Keep an Eye on Money Flows ...

Some time ago, I heard a story about one of Warren Buffett's early mentor's.   As the story goes, he was told early in his career, that the stock market was about money.   When money was moving into the stock market, it went up.   When money was moving out of the stock market, it went down.

Sounds too simplistic, doesn't it?  

Then again, it is just too true to ignore.   How many investors actually bother to try and measure true money flows moving in and out of the stock market?

We have always felt that the directional flow of money was a key, and more importantly, the relative amounts of money flowing in or out.   From data we collect, we recognize that there are only 4 possible conditions worth noting relative to money flows.

-  First, money is in either a state of Expansion or Contraction in the stock market.  When they are in Expansion, they are above our horizontal line on today's chart.   When money flows are in Contraction, they are below our horizontal line. 

The impact of money flows is very logical.  In an Expansion modality, the market goes up as more and more money chases stock prices ... and that pushes them higher.   When money Contraction occurs, investors are cashing out, and it takes lower prices to find a buyer in those environments. You can see those conditions happening in the chart below.

So, that explained 2 conditions, what are the other 2 conditions? 

The other two conditions have to do with trending and patterns.   Even though money flows are in Expansion or Contraction, the inflows or outflows have short term changes of direction as part of their trend.  

For example, look at the far left of the chart.  You can see that April and May of 2008 showed a trend reversal to the upside.  When the trend reversal started, money-flow levels were still in Contraction.  However, that up trend continued, carrying the money flow levels up into Expansion territory.    Later ... that upward trend line was broken to the downside in late May, and then money flows fell back into Contraction, and stayed there for months while the stock market plummeted.

So now, money flows are in Expansion again, and at a high level of money flowing into the market.   But, there is also something else going on that is worth observing and it has to do with labels 1 to 4 that we posted.

So, what is going on at labels 1 to 4?

Each label shows that when money is flowing out, that more flows out than the previous time.   That is telling us that, as this rally matures, more and more profit taking is occurring.  If this continues, it will increase the downside pressure in the market as outflows fall to lower levels.  

For now, things are okay, but risk levels are starting to slowly rise due to this activity. 
This Chart on Long Term Liquidity Flows is posted on our Standard Subscriber Site everyday.
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P.S.  This money outflowing pattern is coinciding with waves of Institutional selling activity that we are seeing.

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