raised optimism that the 17 month recession was starting to ease. Data on Wednesday showed an increase in the sales of previously owned homes.

But high unemployment, underscored by the Labor Department report showing that continued claims have set record highs in every week since Jan. 24, indicate that any recovery after the recession will be painfully slow.

Continuing claims are now more than double the level they were a year ago.“

Unemployment continuing to set record highs each week is an incredibly ominous sign of the dire economic situation we’re facing.

Let me shed light on something for you all who have been brainwashed by the financial media and government agencies: The unemployment rate during the Great Depression maxed out at around 25%. As of December 2008, the government, and kowtowed by the financial media, reported that the unemployment rate is around 7.8%. What they don’t tell us is that they’ve changed the way they account for unemployment since the Great Depression.

But wait, don’t fear, that measurement is still around. Indeed, it was the official measurement during the Clinton administration. As of December 2008, using the same measurement used during the Great Depression, unemployment was nearly 18%. And that was before record highs we’ve seen so far in 2009. It is very likely we’re nearing 20% now, not-so-far away from the Great Depression highs.

Check out this graph.

Pretty scary, right? No wonder the government and it’s media partners want to keep a lid on reality.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

“Borrowers such as Dayton, whose 2004 compensation was almost 10 times the median U.S. household income, are becoming trapped by the same issue facing the poorest subprime homeowners: falling home prices erase equity and make it impossible to sell or refinance without losing money.

The number of U.S. homes valued at more than $729,750, the jumbo-loan limit in the most affluent areas, entering the foreclosure process jumped 127 percent during the first 10 weeks of this year from the same period of 2008, data compiled by RealtyTrac Inc. of Irvine, California, show. The rate rose 72 percent for homes valued at less than $417,000 and 78 percent for all homes, RealtyTrac said.”

By the way, notice that Goldman Sachs (NYSE: GS) put Bank of America (NYSE: BAC) on its “conviction buy” (strong buy) list Monday (the cause of the rally), and today we find that Bank of America is selling 13 billion worth of stock on the public at the inflated price (because of Goldman’s cheerleading). Pretty crazy, huh? The banks are trying to keep each other alive! But the massive dilution (20% from BACs recent offering) will eventually destroy most of shareholders. What’s next for in the dilution game for BAC shareholders? Conversion of private preferred shares to common shares; another 20% dilution at least.

And don’t even tell me the banks will be earning their way out; S&P 500 profits have shrunk by 90%. Yes, 90%. No way they’ll earn their way out of this.

If you’re a BAC shareholder, I’d highly suggest re-thinking (read: sell) your position at the gift price of $11 (compliments of Goldman Sachs). I’d also suggest being in cash for a while until earnings start to come back, but that certainly won’t happen unless people stop losing their jobs.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

This “test” was meant to see how the top 19 banks would hold up in a worsening economy; using both an opitimistic and pessimistic set of assumptions. I want to focus primarily on the pessimistic assumptions for now; specifically the assumption that the unemployment rate for 2009 would be at 8.9%. Well, Mr. Geithner, just this morning there were 539,000 layoffs in April, which brought the total unemployment rate for 2009 (thus far) to 8.9%.

Uh-oh.

We are now facing the most stressful situation the stress test assumed 7 months before the end of 2009, with layoffs occurring at blistering speed each month (though they have slowed). It’s my estimation that an unemployment rate of 10% is far more likely in 2009, which represents a 12% increase over the worst case assumptions of the stress test.

Now I’m not entirely sure what this would do to the capital requirements for the largest banks, but I am sure that it’s worse than we are being told. Obviously I don’t mean to insinuate we’re being lied to, rather the set of assumptions were overly optimistic. I am making sure my clients are well protected against the real worst case scenario and highly suggest you do the same.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

Just a few moments ago, General Motors indicated it’s intention to seek a 1-for-100 reverse split on its common stock. If you’re wondering what a reverse split is, Investopedia has a fairly accurate definition and example:

Investopedia Definition:
A reduction in the number of a corporation’s shares outstanding that increases the par value of its stock or its earnings per share. The market value of the total number of shares (market capitalization) remains the same.

Investopedia Example:
For example, a 1-for-2 reverse split means you get half as many shares, but at twice the price. It’s usually a bad sign if a company is forced to reverse split - firms do it to make their stock look more valuable when, in fact, nothing has changed. A company may also do a reverse split to avoid being delisted.

So what does this mean for GM shareholders? Well, if you own 100 shares at today’s closing price of $1.85, and if the reverse split were to happen tomorrow, your 100 shares would now be shrunken down to 1 share worth $185. Far more often than not, especially for companies in facing serious trouble (as GM is), the $185 share price post-reverse split will drop fast and hard.

