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The Era of Easy Money Is Over and Liquidity Is Tightening: What Do You Want to Do?


The smart money is raising liquidity and the dumb money is providing it.

Each week BAML puts out a very insightful research piece that discloses its institutional (real money), hedge fund (levered money), and private client (retail) flows in and out of the stock market. Institutions are the smart money, hedge funds are the manic money, and retail is the dumb money. Since BAML is the largest brokerage network and does business with virtually every institution, its flows can be seen as a proxy for the entire market.

In Q1 2013 private clients were pretty consistent buyers of equity exposure, but toward the end of the quarter and into Q2, turned net sellers. By the week of May 6, with the S&P 500 (INDEXSP:.INX) crossing 1600, Private Clients had sold $619 million with the 4-week average negative $544 million, the 12-week average negative $257 million, and 52-week average negative $162 million. The week of May 27, just after Bernanke top-ticked the market, Private Clients turned net buyers, increasing equity exposure by $112 billion.

This past week's BAML Equity Client Flow Trend report was titled "Private Clients' Net Buying Streak Is Now the Longest on Record" (data since January 2008). It stated:

Private clients were net buyers for the twelfth consecutive week -- the longest buying streak in the history of our data (since 2008). Private clients have been the only group that has remained confident in the rally as the S&P 500 has continued to make new highs.

For the week ended August 12, BAML Private Clients bought $995 million, moving their 4-week average to $447 million and their 12-week average to $687 million, with their 52-week average finally turning net positive at $6 million. That same week Institutions sold $1.38 billion with their 4-week average at negative $308 million and 12-week average at $539 million. Since turning net buyers the week after Bernanke top-ticked the market, Private Clients have accumulated a net long exposure of $8.2 billion while Institutions have reduced exposure by $6.57 billion. For the past three months with the S&P 500 trading sideways at new all-time highs, the ownership of this market is changing hands. This is not a coincidence.

Smart Money Flow Index Vs. 10-Year Yield

The Bloomberg Smart Money Flow Index (SMFI) is designed to gauge how "smart money" is trading the Dow Jones Industrials (INDEXDJX:.DJI). The index uses simple methodology, assuming dumb money acts emotional and gives orders at the open while smart money waits until the close. According to Bloomberg:

To replicate this index, just start at any given day, subtract the price of the Dow at 10 a.m. from the previous day's close and add today's closing price. Whenever the Dow makes a high which is not confirmed by the SMFI there is trouble ahead.

You can see that the SMFI and DJIA are highly diverged right now and have been since -- you guessed it, the week of May 27. There is a reason for this divergence. Institutions are selling because interest rates are rising and liquidity has evaporated. Once the 10-year took out 2% to the upside, the smart money has been consistently fading this rally.
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