The VIX and Pullbacks, Money Flows, Gasoline Demand

By admin_45 in Blog

Three Data topics today:

#1: The latest US mutual/exchange traded money flow data was out yesterday and confirms continued retail investor interest in equities.

• For the week ending April 14th US equity funds saw inflows of $4.8 billion. That is the same amount as the prior week, although it is well below early March inflows of $17 bn and $43 bn for the weeks ending the 10th and 17th, respectively. February inflows averaged $11.3 bn/week.
• Inflows for non-US equity products last week totaled $6.5 bn. This was slightly below the prior week’s $7.6 bn but very close to March’s weekly average of $6.6 bn.
• Fixed income inflows are accelerating. Last week saw $18.0 bn in fresh investment, only slightly below the prior week’s $21.6 bn and well above the March weekly average of $9.8 bn.
• Commodity fund (mostly physical gold) outflows seem to be slowing. Last week’s redemptions were $498 mn, in line with the prior week’s $466 mn but less than the March weekly average of $913 mn.

Takeaway: we need to reiterate our message from last week that seeing positive inflows into US equity funds for a third month in a row is simply remarkable. For 2019 – 2020, outflows averaged $19 bn/month and this period only saw 3 (non-sequential) months of inflows. As much as US equities may seem richly priced, it’s hard to get too negative as long as inflows remain so steady.

#2: Equity volatility today caused by news of a potential change in US capital gains tax rates is a good reason to talk about the CBOE VIX Index, often dubbed the “fear index” because it rallies when stocks decline quickly as this 2017 – present chart shows. The red line is the 1-year percent change in the VIX (left axis); the black line shows the S&P 500 (right axis). We’ve highlighted 2020’s peak delta in the VIX to show how it corresponds to the near-trough for the S&P on March 16th. From that point forward, as the VIX declined (smaller annual comps to start, more recently negative) the S&P moved higher.

With the VIX now at 19, essentially spot-on its long run average, we can’t make as much of a bull case for US stocks as we could when it was +40 (this was a part of our “buy stocks” call last year). That part of the story is over.

Instead, let’s look at the long run history of the VIX to see how it behaves post-crisis/recession. That’s what this chart shows: the VIX back to 1990, with that 19-level long run average marked by the black horizontal line:

Two important points here:

First, that 19 average on the VIX is the mathematical mean of 2 very different market environments. One is calm, orderly, and generally profitable (the bull markets of 1992 – 1996, 2003 – 2007, 2012 – 2019). The other is volatile but can either be profitable (1997 – 2000 dot com era) or very bad indeed (2001 – 2003: recession and Gulf War II, 2008 – 2012: Great Recession, 2020: Pandemic Crisis).

Second, historically it has taken years (not months) to move from a high volatility regime to a low vol environment. We won’t count the 1990 – 1991 vol burst – that was one event (Gulf War I) which resolved itself quickly. Aside from that, once markets convincingly crossed the 19-level to the upside they were there for 5 years at a stretch.

Takeaway: the points above are the recipe for an eminently sensible if somewhat fuzzy bearish case for US stocks right now. We know a VIX at 19 is right on the demarcation line of 2 sorts of markets, one always good and one usually bad. We also know that we’re only 14 months into a high vol regime caused by a global shock. We also know that these sorts of events take more like 60 months to fully play out. And, lastly, we know that when the VIX goes up the S&P 500 tends to decline.

Virtually every call for a US equity pullback we’ve read leans on this idea at least implicitly, namely that there’s simply no way we can easily revert to a low-vol bull market so quickly after a shock. History certainly agrees, unless we’re about to enter or are already in a 1997 – 2000 bubble market (which sort of negates the bear case, at least for now). On the other side of the argument is $5 trillion in fiscal stimulus, with more to come if President Biden gets his infrastructure package through. We’re of the opinion that cash trumps history when that cash is at levels history has never seen before. But we get it – we’re in unusual times, so if your perspective is different and you want to derisk here history says you are justified in doing so.

Finally, just a quick catch up on the US Energy Information Agency’s weekly chart of American gasoline consumption. The blue line shows daily 4-week average consumption in millions of barrels/day over the last 12 months (May 2020 – May 2021); the brown line shows the prior year.

Takeaway: US gasoline consumption is back to 9 million barrels/day, or 92 percent of pre-pandemic “peak normal” (those 9.75 mn bbls/day you see for July/August 2019). Energy stocks have been a choppy trade since their mid-March highs, but we still like them for a 6-12 month holding period. The domestic demand side of the equation is certainly there, and once Europe gets further through the vaccination process oil prices should respond and help this long-suffering group see a further bounce.