With equity markets rallying hard and fast from late December to April 30, then dipping in May, and now rallying to all-time highs for the S&P 500 in June, you’d think tons of capital flowed into equities, then some flowed out, and now more started flowing back in.
But you’d be wrong.
Investor-driven capital waves haven’t been flooding into equity mutual funds and ETFs.
Quite the opposite.
Since we’re back up near all-time highs, you might be wondering where we’re going from here.
Understanding what investors are really doing and what’s really driving equities higher is important.
Not because stocks could go higher, but because they could tank if the real driver of higher prices is killed.
Market Psychology: Reading the Minds of Traders & Movements of Capital
When people ask me what really moves markets, I always answer, “Capital moves markets, but psychology moves capital.”
So, seeing where capital is flowing in from or flowing out of and understanding the fear and greed moving that money is key to understanding where stocks are going next.
It’s natural to think if stocks are going up investors are putting their money to work and moving prices higher.
And, of course, the opposite surely stands to reason.
But these aren’t natural times.
Markets aren’t “free” anymore. They are mostly manipulated from the top by the Federal Reserve, in the middle in a very big way by corporate CEOs, and on the periphery by computers executing “programs” and high frequency trading (HFT) “pick-off” artists.
As far as the Fed, they did their part to arrest the ugly 20% selloff we experienced from October to late December. And they stepped in again in early June to rally markets with talk of rate cuts.
Everyone knows when the Fed’s going to cut rates bonds rally and stocks rally.
That might make you think psychology is bullish and investors are pouring money into stocks.
Even though the market rally in the first quarter of 2019 saw stocks post their best quarter in nearly a decade, with the S&P 500 rising more than 14%, investors pulled money out of mutual funds and ETFs.
Over the quarter they pulled $39.1 billion dollars out of domestic equity mutual funds and ETFs, according to EPFR data.
They continued to pull money out in April and pulled a lot more out in May. And June isn’t any better.
Investors pulled more than $19 billion out of the market in May.
So far in June, they’ve pulled more than $4.09 billion net out.
Still, stocks are higher, a lot higher than their lows in December.
At the market’s lowest point in December 2018 only 23% of stocks were trading above their 200-day moving averages. Over 75% are now trading above their 200-day moving averages.
If investors aren’t putting money into stock, and more importantly, withdrawing capital from the market, what’s driving prices higher?
That would be corporate CEOs with their share buybacks black magic.
Last year more than $806 billion worth of buybacks hit the market. In the first quarter of 2019, $227 billion worth of buybacks buoyed stocks, according to FactSet data.
Goldman Sachs expects buybacks in all of 2019 to reach $940 billion.
The total count over the past decade is close to $5 trillion of buybacks.
That’s what’s moving markets.
Why’s that so important? Because politicians are jawboning about buybacks and the likes of Chuck Schumer and Bernie Sanders want to put restrictions on them.
What’s possible, maybe not so probable, is that investors bring sidelined money back into the market and stocks take another leg up, maybe a good leg higher.
That’s because there’s a ton of capital on the sidelines that is ready and waiting ammunition for the aging bull market.
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But psychology is shifting.
Investors are wary of the big up-moves, knowing that they’ve been engineered by the Fed.
And while they also know the Fed cutting rates is stimulative, the fact of the matter is they haven’t cut anything, yet.
If July passes without a rate cut, sentiment could turn for both equities and bonds.
If politicians rally around restricting buybacks, psychology for those who know (now, people like you) that buybacks have been the real fuel the market’s been running higher on will turn negative, as in fearful.
And we know what happens when fear strikes the markets.
That’s why I watch capital waves and give you the capital wave forecast right here.
You’ve been warned.