The Culprit Behind Last Week's Market Rout Emerges

On Monday we reported that in a market overflowing with losers, one clear winner had emerged: passive investors in general, and Blackrock in particular, whose exchange-traded fund business attracted more than $25 billion in November inflows, a record monthly haul for the company.

Recall that whereas last week EPFR reported that total stock funds suffered record weekly outflows of $39 billion, this was the result of $53 billion in active fund outflows offset by $14 billion in ETF inflows, as the great rotation from active to passive continues.

The latest figures from BlackRock, the world’s largest money manager and biggest provider of ETFs, confirmed that the shift away from expensive active investing, which has done little if anything to protect investors during the first bear market in a decade, to passive is indeed accelerating... and continuing: "we’re also seeing strong flows in December," Blackrock spokeswoman Melissa Garville told Bloomberg.

So if money was "rotating" to passive, it meant that active managers were hurting badly, and on Wednesday, the Investment Company Institute confirmed that mutual funds suffered near record redemptions of $56.2 billion in the week ended Dec. 19. According to Bloomberg that was the biggest outflow since the week ended Oct. 15, 2008, the peak of the financial crisis. The latest weekly outflow was almost on par with last month's total redemptions from active funds, which in November had outflows of $57.4 billion.

The data, in addition to confirming that active investment as we know it is now a dying breed, also indicates that we now know what the reason for last week's furious rout. Or rather who: because in order to satisfy the massive redemptions, mutual funds had to liquidate the most stocks in a decade, and with market liquidity already at record lows, the overhang from relentless offers sent clearing prices sharply lower, just as we saw in the past week, and indicates that instead of algo traders, who merely accentuated the downward move, the real catalyst behind last week's market plunge was a forced liquidation from the active community.

Yet even as investors were dumping mutual funds last week, the reallocation to passive continued as investors added $25.2 billion to ETFs. Finally, as reported earlier, corporate insiders aggressively stepped up their buying over the past two months, pushing insider purchases to the highest level since August 2011.

As Bloomberg summarizes, here’s the breakdown of the funds investors pulled money from:

Finally, pointing to the flow of money into ETFs, ICI Chief Economist Sean Collins said in a statement that it reinforced the view that "some investors view periods of volatility as a buying opportunity" - money which is clearly being deployed in today's session.