As far as I’m concerned, if you’re invested in GM, get out now. At $1.85 per share, the price is insanely overvalued. If you want American car manufacturing exposure, choose Ford (NYSE: F). They aren’t treating their shareholders like dirt, and they actually have a viable business model without the support of the government.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

If you possess the skills and are prepared to put in the necessary time and hard work to become a top 20% performer, then why accept being mediocre? If there are insufficient quality investments available, then be patient and wait for the right opportunity. Diversification is good for limiting risk (to an extent); it’s awful for maximizing return.

I’ve always had deep respect for Jim Rogers. Once again he garners my respect when he hits the nail on the head with regards to diversification.

The following is an excerpt from this article:

Diversification is something that stock brokers came up with to protect themselves, so they wouldn’t get sued for making bad investment choices for clients, says commodities bull Jim Rogers.

“Henry Ford never diversified, Bill Gates didn’t diversify,” Rogers told Business Week.

“The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket.”

…

Diversification is the end result of applying asset allocation strategies, which derive from modern portfolio theory, an offshoot of economics from the early 1950s.

Asset allocation holds that investors should combine various asset classes that do not correlate perfectly to achieve a diversity that protects some asset classes when others are adversely affected.

“There is a saying that you have to concentrate to get rich and diversify to stay rich, and over the past couple of years that has not worked,” Paul Vaillancourt, senior vice-president of Franklin Templeton Investments, told Canada.com.

“I don’t want to say diversification is a myth, but it is overdone.”

Another saying comes to mind when I think about diversification: “The fool says: ‘Do not put all your eggs in one basket.’ Which is just another way of saying, ‘Scatter both your money and your attention.’ The wise man, however, says: ‘Put all your eggs in one basket, and then watch the damn basket.’”

The only question becomes, how does one choose the right basket and have the ability to watch it like a hawk? The answer: get a professional investment advisor to do it for you. That’s what they’re paid to do.

Burlington Northern, whose stock has plunged 21% since Buffett’s last investment in October 2008, engages primarily in the freight rail transportation business. It transports various products and commodities, including consumer, industrial, coal, and agricultural products. The shipments of consumer products include automotive, such as motor vehicles and vehicle parts.

The company also offers transportation services for industrial products, including construction products, such as clays, sands, cements, aggregates, sodium compounds, and other industrial minerals; building products comprising lumber, plywood, oriented strand board, particleboard, paper products, pulpmill feedstocks, wood pulp, and sawlogs; petroleum products, such as liquefied petroleum gas, diesel fuels, asphalt, alcohol, solvents, petroleum coke, lubes, oils, waxes, and carbon black; chemicals and plastic products, including caustic soda, chlorine, industrial gases, acids, polyethylene, polypropylene, and polyvinyl chloride; and food and beverages, such as canned goods and perishable food items, as well as cotton, salt, rubber and tires, and miscellaneous boxcar shipments.

Buffett’s railroad bets have been devastated by both the economy and sinking energy prices, the latter of which erodes the competitive fuel saving benefits of transporting goods via rail. Buffett’s latest purchase indicates that he believes oil prices are not going to stay this low for very long, which I believe most economists would agree with.

If you believe Buffett knows what he’s doing, you could ride Buffett’s coattails and invest in Burlington Northern (which Buffett now owns 20% of), knowing full well he will guard his $4.6 billion investment vigorously. Who knows, It might be one of the best (and safest) bets on the market today. Not to mention you get a solid 2.5% dividend while you wait for the economy to turn around.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

Through further research, I compiled a list of options we have for dealing with the credit rating agencies.

Option 1: Restructure Them

In a January 3rd New York Times op-ed, columnists Michael Lewis and David Einhorn rail against the rating agencies:

“End the official status of the rating agencies. Given their performance it’s hard to believe credit rating agencies are still around. There’s no question that the world is worse off for the existence of companies like Moody’s and Standard & Poor’s. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided.”

Those are some pretty harsh words, Mr. Lewis and Mr. Einhorn, but as a professional investment adviser I happen to agree with you. Issuers buying ratings from rating agencies to sell investors securities is akin to an individual (issuer) buying a credit score (rating) from Experian (rating agency, who is competing with other rating agencies for business) then going to any number of banks (investors) to apply for a loan (security).

As you can imagine, the individual wants a good credit rating from Experian, and Experian desperately wants the individuals’ business, so their incentives are aligned. But what about the bank’s incentive? Their incentive is to make sure their money is safe, but they only have this Experian rating to rely on. Too bad for the bank.

Option 2: Eliminate Them

I like Mr. Lewis and Mr. Einhorn’s ideas, but I found another viewpoint that I might like even more. Financial blogger Paul Kedrosky takes it one step further and suggests that rather than restructuring these entities, we should do away with them altogether. Mr. Kedrosky correctly points out that there is no regulatory oversight for equities, which begs the question: Why don’t we just let the private investors rate these securities, like they do with equities? Sure,  private investors don’t always value equities perfectly, but obviously rating agencies don’t either.

