Money has been flowing in and out of financial markets more rapidly than ever before this year, a bullish signal as the threat of a U.S. government default fades.

About $47 billion has gone to exchange-traded funds that track everything from stocks to bonds to commodities since Sept. 1, according to data compiled by Bloomberg. That followed about $18 billion pulled in August, $40 billion added in July and $11 billion pulled in June, making it the most volatile period on record for flows. Almost $7 billion went to ETFs on Oct. 17 alone, as Congress passed legislation to avoid a default.

The unleashing of investor funds this year has coincided with the broadest U.S. stock-market rally in at least a quarter century as fresh cash helped overcome slowing profit growth and concern the Federal Reserve will cut stimulus. Resolution of the budget impasse sends an all-clear signal that will spur another round of deposits, according to David Kelly, the chief global strategist at JPMorgan Funds in New York, which oversees about $400 billion in long-term assets.

"The pattern we'd seen with flows for much of 2013 is going to resume now that things have settled down," Kelly said by phone Oct. 17. "It's a realization that the markets have been able to survive Washington."

And

"There's no doubt that ETFs have greater influence than before, and the swings in the ETFs are indicative of general market feelings," Nick Sargen, who oversees $45 billion as chief investment officer at Fort Washington Investment Advisors in Cincinnati, said in an Oct. 16 phone interview. "They become the market."

ETF inflows were similarly strong when the S&P 500 was peaking in October 2007. In the four months leading up to the record on Oct. 9 of that year, they attracted more than $54 billion. Money continued to go in even as the equity gauge floundered through the end of the year, with another $65 billion coming in through December, data compiled by Bloomberg show.

Now that the S&P 500's rally since March 2009 has lasted longer than the average bull market since World War II and corporate earnings growth is slowing, investors shouldn't expect to make the same kind of easy money, according to Eric Marshall, who oversees $1.4 billion as president and portfolio manager at Hodges Capital Management.

David Fuller's view Stock markets have been the best game in town over the last year. Most equity investors hold at least an ETF or two. However, they also provide the most efficient means by which leveraged institutional participants, and not least their programmed trading systems, can quickly pile in or bail out of the market.

This has increased market volatility, as the article above points out, including the speed with which short-term trends in share indices reverse. The fuel for this activity has been provided by the Federal Reserve's quantitative easing (QE) and similar policies by other central banks, notably the European Central Bank and the Bank of Japan. The combined effect of these policies has been an increase in volatility well beyond their domestic shores.

Benjamin Graham said: "The stock market behaves like a voting machine, but in the long term it acts like a weighing machine." In other words, its true value will in the long run be reflected by stock prices. He was a modest, pleasant man with whom I once had the pleasure of a short conversation in the late 1960s. Were he alive today, I think he would say that the stock market increasingly behaves like a casino in the short term.


The challenge for long-term investors today is to hold our nerve while the liquidity driven bull market is still in form, particularly on Wall Street given the US markets massive global influence. Shorter-term investors or traders may wish to time some of the short term swings. Meanwhile, and as I wrote in Comment of the Day on Sunday, the US markets are registering another short-term overbought condition which is particularly evident on the Nasdaq 100 and also the Russell 2000.

(Note: The short-term Stochastic Indicator defaults to 9 and 3 days but you can adjust the 'Analysis' time frame in the 'Chart' section of the gray tool bar above each graph in the Library. There is no best combination, in my opinion, but I have used 40 and 20 days for the weekly charts above.)

Lastly, QE was introduced by Ben Bernanke to lift the stock market and increase business confidence. It has succeeded, particularly with the former. There is some evidence on price charts of leading indices that short-term overbought conditions are becoming more prevalent, although this is unlikely to be a significant problem while overall upward trends maintain their consistency and QE continues unabated. However, the higher markets go in the short to medium term, the more likely they are to fall back sharply when tapering next appears to be imminent.

(See also Sunday's Comment.)