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ETF investors are missing the boat on many of the market’s twists and turns and their movements may actually be an inverse indicator of where things are headed next, according to a Trimtrabs report from 2010.The report suggests that one month after ETFs see money flow in, stocks tend to fall. It also works in with reverse, with stocks rising when ETF flows decrease. Further, high flows into short ETFs signal that stocks will rise.
From the report:
Monthly equity ETF flows (as a percentage of assets) and the returns of the S&P 500 one month later are negatively correlated to the tune of 21.4%.
The negative correlation rises to 45.6% for a two-month period, and to 52.4% for a three-month period. The correlation coefficients are statistically significant at the 1% level of confidence in all cases.
ETF investors out there may find their presence in this trend slightly alarming. It could be about their knowledge of the market, or because of specific hedge fund movements.
From the report:
We have two explanations for the strongly negative correlation between equity ETF flows and future market returns. First, ETFs are traded mostly by retail investors and day traders. These are the least informed and most emotional market participants—the ones most likely to lose money over time. Second, we suspect hedge funds use ETFs when liquidity dries up. Hedge funds were forced to close individual stock positions during the credit crisis, so they bought equity ETFs instead. Equity ETFs posted large outflows in 2009, when liquidity improved.
So you may want to think about doing the opposite, or at least keeping a closer eye on ETF flows when making investing decisions.