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Smart Money/Dumb Money Confidence Spread reaches a minimum threshold...

Jay Kaeppel
2022-02-28
The more extreme the spread between Smart Money Confidence and Dumb Money Confidence, the more likely investor sentiment is washed out, and the greater the probability of higher stock prices in the immediate future. However, waiting around for the most extreme case to play out can lead to an "a miss is as good as a mile" situation. Therefore, it is important to note when this spread reaches even a minimum threshold.

Key Points

  • The more significant the gap between Smart Money Confidence and Dumb Money Confidence, the more meaningful the information
  • But this spread does not always go to extremes
  • Even a lesser extreme reading can offer important clues regarding the stock market

Smart Money / Dumb Money Confidence Spread

The chart below displays those days when the Smart Money / Dumb Money Confidence Spread crossed above 55 for the first time in a month. You can run this test in the Backtest Engine.

The most recent signal occurred after the close on 2/23/2022.

The table below displays a summary of S&P 500 Index performance following previous signals.

The table below displays SPX performance following each date highlighted in the chart above.

Another perspective on performance

Let's consider the following approach to using these signals:

  • Each time the spread exceeds 55 for the first time in a month, we will hold the S&P 500 Index for 42 trading days (2 months x roughly 21 trading days per month)
  • If a new signal occurs while an existing signal is active, the holding period is extended for another 42 trading days
  • So, if only one signal occurs, the holding period will be 42 trading days (i.e., roughly two months); If there are overlapping signals, the holding period will be longer

The chart below displays the hypothetical growth of $1 invested in the S&P 500 Index only as described above.

The table below displays start and end dates for each favorable period using the rules above and the percentage +(-) for the S&P 500 Index.

Of the previous signals:

  • 15 of 16 (94%) have shown a gain
  • The average gain was +6.9%
  • The median gain was +5.8%
  • The maximum gain was +18.3%
  • The maximum loss was -5.8% 

What the research tells us…

There are many other factors in play at the moment beyond investor sentiment - inflation, rising interest rates and geopolitical risk, to name a few. Stock could easily continue to sell off of to lower levels and the Smart Money / Dumb Money Confidence Spread could reach higher levels in the weeks and months ahead. But for now it is important to recognize that sentiment has reached something of a bearish extreme. And we should not overlook that the strategy detailed above witnessed a higher price for the S&P 500 Index over 90% of the time over the ensuing two months.

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