February 17, 2012 / 7:49 PM / 8 years ago

Analysis: Smart money points to more gains in U.S. stocks

NEW YORK (Reuters) - When equity markets shuddered last summer during the European debt crisis the smart money bought the weakness in a precursor to a big rally into 2012.

After easing off, those buyers are back in the market. That suggests the stocks rally may be about to take off again after renewed concerns over Europe pushed retail investors onto the sidelines in early February.

The question to ask about the smart money isn’t who, but when.

While the opening minutes of trading is dominated by retail investors reacting to morning news, it’s the close of the session that matters more. That’s when institutional investors who have spent the day digesting the data and headlines stake their claim.

“The smart money was buying heavily into last year’s weakness, and then stalled out towards the end of the year,” said Paul Hickey, an analyst at Bespoke Investment Group in Harrison, New York.

Hickey has compiled data on the first half hour and last hour of trading in the S&P 500. His figures show late-day traders started to buy from summer of 2011, a precursor to a big market rally later in the year.

The late-day buying by the smart money that began in the middle of 2011 preceded a near 30 percent rally in the S&P 500 that began in October.

After a period of stagnation by the so-called smart money, their performance has picked up again of late - and can be viewed as a leading indicator for the overall market.

“In the last several days the smart money has perked up again and actually made a new high for the first time since October 21,” he said.

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GRAPHIC: Bespoke smart money data: link.reuters.com/cus66s

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Around 20 percent of the trading volume in S&P 500 stocks is concentrated in the last 30 minutes of trading, according to Credit Suisse. A further 10 percent is during the first hour.

Professional traders are keen to get the best price possible and often wait until the end of the day to get a better idea of where in the day’s trading cycle they are buying.

Their performance for institutions is often judged by comparing the price they pay for their target stock against the volume weighted average price (VWAP) for the day. This shows the price where the heaviest trading took place, and by waiting until the end of the day traders can judge how their trades will compare to daily VWAP.

“We’ve had days when we were down early and then we had late day rallies and that’s generally pretty supportive of smart money,” said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. who oversees more than $50 billion.

One new wrinkle in daily activity, however, is the close of European markets at 11:30 a.m. ET. Of late, the U.S. stock market has tended to rise after that market closes and news from the region diminishes.

David Lutz, managing director of trading at Stifel Nicolaus Capital Markets, Baltimore, has been keeping tabs on the trend. By his calculations, as of Thursday 26, of the last 30 trading days, the market has ended higher after the European markets close.

“A lot of people have been trading that trend,” said Lutz. “I think people have been a little bit cautious on their sell tickets on down mornings here in the U.S., anticipating some kind of pop later in the afternoon.”

“The worst thing a trader could do would be to blow out a big sell order at noon and watch the market rip north going into the bell, especially when we have statistics around it that are showing it’s not necessarily the smartest thing to do,” he said.

If avoiding getting blindsided by news from Europe is the reason for the dislocation between the open and the close, it suggests additional caution by traders, who remain concerned about what is called “tail risk” - the unknown surprise factor.

“We could have a huge downdraft off the simplest bad news,” said Brian Battle, vice president of trading at Performance Trust Capital Partners in Chicago.

Markets can move late and fast for other reasons, too. In less than an hour on October 4 the U.S. stock market surged 4 percent into the close, with an explosion of algorithmic trading cited for the move.

Some question the validity of the smart-money approach altogether. In an age of 24-hour news, gone are the days when investors just looked at the morning paper and nightly TV news.

“Now that we get news by the second we not only react but overreact throughout the day,” said Marc Pado, U.S. market strategist at DowBull.com in San Francisco.

Still, sharp late-day moves suggest institutional interest with the muscle to move the market at its busiest time. If these buyers are as shrewd as they were last year, the rally may have some juice left.

“Generally speaking it’s a good leading indicator,” said Ablin.

Additional reporting By Ryan Vlastelica

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