Stocks are reaching new highs, but it’s not because investors are unanimously bullish. Experienced Wall Street players, including hedge funds and institutional investors, have become increasingly pessimistic while inexperienced investors have grown feverishly optimistic. Essentially it’s the smart money versus the dumb money, and when those two groups are in disagreement, it’s generally the smart money that wins out, according to a recent story in Business Insider.

“Typically at extremes and directionally, the smart money tends to be right and the dumb money tends to be wrong,” says Liz Ann Sonders, chief investment strategist at Charles Schwab, which has a total of $3.8 trillion in assets under management (AUM). 

Key Takeaways

  • Stock markets are hitting record highs.
  • Smart money investors have grown increasingly pessimistic.
  • Dumb money investors have grown increasingly optimistic.
  • Generally the smart money is right when the two groups diverge.

What It Means for Investors

There are lots of surveys indicating the sentiment of different types of investors, but Sonders says that what she’s watching is how the big institutional investors are actually positioning their money compared to individual retail investors. Sundial Capital Research’s SentimenTrader, which attempts to track both types of investors, is one of her key sources of data.

Based on factors such as positions in equity index futures Sundial constructs statistics to track the sentiment of the two groups of investors, a Smart Money Confidence tracker and a Dumb Money Confidence tracker. The current relationship between those two trackers suggests that the more experienced and successful investors are growing increasingly bearish while the inexperienced ones are becoming increasingly bullish.

The gap in sentiment between the two groups has been wider than it currently is at various times throughout the past decade, including late last year just before stocks went tumbling. The current confidence gap suggests inexperienced investors may be a little too optimistic. “Sentiment has started to look a little bit frothy,” said Sonders, arguing that retail investors may be ignoring the broader negative effects stemming from the U.S.–China trade war.

The fall 2019 version of the Big Money Poll published by Barron’s confirms the increasingly bearish sentiment of experienced investors. According to the poll, only 27% of money managers that responded to the survey said they were bullish about the market’s prospects over the next year, which is down from 49% in the spring survey and from 56% a year ago. Indeed, the latest results show that the percentage of money managers that are bullish is at its lowest level in more than two decades. 

Looking Ahead

As for confirmation of individual investor sentiment, the AAII Investor Sentiment Survey suggests that group has a generally neutral “outlook” for where stocks are headed. More telling is the fact that overall optimism has declined while pessimism has increased slightly since the last survey. Individual investors appear to wising up and may soon begin following the smart money. If that’s the case, stock markets could be headed south as the holiday season arrives.