Are You 'Smart Money' Or 'Dumb Money'? And How To Figure It Out

Monday, June 5, 2017

market analysis

In our weekend report published in our Trading Room last Saturday May 27, I noted that I was unsure whether we were heading directly to 2500SPX, or if we would see one more pullback before that rally takes hold:

"This past week, the market moved into this resistance region, and how it reacts from this region will tell us if we are taking the direct route to 2500SPX or if we revisit the 2330SPX region before the run to 2500SPX begins in earnest. Currently, support resides in the 2400SPX region. Should we see a strong drop below 2400SPX, it opens a trap door which can allow us to revisit the 2330SPX region and the drop can be fast and furious.

However, if the market is able to continue to melt up through this resistance region, and follow through strongly over 2428SPX, then it signals we are rallying to 2500SPX sooner rather than later. . ."

Well, the price clearly broke through our resistance, and it seems we are on our way to 2500SPX.

About a year and a half ago, one would be hard pressed to find many bulls in the market, as the market was predominantly bearish. Back on February 10, 2016, bearish sentiment, according to the AAII Investor Sentiment Survey, was at one of its highest readings, hitting 48.7% (with only 24% responding as bullish), whereas it has a historical average of 30.5% bears and over 40% bulls. The February 10th measurements are considered to be relatively extreme bearish numbers.

Since that time, the market has struck a significant low at the peak of market bearishness, and began the rally towards our long-term target between 2537-2611SPX. However, this means that those who were bearish when the market was striking its major low in February 2016 were "dumb money," as commonly referred to those who are on the wrong side of the market.

Yet, even though the market struck a long-term low in February 2016, many market participants and analysts still were trying to short the rally for the rest of the year. From what I recall, the significant majority of articles on the market were bearish. Most analysts were claiming that we were setting up for the next "big one," and that now is the time to "load the boat" on the short side to take advantage of this once in a lifetime opportunity. Yes, I remember it all too well, as I was fighting against this common perception with our strong bullish bias. And, these bears, too, were considered "dumb money."

Now, a year later, after the market moved through the "heart of the 3rd wave," which Bob Prechter has called the "point of recognition," many of these market participants and analysts have changed their tune. They are coming to recognize that we are in a bull market, and it only took them a bit over a year, and a 35% rally to do so.

Recently, I was reading an article by one of the former strongly bearish analysts. In fact, he was one of those who were suggesting to load the boat on the short side for the last year. Yet, his latest article was entitled "The New Bull Market Of 2017!," which was a follow up to his other recent article regarding a "stealth bull market in stocks." The only problem is that this market was not stealthily bullish, nor did it begin in 2017.

Rather, it is only recently that he has embraced the bull market, so, of course, it is likely new to him. However, there were some of us that were riding the great majority of the 35% bull market move off that February 2016 low. So, to us, this move is well over a year old, and quite mature. I guess his view of the "new bull market" would be comparable to considering a 50-year-old adult as a "baby."

But, he is not alone. Many leading bearish analysts have turned quite bullish in the first half of 2017, once we moved through the "point of recognition." One of the most notable is Harry Dent, who has been calling for an Armageddon-type of market event for the last 6 years.

"No matter how irrational this market is, I admit I've gotten the timing wrong," said Dent.

"The markets have defied all of my research, and all of the indicators I follow closely. They've even defied dozens of other indicators that have proved accurate before, that I looked to when it became clear that my tools were failing."

And, again, he is not alone. In the last few months, I have read the following quotes from a number of analysts:

"I've been bearish or skeptical about the stock market for the past couple of years, but now I'm bullish on stocks."

"the traditional causes of recessions . . . are nowhere on the horizon."

As I said, this only began to happen once we moved through the "point of recognition," which is often more than half way through the larger degree bullish move. But, this is a necessary step for any market before it can develop a long-term top. Market participants have to begin to pile into the bullish side of the market before a long-term top can be struck. In fact, the market will only top when there are relatively no more buyers left. And, this is the point in time when the bulls will become the "dumb money."

But, don't worry. There are still plenty of bears out there to maintain that wall of worry for us to climb. Just this weekend, I read a number of bearish articles, with their continued head scratching being exhibited in their writings. Clearly, their analysis methods are simply not equipped to understand this market, no different than what Dent described above. The only difference is that Dent actually realized it.

