Sunday, March 23, 2014

Money Flow Index, Money Flows, And Fund Flows Are All Different In Quality

Flows can be fun to watch.  Morons find them boring but geniuses like Yours Truly know what they mean.  It's too bad that some market flows are nonsense while others matter just a little bit.  Today I'm going to sort the wheat from the chaff.

The money flow index (MFI) is one type of flow that I safely ignore.  It is a technical indicator.  Academic studies have proven many times that technical indicators don't count for jack squat.  Investopedia notes that traders use a stock's MFI to indicate a trend reversal.  I say it indicates no such thing.  A simple average of a stock's three key prices during a day's trading range has no more statistical validity than the result of three coin tosses.  Using a random result to spot a trend is really silly.

The Wall Street Journal's Money Flows table is slightly more useful than a technical indicator.  The breakdowns of individual stocks, sectors, and the broad market aren't range-bound like the MFI.  The difference between buying and selling strength is a simple ratio.  It is a much purer supply/demand relationship than the MFI because it accounts for a total dollar volume of transactions and isn't smoothed with internal averaging.  This is meaningful in conjunction with a fundamental analysis that estimates an intrinsic value for a stock.  The ratio indicates whether the market is ignorant of something the intrinsic value reveals.  If I think a stock's intrinsic value is worth less than its market value, but I see strong demand in this money flow data, I'm going to wonder what crazy plant the institutional investors are smoking by bidding up an overvalued stock.  This ratio is also useful in evaluating index funds that track broad averages.  If the economy's P/E is above its long-term average of about 14, and the WSJ money flow ratio for the total market shows strong demand, I will once again wonder why institutions are so desperate to pay a premium.  Birinyi Associates uses a variation of this money flow analysis without my sarcastic flair.

The most useful flows I've discovered are the ICI's statistics on weekly and monthly fund flows.  The weekly estimated long-term mutual fund flows are the most frequently cited series.  Mutual fund data is a barometer for individual investor sentiment because investment companies market actively managed products to retail investors.  I often see Zero Hedge writers go nuts about this data every week.  Lemmings rush into mutual funds when they get greedy in bull markets and stampede out when they're terrified in bear markets.  Market panic is a value investor's gift-bearing friend.

I needed to explain all of these flows because some folks are bound to get them confused when they go looking for stock market sign posts.  The WSJ money flows and ICI data series are probably even less useful than the "Warren Buffett Indicator."   The MFI is not useful at all.  These things are rough guesses at market sentiment but they cannot be the sole decision triggers for any competent investment decision.  That only comes from detailed fundamental analysis.  I exist to clarify and explain complex ideas.  I enjoy showing off my intellect.  Look upon my works and despair, puny mortals.