Here's the story behind that huge disconnect in the stock market

There’s been a growing disconnect in stocks.

Over the last few weeks, we’ve highlighted versions of the following chart from Bank of America Merril Lynch, which shows that US equity funds have seen massive outflows this year while stocks continue to climb to record highs.

The big questions surrounding this disconnect relates to where the outflowing cash is being invested and who’s propping up stocks.

In a note Monday, Bank of America’s Michael Hartnett updated the chart with a few potential answers:

US equity funds have suffered $US100bn of outflows in 2015 and the S&P 500 has been a rock, and is currently flirting with all-time highs. Clearly,
clients have been buying European and Japanese equities at the expense of the US. And buying from sovereign wealth funds, pension funds and central banks, i.e. investors not captured by weekly flow data, may be propping up US equity
indices. The ongoing low expected returns from bonds remains a potent secular rotation positive for stocks.

Hartnett wrote that the fund outflows from stocks is an “ominous sign” for stock performance; in a previous note, he said the market risks a correction. Hartnett advises that investors reduce risk rather than maximise return as a mid-2015 strategy.

“We advise selling risk into strength, buying volatility into weakness, advocate higher than normal levels of cash and would add some gold,” he wrote.

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