Who Moves the Market? A Study of Stock Prices and Investment Cashflows

In this paper, we explore the relation between stock market returns and cash flows to the stock market from seven major investment sectors in the economy: mutual funds, households, pension funds, foreign investors, insurance companies, closed-end funds, and other institutional investors. Our goal is to address the following questions: 1) Does the return-cashflow relation differ across sectors? 2) Are the differences caused by distinct trading behaviors, such as positive feedback trading, or the fact that trades of specific sectors systematically impact the overall level of the market? Using the Flow of Funds Accounts, we find that the quarterly contemporaneous return-flow relation is positive and significant for mutual funds, foreigners, and pension funds, but not for the other sectors. For example, over the entire sample we find that a one standard deviation change in mutual fund flow corresponds with a 1.46 percent increase in the quarterly stock market return. Applying a covariance decomposition method developed in Sias, Starks and Titman (2001), we find that the positive contemporaneous quarterly covariance for mutual funds and foreigners is driven mainly by a strong contemporaneous monthly relation, suggesting that these sectors may exert price pressure on the market through their demand for stocks. The price impact appears to be temporary and is reversed in the subsequent months