Option 3: Increase Oversight

Yuck. I don’t even want to think about this option. But if any of you think this one is a good option, please share your thoughts.

Option 4: Do Nothing

I doubt many of you think that we should do nothing. The credit rating agencies really messed up and led investors to slaughter by not recognizing (or perhaps willfully ignoring) risks in the products they rated. But again, I’m willing to hear any opinion out.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

What Do Banks Do?

In the aforementioned article, one part I found particularly amusing was Vikram Pandit’s response to a question posed at a Town Hall meeting:

Responding to a rhetorical “What does a bank do?” question at a Town Hall meeting last November, Citigroup (C) CEO Vikram Pandit explained that “a bank takes deposits and puts them to work by investing and making loans.”

Unfortunately, Mr. Pandit, that’s not entirely true. The truth is that large banks in their current form, especially Citigroup, deal in some of the most complex derivatives the financial world has ever seen.

Famed investor Warren Buffett has always maintained that he only invests in businesses he understands very well. I do the same. While I certainly understand a (very small) portion of the large and complex derivatives market, there’s little chance of me explaining it adequately to a novice. In fact, the vast majority of people on this planet probably could not do so, besides (maybe?) the individuals who designed them. Honestly, I doubt Mr. Pandit could even explain them.

So there’s strike 1 against investing in financial stocks; they’re nearly impossible for even Wall Street veterans to understand.

It’s the Government, Stupid

If the free market forces had their way, Citigroup and a large majority of banking institutions would be gone within the year, or at least reduced to a shadow of their former selves. So theoretically, shorting these stocks might be a very good idea. In fact, I believed shorting financial stocks was a great idea back in November, 2007. I was quoted in Business Week here, for my article: Profiting from the Housing Bubble. In the article, I recommended purchasing shares of Ultra Short Financials Proshares (AMEX: SKF) exchange traded fund (ETF), which shorts financial stocks.

Do I still recommend SKF? Theoretically, yes, but practically, probably not. The issue now is summed up quite nicely in a response to Mr. Saxena’s article, courtesy of Crocodillian:

“At this point, though, while all of these firms deserve to go broke, going short is risky– their fortunes now rest in the political arena, not business logic. On what terms will Citi be bailed out? Who can say? It is as much in Washington as on Wall Street that this will be decided.”

Bingo. There are two forces at work here. One is the free market, which dictates that these financial institutions are technically bankrupt (they have insufficient assets to cover their liabilities), and the other is the government, which is keeping them afloat with bailouts. Which one will win? I don’t have the faintest idea.

The Bottom Line

It seems to me that the government will be unable to prevent a wave of financial institution bankruptcies from happening in 2009, which is why I favor shorting over going long. But I’m hesitant to even short; there are just too many unknowns and what ifs.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.

Obviously we cannot - and do not - rely solely on insider purchases, but we feel that it is a very good way to find potentially great companies to invest in.

Aligning incentives

Insider buying absolutely indicates an upbeat management team, but it also aligns the incentives of management with those of the owners (shareholders). Management teams that have a significant monetary stake in the performance of the company - through ownership of stock - are far more likely to increase shareholder value more effectively and efficiently than those who do not.

Here are some significant insider purchases that we ran across during our research that we believe warrant further investigation.

Visa, Inc.

Since its initial public offering (IPO) in early 2008, Visa (NYSE: V) shares are currently 40% below their 52-week high of $89, but still 22% above the listed IPO price of $44 per share. Just today, Visa Chief Executive Joseph Saunders re-iterated the Company’s guidance of 20% growth in 2009, and an adjusted operating margin in the mid-to-high 40 percent range.

Considering the economic conditions in the credit market - and the global economy as a whole - this guidance is extremely positive for the company. Furthermore, Visa is not exposed directly to rising defaults because it does not issue cards directly, similar to Mastercard (NYSE: MA), but unlike American Express (NYSE: AXP), Bank of America (NYSE: BAC), Capital One (NYSE: COF), Citigroup (NYSE: C), and JP Morgan (NYSE: JPM).

It’s no surprise, then, that in December alone, insiders - including Joseph Saunders - have purchased more than $1.1 million worth of stock on the open market.

Allied Nevada Gold Corp.

As we discussed in an earlier article, Gold to $2,000 by 2009? Citigroup Thinks So., we believe that gold could be a great investment to weather the economic downturn, and suggested investors take a look at Yamana Gold (NYSE: AUY), Kinross Gold Corp (NYSE: KGC), and GoldCorp (NYSE: GG) or any number of individual gold stocks.

One additional gold explorer and producer that caught our attention this week was Allied Nevada Gold Corp. (AMEX: ANV) when a director for the company, Robert Mackay Buchan, reported that he had bought more than $800,000 worth of the stock on the open market back in October, at prices similar to the $3.55 per share we see today.

As always, the companies mentioned in this article should NOT be taken as recommendations, but rather as a list of companies that merit further research.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.