Behavioral Economics and Main Players
Big Players Drive Capital Flows
In lesson 21 we learned how to locate the instrument table for the market that we want to study.
In lesson 22 we learned how to use price information to identify motivated sectors in that particular market.
However, not all capital flows are equal.
Big players with the largest net cash flows are more significant in explaining price trends.
Some Players Are More Important Than Others
The size of sectors that appear in the Federal Reserve flow of funds accounts varies considerably.
In Q4 2004, financial assets controlled by the sector groups presented on this site were as follows:
| Player Category | $ trillion | % of total | |
|---|---|---|---|
| 1 | Households | 36.7 |
36.3% |
| 2 | Fund Managers | 16.1 |
16.0% |
| 3 | Bankers and Brokers | 14.8 |
14.6% |
| 4 | Corporate Managers | 13.1 |
12.9% |
| 5 | Foreign Investors | 9.2 |
9.1% |
| 6 | Government Officials | 5.5 |
5.4% |
| 7 | Insurance Executives | 5.3 |
5.2% |
Total Players |
101.1 |
100.0% |
Obviously, a change in asset allocation of the Household sector will have a far greater effect on security prices than a proportionately similar change in asset allocation by insurance company executives.
When reading instrument tables, we should keep in mind the relative power of the various sectors, even when this is not reflected in current flows.
Instrument Table Coding
Examining the flow table for the instrument chosen, we note the motivated sectors and the direction and size of flows.
On this site, instrument tables can be recognized by the red and green background.
(The background of a sector table is blue and yellow.)
Red-green coding identifies an instrument table.An instrument table shows sectors that were net buyers or net sellers of that type of security.
The instrument table is divided horizontally into two groups: issuers and purchasers.
- Issuers are labeled in the left column against a pink background.
- Purchasers are labeled in the left column against a light green background.
Ordinarily, issuers are sellers of securities and purchasers are buyers of securities, but sometimes this is reversed; issuers may buy back or redeem securities while sectors listed as purchasers may be net sellers.
To avoid mistaken interpretation, tables are color-coded:
- Flows for buyers (whether issuers or purchasers) are indicated by a bright green background.
- Flows for sellers (whether issuers or purchasers) are shown on a bright red background.
Take this opportunity to check this on the flow table for corporate equities, F.213.
The Help Bar
In the upper left corner of the instrument table, there is a help-bar that allows you to use the instrument table as a command center when examining the market for that security.
The Four-button Help Bar
The first button on the right provides help on interpreting the color-coding of the table.
The second button from the right opens a pop-up window (if you have javascript enabled) that shows a summary of major flows in the latest quarter.
The third button opens a pop-up window with external links to recent data relevant to the table.
The second button from the left leads to the Instrument Definition Page that we discussed in lesson 21.
The instrument definition is taken from the Federal Reserve Guide to the Flow of Funds Accounts.
This comprehensive guide is available from the Board of Governors of the Federal Reserve System as a 1,200-page publication, in two volumes, providing general and detailed information helpful in understanding and using the accounts. The guide may be purchased for $20 from the Federal Reserve Board.
The definition pages on this site provide summarized information that is usually sufficient for Capital Flow Analysis.
Keeping the Instrument Definition Page open in the pop-up window, you can visit the level table for that instrument and related external links, while the instrument flow table remains in the background.
You may close the pop-up window when you are done.
Identifying Main Players
What you need to know next is, 'Which sectors were major buyers and sellers of this security over the period?.'
At the same time, your attention should be directed to motivated buyers and sellers, according to the Motivation Axiom, described in lesson 2.
Coding highlights the answer:
- Flows for buyers or sellers that account for more than ten percent of the respective net flows are indicated in bold type.
- Flows for motivated sectors are underlined.
- The main players that drive the market are indicated in bold type underlined, indicating motivated sectors that account for more than ten percent of net flows.
In accordance with the Dominance Presumption described in lesson 9, we presume that issuers are important in determining price trends.
Usually, there are not more than five or six main players that drive prices in a particular market, indicated with bold type underlined.
Usually only one of these players is an issuer.
The 'Last Quarter Summary'
For the most recent quarter, there is an quick way to identify sectors that drive prices in a particular market.
Click on the 'Last Quarter Summary' tab on the help-bar.
A pop-up window appears (if you have javascript enabled).
- On instrument tables, the 'Last Quarter Summary' shows sectors accounting for more than ten-percent of total flows, arranged in two groups: buyers and sellers.
- On sector tables, the 'Last Quarter Summary' shows sources and uses of financial assets and liabilities, accounting for more than ten percent of the sector flows.
The 'Last Quarter Summary' pop-up window on an instrument table. With a little practice, in a few clicks you can go to the instrument table for a particular market and have information to identify the motivated groups of players that drive that market.
What Net Flows Signify
Keep in mind that instrument flow tables show net purchases and net sales for that type of security.
The instrument tables do not show total purchases or total sales.
In Capital Flow Analysis, we assume that net flows between sectors are significant in explaining price movements.
For purposes of analysis, we simplify our concept of a sector.
For example, the commercial banking sector (F.109) is made up thousands of banks, each with individual managers and different motivation.
However, we think of the commercial banking sector as if it were a single bank with a single manager whose interaction between other sectors (such as life insurance companies, or mutual funds) is represented by the net flows between other sectors.
At this step of analysis, we treat interaction between banks as irrelevant.
Each sector has characteristics that are significantly different from the next and this difference is reflected in patterns of flows over time that reveal distinct behavior.
This is to be expected. Banks are, in fact, different from insurance companies, and nonfinancial corporations are different from mutual funds.
No Single Class of Investors
There is no uniform class of investors, although economists often pretend that the market is uniform.
If all market participants were equal, all seeking the same goals, like the players in John Maynard Keynes's game of musical chairs, then we would expect the net flows between the various sectors to be arbitrary — positive in some periods and negative in others, with a variance approaching zero over time.
Keynes' musical chair analogy is important because it has influenced thinking of economists for generations.
However, even a casual examination of the flow of funds tables shows that this is not the case; there are distinct behavioral differences between classes of players.
For many years, mutual funds have been net buyers of equities, while households have been net sellers.
This could not occur if players were equally motivated.
The behavior of mutual funds is as different from that of corporate issuers as the behavior of households is from insurance companies.
Before proceeding, check your progress:
Self-Test
To which sectors should the capital flow analyst direct primary attention?
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Indicate which are true:
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Keynes' analogy comparing investor behavior to a game of musical chairs is misleading because:
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