Just How Smart is the “Smart Money”?

“The availability heuristic is a rule of thumb, heuristic, or cognitive bias, where people base their prediction of an outcome on the vividness and emotional impact rather than on actual probability.”*

"Are US individual investors more cautious in this bull market due to their recent experience with the bursting of the tech bubble? Does that help explain why individual investors appear to be less ebullient than the “smart money”?

Behavioral finance teaches us that investors tend to overweight those events that are most vivid over events that are less so. This is known as the “availability heuristic” (defined above). Events that are most vivid tend to be those that are (a) most dramatic and (b) most recent. The more dramatic and recent the event, the more vivid in the mind it will be and, therefore, the more likely it will overweighted in the minds of investors.

One current application of this behavioral tendency is the aforementioned US individual investor who experienced the tech bubble bursting, and appears to be more cautious than they might otherwise be. In this regard, two questions come to mind:

1. Will individual investors stand their ground and, due to their absence from the bull market party, cause an eventual (and substantial) contraction in equity prices? Or

2. Will their resolve to not join the bull market party eventually give way (capitulation) and, therefore, become the necessary final push of liquidity for the “smart money” to sell to?

In other words, just who is the smart money?..."

"There is another aspect to consider, however, one that involves the subject being described in this report – the behavioral tendencies of investors. And for that, it's worthwhile to take a look back at the last period investors had to deal with the aftermath of a real bear market – the mid to late 1970s.

The bear market of 1973-74 had its roots in..."

Investment Strategy Implications

"This bull market may not experience the “dumb money” bailing out the so-called smart money crowd. The experience of the last US equity bubble is still vivid in the minds of many investors. Whether this results in a capitulation or not remains to be seen. Nevertheless, it is advisable to remember that stocks can remain undervalued for an extended period of time. Particularly when risk is as abundant as liquidity.

If the “smart money” is waiting for the “dumb dough” to show up, they may be disappointed. Investor behavior is a sticky tendency. Besides, if the “smart money” wants to find where the “dumb money” is, perhaps a trip across the Pacific is a better place to look. Can you translate this?: 泡影"

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* Wikipedia