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Seeking Alpha

Thursday, January 31, 2008

Smart Money


(Stocks in this article: NYSE: SPY, NYSE: DIA, Nasdaq: QQQQ, NYSE: SDS, NYSE: QLD, NYSE: QID, NYSE: MAT, NYSE: MBI, NYSE: MA, NYSE: PG, NYSE: CVS, NYSE: BMY, NYSE: SNE, Nasdaq: AMZN, NYSE: BKC, NYSE: LLL)

What is smart money? Smart money is the money guided by people we assume are smarter than us, institutions. But, it's more than just that, taken to another level, smart money is assumed to be that capital guided by successful institutional investors, the guys traders call "smart money." These traders receive orders from successful or perceived successful money managers, and the rumors of where the smart money is moving are born.

At times like these, with the market in turmoil, everybody wants to know where the smart money is. There are two ways to look at the current investment environment. While we here at The Greek are expecting recession, and calling for weakening consumer spending and consolidation within consumer sensitive industries including retail, restaurant and even spillover into commercial construction, at the same time, stimulants are arriving that should eventually turn the situation around.

When I go out on a limb and make a recommendation to buy stocks like I did yesterday, I must admit to some trepidation. My natural instincts tell me sell, run and hide. Human psychology probably explains this, and likely explains why the market is now reacting to pending recession, when people like me were warning of it since early last year. So, I have to ask myself, "am I too early?" Myself replies, "I don't know, but I'm terrified." I'm also cracking myself up at the moment...

It's a fact that the market is efficient, while pockets and moments of inefficiency exist that offer up opportunity. Human psychological factors like fear and hope (often called greed) create inefficiencies at times of great universal trepidation. So, as Main Street realizes the economy is headed for recession, much of Wall Street knew it at some point last year. But, Main Street guides much of money flow.

Here's an example: I had a dear friend call me a couple weeks ago. She told me she had liquidated her equity investments in her 401K and gone to cash. This was after equities had dropped near 20% from their October highs already, and just as fiscal stimulus was gaining support. I flat out told her she was bailing at completely the wrong time, and that I had just gone bullish after being bearish for much of last year.

This is a pure example of how Main Street, or "dumb money" can influence the stock market. Dumb money is not owned by dumb people, so please no hate mail... Dumb money just depicts the capital controlled by unsophisticated investors. When people like you out there on Main Street head to the exits en masse, capital flows draw from equity and many other funds. Often times, unprepared money managers must then sell stocks to feed redemptions. The people who invest in these funds hold a gun to the head of some "smart money" managers and force them into what they know are dumb decisions, but necessary to honor the charter of their fund and contract they have with investors.

There's other smart money though, that completely controlled by sophisticated investors. That money is itching to get into this market, and plenty of it is probably already working its way in. That money knows the actions of the government are significant. At the same time, that money weighs the impact of the herd. So, while the signal was sounded for a coming turn in stocks, the timing is still impacted by capital flows, and unfortunately, fear is still rampant. That fear is only fueled further by the political race and the perverted use of it by political candidates to differentiate themselves from Washington. Even the Republicans are decoupling themselves from President Bush now in order to win votes and ensure a chance to hold off the Democrats.

So, is The Greek early...

There's risk in being early. Paper losses can mount. So, what you do is you avoid getting caught up in the early morning market frenzy and later afternoon frenzy. Emotions, panic, fear and greed impact that trading. If you really have courage, it's also when the best opportunities are found for short-term traders and more smart money. In the middle of the day, smart money moves become more evident. So, this morning and yesterday afternoon, as the market panicked about risk tied to bond insurance and employment and consumption data, guys like me had to talk to ourselves outing jumping off the ledge and debate locking ourselves away from the trading screen.

What you want to do is what Cramer advises, take small bites into positions, thus reducing your cost risk. Consider using stop orders to limit losses in case you’ve missed something. Consider reducing your beta risk, by including short positions in your portfolio. Diversify your sector risk with a diversified portfolio. These steps help you limit risk, while also placing your bet on the smart money move.

As you see equities recovering now, you understand it's the long-term drivers moving them, and the smart money that looks forward. That's an important fact to note. The market looks ahead, or the market guided by smart money looks ahead. This is why the stock market begins to recover while the economy is still in recession. This is why the stock market started to correct before data indicated recession, and the data still doesn't show it. We only have signs of it now.

So, over the next few months the data will likely deteriorate, and this should cause fluctuation in stock prices. However, I believe the trend for stocks this year should be one of upward direction. In this dynamic market, we cannot ignore the changes that occur. While we are still concerned about consumer-spending softness, as indicated in today's personal consumption data, we also cannot overlook the significant actions of the federal government and the Federal Reserve to mitigate this deterioration. So, that’s why I follow my conviction and say start buying stocks now, while closing my eyes and saying a prayer as well. History tells me, as well as my knowledge that is uninfluenced by emotion, that the market should turn before the economy. However, since the market is dynamic, we must constantly monitor changes in factors and the entry of new factors that could change the outlook for stocks.


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