Warning Signs of a Deeper Market Correction Are Building
The Smart Money/Dumb Money Indicator should be watched closely.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
The S&P 500 is less than one percent from its recent all-time high, but warning signs of a deeper pullback are building.
For four straight days, the S&P 500 has closed near the intraday lows. There have only been minor losses so far, and breadth has stayed strong due to relative strength in smaller stocks. However, there is a slight change in character that shows that institutional buyers are starting to be more cautious.
There is a market indicator that is sometimes called the smart money/dumb money indicator. More recently, it has been called the Smart Money Flow Index (SMFI). In both cases, retail money is deemed to be dumb or uninformed, while institutional money is believed to be smarter or more informed.
The theory is that dumb retail money tends to be most active in the first hour of the trading day, while smart institutional money tends to be most active in the last hour of the day. Buying or selling the open is deemed to be driven more by emotions, while late-day action is deemed to be more strategic.
When the market consistently closes weak, the theory is that institutions are becoming more cautious and are cutting exposure. Since they are ‘smart’ money, perhaps they know something that we dumb retail investors don’t know.
I don’t know of any statistical studies that track how well this theory works, but it is reasonable to argue that action at the open is likely more emotional than action at the close.
The bottom line is that a series of weak closes is a warning sign that should lead to greater vigilance.
One of the big problems right now is that there is a news vacuum in front of the Easter holiday. The PCE inflation report will be released on Friday when the market is closed, and there is likely some hesitation in increasing exposure in front of that news.
The good news is that there is quite a bit of rotational action, and many individual stocks are not correlated with the indexes. The recent weakness has come on strong breadth. So far, this is not a situation where investors dump stocks without regard to their individual merits.
The bears have squandered a number of opportunities to create downside momentum since the market bottomed in October 2023. The dip buyers show up, and the Magnificent Seven names always seem to ride to the rescue in the nick of time. One of these days, it won’t happen, and we will have to be ready to react quickly.
We have some bounce on Wednesday morning, but the close is what matters.
At the time of publication, James "Rev Shark" DePorre had no position in the securities mentioned.
