What is smart money doing right now?

Investors frequently wonder what the "smart money" is doing. Who or what is smart money?

Smart money usually refers to big investors who got that way by generating high investing returns over a long period of time. That doesn't necessarily mean big money.

A lot of money is managed by large organizations that didn't necessarily get that way from smart investing. Think about a large pension fund or insurance company. Those organizations have a lot of money because a lot of money has been contributed to them (pension contributions and insurance premiums), not necessarily because they've managed it well. Big money is not the same as smart money.

Smart money has a lot of money because they've compounded initial investments at high rates for a sustained amount of time. Smart money moves into and out of markets before they move, not after or as they are moving. Smart money includes the "lead bulls" that the rest of the herd follows. Knowing what the smart money is doing can help build wealth because you can buy before things move.

This last reason is why everyone, including me, wonders what the smart money is doing.

So, what is the smart money doing now? I don't know exactly, but I have an idea.

For example, a lot of smart money is still on the sidelines--in cash. It's not there because they sold at the top or because they were timing the market. It was in cash because the smart money has been waiting for opportunities, waiting for years most likely.

Why haven't they started buying? They have, but very selectively. Remember, smart money buys before things move, so you can't look at price movements to see what they are doing. They are buying things on the cheap, at prices they can only get once every two or three decades, but they are taking their time.

Why are they taking their time? That's the most important question, and I think I have an answer. They're taking their time because the rules have changed. When the rules change, you have to wait for new rules before you can act.

What new rules am I talking about? Let me use banking as an example. It used to be that bad banks went out of business and good banks thrived. But recently, bad banks have been deemed "too big to fail," and so they have been kept alive. Keeping them alive hurts good banks, and so the smart money is waiting for the new rules to invest. They don't want to invest in good banks only to find out the new rules will hurt the good for the benefit of the bad.

The same could be said for distressed debt investing. Whether a company survives or not has less to do with assets, liabilities, cash flows and business model, currently. Instead, it has as much to do with number of employees and perception. Look at U.S. car companies. No one cried when Circuit City or Pilgrims Pride declared bankruptcy, but if a U.S. car company is in trouble, it doesn't need to go bankrupt. The rules have changed, and the smart money doesn't want to invest until they know those news rules.

I think the key reason markets haven't been improving is because the rules have changed, and the smart money is waiting to learn those new rules. When those rules are made clear, then the smart money and, eventually, everyone else, will jump back into the pool. Market values are cheap enough, whether equity, debt or real estate. I don't believe the smart money is waiting for markets to get cheaper, they are waiting to discover the new rules of the game.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.