November was a record rush into US equity ETFs. No. 2 all-time? Just as 2008 market crashed

As exchange-traded funds have grown to be a $2.4 trillion industry, flows in and out of ETFs have become a new way to read the market tea leaves. November was the best month ever for inflows into U.S. equity ETFs, with $49 billion in U.S. stock ETFs taken in from investors.

It's hard to ignore such numbers, especially when new records are being set — not just in ETF flows but stock market indices. But a focus on ETF flows leads to a question: How good are they at predicting the future direction of stocks?

Well, here's one way to answer that question: The second best month ever for U.S. equity ETF flows was September 2008 — you know, as Lehman was declaring bankruptcy and the world was descending further into economic chaos.

(Source: FactSet Research)

In all, three of the top 10 months for ETF flows in the past decade occurred in 2008, including March and December of that train wreck of a year.

It's possible opportunistic buyers were already calling a bottom in September 2008. They would have been wrong. But December 2008 does make more sense for value investors seeing deep discounts in every stock. In the six months after December 2008, the S&P 500 was up 2.7 percent; in the one-year period beginning Dec. 2008, the S&P 500 returned 23 percent.

"I think ETF flows just reveal investor sentiment and are no indicator/predictor of performance going forward," said Neena Mishra, director of ETF research at Zacks Investment Research.

They're certainly useless — at least, based on this last year — for any market call 12 months in duration. The SPDR S&P 500 ETF (SPY (NYSE Arca: SPY)), the iShares Russell 2000 ETF (IWM (NYSE Arca: IWM)) and the PowerShares QQQ Trust (QQQ (QQQ)) were the biggest asset losers during the months of January and February, while SPDR Gold (GLD (NYSE Arca: GLD)) and bond ETFs were the biggest gainers. "Obviously, fund flows at the beginning of the year gave no indication of things to come," Mishra said.

The truth about looking over the 10 top months ever for U.S. equity ETF inflows: It's been a mixed bag.

The big months that occurred during the first half of the past decade were, more often than not, pretty bad at calling further gains for the market in the following three- and six-month periods.

But the more recent big months for U.S. equity ETFs often preceded further equity gains in the following three- and six-month periods.

(Source: S&P Global Market Intelligence)

Another mistake investors make in using ETF flows is looking for a reason to call a market top, thinking it is proverbial mom-and-pops rushing into ETFs. But that's another misconception to clear up.

ETFs are not primarily mom-and-pop investments. According to FactSet Research, less than half (43 percent) of ETF assets come direct from retail investors. A diverse group including investment advisers, brokers, private banks/high-net-worth groups, institutional investors and mutual fund managers hold the 57 percent majority of ETF assets.

The best advice is to avoid the mistake of using ETF flows in isolation as actionable advice.

"Flows are notoriously difficult inputs for any market model," said Elisabeth Kashner, director of ETF research at FactSet. "Some quants find them valuable, but of course they're not sharing their methodology."

"We don't think investors should use strong ETF demand to confirm their belief that the market will climb higher in the near term," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA and a member of its investment policy committee.

The ETF tea leaves are an opportunity to put on your market contrarian hat. "When sentiment is too bullish, securities can be priced to perfection and ripe for a sell-off," Rosenbluth said.

But it would be just as bad to do the market math this way: November ETF record + September 2008 record = impending crash.

CFRA has an S&P 500 12-month target of 2335. (The index closed at 2253 on Wednesday.) CFRA thinks there is upside price-appreciation potential in the year ahead; it just may be limited.

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Record months for U.S. equity ETF inflows should take you back to a fundamental question about being in the market: What are companies doing to create value that will flow through to earnings?

If you can't come up with an answer to that question, then that's the worst signal of all.

Here are a few S&P 500 stats from S&P Global Market Intelligence:

• On a trailing basis, the S&P 500 is trading at an elevated price-to-earnings ratio of 19.5x 2016 estimated operating earnings per share, or a 13 percent premium to the quarter-century median P/E ratio.

• The P/E on trailing GAAP EPS is at a 26 percent premium.

• The P/E on forward 12-month EPS is 17.2x versus the average of 16.2x since the end of 1999, according to S&P Capital IQ.

Mitch Goldberg, president of investment advisory firm ClientFirst Strategy, said he isn't worried about the rally that led to the massive ETF rush or that noted market gurus, like Jeremy Siegel of the Wharton School, have called "98 percent Trump."

"I know everyone wants a binary market call of whether we have come too far too fast or if there is more to go," Goldberg said. "But what investors need to look out for are the conditions pushing stocks higher and bonds lower. Are those ending, or are they evolving in a way that adds to the positive sentiment?"

Here are a few of his reasons to not doubt current market buying:

• A lot of the potential returns for 2017 are being pulled into 2016.

• Earnings are on the rebound after several quarters of negative growth.

• Energy earnings clearly bottomed out.

• The banks are leading.

• The Fed is hiking — though on Wednesday the market did react negatively to its surprise forecast for three rate hikes next year.

• Q3 GDP came in over 3 percent.

"It started before [Trump]," Goldberg said. "It is a mix of fundamentals improving and the belief Trump's policies will accelerate things." He added, "Either way, companies are giving investors a reason to own their stocks."

Just don't include record ETF flows among them.