When Zero Hedge first admonished our readers in June of 2009 to stay away from markets in light of a general deterioration in market structure, which included a regulator-authorized form of structural frontrunning in the form Flash trading (not to be confused with the imminently following Flash crash), an unprecedented mismatch between stock valuations and economic reality, and Wall Street continued attempts to reflate the ponzi merely for the sake of proving that it can be done, we never expected that retail would take to our warning with the ensuing solemnity. Yet with 16 consecutive outflows from domestic equity mutual funds, shut downs by legendary hedge fund managers such as Druckenmiller and Pellegrini (and many more Tiger derivative blows up to be disclosed soon, once the full extent of the carnage of the flattening of the steepener bandwagon trade is fully appreciated), virtually everyone is asking themselves how did Wall Street not only get it all so wrong, but how on earth is the primary business of the post-facelift Wall Street, which is no longer investment banking, but merely trading (with or without flow-facilitated prop frontrunning) going to sustain the recent record headcount levels (hint: it won't, and many more banks will soon let go thousands of additional staffers as key revenue sources have now disappeared forever), and most importantly, why is this time different? Why did the "dumb money" for the first time ever, not bite on the Wall Street siren song lure of an economic "rebound", but instead has hunkered down, proving that not only is Wall Street nothing more than a pure-play enabler of the ponzi regime's status quo, but that all those who were warning that the economy is far more dire than Wall Street represents, were proven right. These same individuals (and bloggers), first validated in predicting the downward direction of the economy, will see their pessimistic forecasts about stocks validated next. Yet while that happens, all those who still somehow find this a surprising development, are now left proposing hypothesis as to what went wrong. Such as the following piece by the Financial Times.

Deep into the dog days of August, a rather unpleasant scenario is unfolding among the ranks of professional investors on Wall Street.



Against the backdrop of unusually low equity trading volumes, even for a typically sleepy August, continued strong flows out of equities into bonds, and high-profile hedge funds shutting down, a bitter truth is dawning for investment professionals.



Namely, that the ranks of retail investors, commonly derided as “dumb money” by the Street, have made the right call on US equity and bond markets in 2010.



As recently as July, much of Wall Street was awash with bullish research notes for the second half of 2010 calling for higher stocks and warning about low government bond yields.



Such bullish research is a staple of the industry and, flush with their bonuses from 2009, the Street simply thought the massive stimulus from the Federal Reserve and US government would translate into a sustainable recovery this year.



But since the eruption of the financial crisis in 2008, retail investors, like Odysseus, have stuffed their ears with wax so as to silence the allure of such sirens.

Like Odysseus, the successful return to the Ithaca of market efficiency (i.e., the purging of Wall Street's siren songs of capital destruction), will ultimately require continued resistance to the temptation of a relapse into the Ponzi. Yet we are rather confident that having gone far beyond merely a contrarian indicator, the recent divergence of fund flows out of equities and into money markets (to a small extent, and a 180 degree shift from patterns established earlier in the year), but mostly in fixed income, the case is now that with the demographic shift accelerating to the point where few if any are hoping for "double baggers" (and are willing to allocate capital to trades which have worse odds than playing blackjack in Las Vegas), the attempt to front run the dumb money has failed. What this means is that the proverbial bagholder is now Wall Street itself, namely the various prop trading desks, and assorted HFT non-overnight holding strategies (and yes, there are thousands of these). Thus instead of slowly, calmly and methodically selling to the last money in, Wall Street is now stuck in a Catch 22 of how much higher beyond fair value can the "Pig Farmers" (as defined by David Rosenberg) push stocks, before defection becomes the normative game theory mode, and the market crashes to unseen before levels, especially since prevalent short selling levels are now at near record lows, eliminating the natural buffer to a downside acceleration.

More from the FT:

Beyond the two big equity bear markets of the past decade, it’s no surprise that Main Street has soured on equities thanks to the Madoff scandal and the bail-out of Wall Street banks, followed by high bonuses paid out to bankers last year, all crowned by May’s “flash crash”.



While retail investors ran from equities and piled record amounts of their cash into money market funds in 2008, what really hurts the Street is their failure to forget and come back.



The common punchline on Wall Street is that once the markets have rallied for a while, you wait for the “dumb money” to rush in for a slice of the action. Then the “smart money” sells out and sit backs as retail investors get hosed when the market falters.



Except this year, the dumb money has resolutely stayed away and kept buying bonds and foreign equities, leaving the professionals twisting in the wind. So far in 2010, $50.2bn has been pulled from US equity funds on top of the $74.6bn in outflows during 2009, while $152bn has flooded into US bond funds, according to EPFR Global.



Such flows aptly illustrate Wall Street’s sour mood. Talk to people in prime brokerage at big banks and they mutter darkly that many hedge funds are struggling to make money and risk big redemptions later this year. The recent decision by Stanley Druckenmiller to wind down his Duquesne hedge fund is the type of shot across the bow that people in the industry could well look back upon as a foreboding omen.

Of course, this is verbatim what we have been warning about for months and months and months. And just as we have warned about the economy tanking, which is now confirmed by even the biggest permabulls on Wall Street (and we note with a deliberate dose of gloating the even Morgan Stanley's "economists" have now stepped away from the Kool Aid punchbowl to their unquantifiable chagrin...and derision), the next leg down is stocks themselves, first as multiples collapse, and second, as all those corporate decisions to conserve cash (absent a few idiotic decisions by corp fin departments ostensibly populated by crystal meth snorting monkeys such as those of HP and Dell), are finally seen for what they have been all along - prudent capital management in light of the next major downleg in the economy (and, yes, a major rise in corporation taxation) seen all too clearly by corporate Treasurers and CFOs, are all effectuated.

As for the winner out of this?

For many on Wall Street, the pain has been minimal, which perhaps underpins their usually bullish take on stocks and why they think the economy is currently experiencing a soft patch. The reality for Main Street, however, has been and remains a lot harsher. Unless the economy starts picking up speed, housing stabilises and unemployment abates, Wall Street stands to learn that the “dumb money” has a much better handle on the outlook for the economy and stocks.

The dumb money also knows one other thing - that the Fed has now run out of all options to restimulate the economy (and prepare for the Fed's escalating appeal of the Pittman decision to the Supreme Court in the week before mid-term elections to take on a very contentious gravity from a political angle), absent for the nuclear option. That option, as Bernanke knows all too well, will do nothing to reflate leverage-heavy assets, and will merely shoot critical commodities like wheat, oil, cocoa (as recently demonstrated by deranged speculation) into the stratosphere, finally ending the lie of the Core-CPI "disinflation." Wall Street has yet to realize just how ahead of it the "dumb money" finally is - we have long said that Americans, especially those of financial decision-making relevance, are nowhere near as dumb as Wall Street would like to believe, and they just need the right pointers now and then.

Zero Hedge will continue to provide such "pointers", and will be more than happy to read additional validation as this particular FT article, which also confirms that unlike even moderately wise people, who are all too aware that they know nothing at all, Wall Street, being at the other end of this spectrum, believes it knows everything, when the reality is precisely the opposite. And now that the majority has finally been awakened to Wall Street's simplistic ploy to control capital markets, and the general economy, with nothing else up its sleeve than a confidence game, it will be time to finally pay for decades of outright lies to those whose interests Wall Street should have held in highest regard all these years.