Smart money is a rare positive for the stock market

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Looking for a silver lining amid the stock market’s recent travails?

One Wall Street veteran offers this: An index measuring the trading patterns of institutional investors paints a rather bullish picture of the market going forward.

The smart money index -- so called because it measures the trading of supposedly in-the-know institutional investors, such as hedge funds -- indicates that the Standard & Poor’s 500 index could reach roughly 1,325. That would be a 15% advance from the 1,151.06 at which it closed Wednesday.

The smart money index bottomed in mid-August, along with the S&P 500, but has rallied since then while the actual index has stagnated.

‘While the smart money index is not one of our primary metrics, it has been a useful guide in gauging bottoms,’ Jack Ablin, chief investment officer at Harris Private Bank, wrote in a note to clients.

The index places extra emphasis on trading patterns in the final half-hour of each day, which is dominated by institutional investors. (Big-money players often place their bets late in the day after assessing economic news and market developments.)

Conversely, the index de-emphasizes trading in the first 30 minutes of the day, when activity from small investors is heaviest. (That’s when online brokerages execute orders that individual investors -- the so-called dumb money -- have placed the previous night.)

The logic is that the dumb money will eventually follow the smart money as soon as the trends that institutions saw early on become obvious to the hoi polloi.

Small investors can only hope things play out like they did two years ago, when the smart money index presaged the end of the bear market that was induced by the global financial crisis. The index rallied in advance of the March low, signaling that a sustainable advance was on the way.

‘In a market with few technical positives, the smart money index is a standout,’ Ablin said.

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-- Walter Hamilton