Capital Flow Analysis in the open market of 'investment experts' Capital Flow Analysis in the Open Market: continued

Capital Flows in Context

An Open Market for 'Investment Experts'

Many of the proponents of these various theories and techniques have official claims of professional validity from associations that award certificates of competence and set standards.

This is just a partial list of investment professional designations.

Meeting Objections

The capital flow analyst that presents a thesis to a group of investment professionals is almost certain to be challenged by competing analysts, bearing a variety of credentials, who not only have never heard of flow of funds accounts but who are skeptical that such information could be of use, because it was not included in the curriculum of their particular institute.

This means that the capital flow analyst should anticipate objections that might be made by those holding views based on opposing market theories.

We need to anticipate objections by those with opposing views

The analyst must do double duty researching, not only to make sure of the facts on which forecasts are based, but also to build counter-arguments for anticipated objections.

Most objections can be expected to based on:

  1. Objections to Irrationality: The Efficient Market Hypothesis and markets driven by rational investors, acting in an expected manner, are beliefs that dominate the market.
  2. The capital flow analyst is also influenced by these beliefs and needs to focus on facts so as not to fall into the 'rationality trap'.
  3. Unfamiliarity with Facts: The flow of funds accounts reveal patterns that are often unknown to professionals who do not study this data.
  4. Greenspan's 'irrational exuberance' showed he had misread investor behavior.

    For example, Chairman Greenspan's comment about 'irrational exuberance' in 1996, suggests that his concept of the stock market was one in which individual investors (speculators) were driving prices upwards in a fit of over-optimism. However, the facts were that individual investors had been selling stocks, on balance, for many years. The motivated buyers were corporations repurchasing their own stock to manipulate the value of stock options and tuned-out long-term investors putting tax deferred money into mutual funds, based on their faith in the Common Stock Legend.
  5. Opinions of Market Icons: In April 2004, Bill Gross, the bond market super-pundit and boss of PIMCO, advised bond investors to 'get out of Dodge', predicting that rates on long bonds would be much higher by year end.
  6. It turned out that Bill Gross was wrong (primarily because his reasoning was based on 'investor rationality'), but nevertheless, pronouncements of this nature from famous players mean extra work for the unknown capital flow analyst who dares to take an opposing view.

Capital Flow Analysis is in some ways related to Behavioral Economics in that there is a shared skeptical view regarding economic rationality. The first Nobel prize for contributions to behavioral economics was awarded to a psychologist, Daniel Kahneman, in 2002.

When we come to present a thesis regarding market trends to clients, we should keep the following in mind:

Consequently, a prediction based on well-researched analysis of flow of funds data, succinctly presented in language that assumes that the client knows nothing about Capital Flow Analysis, is apt to be received with respect, especially if the analyst holds in reserve detailed factual justifications for anticipated objections based on commonly-held misconceptions.

Support from Long-Term Data

Let us say that it is 1999 and you, the capital flow analyst, are trying to make a forecast for the U.S. equity market.

You know that equity prices have been driven up by massive corporate buybacks for more than a decade.

You also know that equities, in historical terms, are dramatically over-priced.

Because the equity bull market is still raging on, you know that a prediction that the stock market might be in for difficulty in 2000 will be met with hoots of derision.

You run over in your mind the objections you expect to hear from those adept in Modern Financial Theory:

Be prepared for objections that other may raise to your ideas

The first two objections have to do with the ethics of buybacks and are not the main determinant in your forecast, since you don't expect market perceptions of ethics to change rapidly.

However the question that is directly related to your prediction of a risky market for equities in 2000 is whether corporations can really continue the practice of buybacks indefinitely.

Here you need to know:

  1. Has the percentage of earnings spent on buybacks remained constant?
  2. Has cash retained in the corporation after buybacks and dividends remained constant?

It the answer to both of these questions is yes, then buybacks may indeed continue to support equity prices for some time.


Before proceeding, check your progress:


There is no assocation certifying knowledge of:
Choice 2 The Motivation Axiom.
Choice 3 The Sharpe ratio.
Choice 1 Cultural astronomy.
Choice 4 Elliot waves.
The capital flow analyst should anticipate objections from people who :
Choice 2 Accept the Efficient Market Hypothesis.
Choice 1 Accept opinions of market pundits.
Choice 3 Accept the Motivation Axiom.
Choice 4 Accept the Irrationality Axiom.
Capital Flow Analysis is in some ways similar to:
Choice 2 Behavioral Economics.
Choice 3 Vibration Theory.
Choice 1 Dialectical Materialism.
Choice 4 Dow Theory.

Learning Module: Steps in Capital Flow Analysis  learning module : continued >

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