How to Trade Like a Congressman

by Marc Lichtenfeld, Investment U Senior Analyst

Wednesday, November 16, 2011: Issue #1644

I have a foolproof way of getting rich. It doesn’t involve signing up for one of The Oxford Club’s services, and it doesn’t require much risk because you already know the outcome. In fact, you’ll help decide it. All you have to do to increase your net worth by 10-fold is get elected to Congress.

Consider:

  • Former Speaker of the House Denny Hastert was worth a few hundred thousand dollars when he was elected to Congress. Despite a Congressional salary that topped out at $212,000, he left Congress a millionaire many times over.
  • Current Speaker John Boehner bought healthcare insurance stocks right before the public option in President Obama’s healthcare plan was killed. Those stocks took off after the provision was defeated.
  • Former Speaker Nancy Pelosi bought into the Visa (NYSE: V) IPO despite the fact that the House was working on legislation affecting the credit card industry.
  • During the financial crisis in 2008, Chairman of the House Financial Services Committee Spencer Bachus was in a closed door meeting with Federal Reserve Chairman Ben Bernanke that was so secretive cellphones and blackberries were confiscated. The next day, Bachus bought investments that would rise if the market fell.

All of these assertions are according to a “60 Minutes” report that aired on Sunday. You can watch the segment on Congressional insider trading. But I warn you, if you have high blood pressure, take your medicine first. If you don’t have high blood pressure, you will after seeing this.

Is it any wonder Congress has an approval rating of just 12 percent? (And who are these 12 percent who think Congress is doing a good job?)

Legal, But Immoral

Keep in mind; these elected officials did nothing illegal. There are no laws on the books that say a Congressman or Senator is not allowed to act on non-public information he or she is privy to.

In fact, Dennis Hastert made about $2 million buying land next to property that would eventually become a highway, that he had secured the funding for.

But just because it’s not illegal doesn’t mean it’s moral.

The President of the United States has to keep his finances in a blind trust. Members of Congress should have to do the same.

Heck, a secretary at a public company can be sentenced to prison if she buys stock based on something she hears her boss discussing. But a congressman appropriating hundreds of millions of dollars to a defense contractor can go in and buy call options on that company before the funding is announced.

What the Average Joe Can Do

While we may not have access to the kind of lucrative information that our esteemed representatives in Washington have, we can look to the market for clues as to where the smart money is investing.

  • Insider Activity – When CEOs, CFOs and other managers and directors of a company buy shares on the open market, that’s usually a sign that good things are about to happen. As an example, two weeks ago, Ameriprise Financial (NYSE: AMP) Director Robert Francis Sharpe, Jr. bought 12,000 shares in the open market, increasing his stake by over 50 percent.
  • Hedge Funds – Hedge funds that acquire large stakes in companies have usually done their homework. I’m not talking about funds that actively trade in and out of stocks. If a hedge fund takes a five-percent or more stakes in a company, it’s because they see significant value there and possibly a catalyst.

Funds that own five percent or more of a company must file documents with the SEC. They either file a 13G or a 13D. The 13G simply states that they own five percent or more of the company and includes when they bought the stock and for how much.

A 13D filing is similar, except that it also states the company is going activist. That means they will, or reserve the right to, demand changes from management. Those demands often include the resignation of the CEO, the sale of the company, restructuring of the board, etc.

Historically, stocks with activist investors have outperformed the market by 21.6 percent, according to research by professors at New York University’s Stern School of Business.

Yahoo! (Nasdaq: YHOO) is a recent example of an activist stock. Dan Loeb, one of the world’s most successful activist investors, wants the company sold and for co-founder Jerry Yang to resign from the board. Loeb has a tremendous track record and I expect him to be successful in his push to get Yahoo! sold. I recommended Yahoo! in my Activist Trader service when the stock was trading in the mid $14 range.

  • Technical Analysis – The art of reading charts. Stock charts often tell you where the smart money is heading. When you see a pick up in volume, particularly when there’s no significant news, that’s often the people in the know getting in or heading for the exits. Pay attention to increases in volume and changes in price. More often than not, stocks will continue in the same direction. And you will frequently see news at a later date that confirms the price movement on heavy volume.

Lastly, if you’re as infuriated as I am over Congress’ trading on inside information, I urge you to call your Representatives and Senators and demand that they pass the Stop Trading on Congressional Knowledge (STOCK) Act.

It’s a bill that will prohibit congressmen and women from trading on inside information. Not surprisingly, it has received practically no support from Congress.

You can obtain your representatives contact information here.

Good investing,

Marc Lichtenfeld