One such author recently noted his perception of a "ridiculous disconnect. In short: stocks are out of control. . . Long story short, Friday plunged us even further into the equity disconnect twilight zone. . . . Of course, the valuations don't make any sense either . . . It is quite literally out of control." We should thank authors like this, as they have been acting as the maintenance crew for the "wall of worry" which the rest of us have been climbing to our profits.

But, reforming bears and transforming them into bulls is usually not enough. Rather, the greater majority of the market has to become strongly convinced that this bull market has a very long way to go, and only then will we develop the euphoria needed to strike a long-term top.

One of the first steps is seeing many former bearish analysts turning bullish. As noted above, that process is well underway. Next, we will need to start seeing the average citizen become interested in the stock market. And, this past week, one of my members posted this in our trading room:

"My sister in law, who doesn't know a stock from a bond and has never shown any interest, called me yesterday asking 'Which should I buy, Amazon or Google?'"

Another member posted the following story:

". . . my brother who has never traded or invested in stocks, called me to ask if he should start buying some stocks. Just after the call, in a Uber cab, a driver is boasting how much he has made this week and how the market is going to double from here. . ."

While these are only a few anecdotal examples, I am quite certain that this process is well underway among the average citizen. But, I still think we have some more work to do in this area.

This brings me to the final step in the progression of a bull market, which will mark the point in time when those strongly long the market will turn into the "dumb money." And, that is when euphoria is prominent in the market.

Now, as I have noted, we have moved through the point of recognition, and many have begun to switch over to the bullish side. And, the closer we get to the 2500-2550SPX region, the more and more we will see euphoria seep out of the pores of the market. In fact, I have begun seeing initial evidence of euphoria this past week. Someone forwarded me the following call by an analyst, who was formerly looking for a market crash in November:

"The easy money is in the stock market: Nasdaq 10,000. Piece of cake."

Hmmm. Easy money in the stock market? Well, maybe I need to find that gentleman that said he had a bridge to sell me and was willing to give me a good deal!?

As we move higher and higher into 2018, we will begin to see more and more statements about "easy money" in the stock market, as well as hearing from relatives and the "shoe shine boy" about how much money they are making in the stock market. And, the more and more you see statements like this, the more fearful you should become of an impending market top. Yes, my friends, this is how dumb money gets caught at the highs in a bull market. So, don't be dumb money.

But, for now, dumb money will likely be on the short side of this market until 2018. Those of us who have been enjoying the profits of the rally off the February 2016 lows owe them a debt of gratitude. And, thank G-d we now have the profits to pay off that debt.

With the market rallying through 2428SPX, it moved our support up to 2410-2420SPX quite immediately. So, anyone that added positions on the move through 2428SPX will have done so with relatively low risk. In fact, I am even able to move upper support up to the 2420SPX level at this time.

So, as long as the market does not break back down below 2420SPX, then we have a very strong bullish pattern pointing us to the 2500-2565SPX region within the next two months or so. However, if we see a break down in the coming week below 2420SPX, it does not mean that the market is still not in a larger bullish posture, but it does open other potential patterns to play out, one of which is still the possibility to drop back down to the 2330SPX region. But, I will have to cross that bridge if it comes to it. For now, the market is in a very bullish posture as long as we remain over 2420SPX, and we can raise that support as we move higher.

Should this immediate bullish pattern continue to push us higher into our target zone in the summer, then we will likely have to prepare at that time for the next pullback/consolidation in the market, which will likely be larger than the one we recently completed. Furthermore, the next pullback can take us from the 2500SPX region back down towards the 2300SPX. So, it may be prudent for investors to use this rally to lighten their load as we head to 2500SPX, and then prepare for the next buying opportunity which will likely occur in the fall (maybe even around Thanksgiving) should we top in the middle of this summer.

See charts illustrating the wave counts on the S&P 500 at https://www.elliottwavetrader.net/scharts/Charts-on-S-P-INX-201706041593.html .

Avi Gilburt

Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net (www.elliottwavetrader.net); a live Trading Room featuring his intraday market analysis (including S&P500, metals, oil, USD & VXX); interactive member-analyst forum; and detailed library of Elliott Wave education. Visit his website:https://www.elliottwavetrader.net. You can contact Avi at info@elliottwavetrader.net.