Volatility returned to equity markets last week, but it was a quick visit. The S&P 500 slid 1.8% on Wednesday, the VIX jumped and babies were thrown out of with the bathwater in Brazil. For a short while, it looked like significant chink in the armour, but this market is not easy to bring down. Equities snapped back at the end of the week and volatility receded. On the week, the S&P 500 ended down 0.4%—after a 0.3% decline the week before—just about the same as the MSCI World. One of the main debates on the Tee Vee Thursday morning was whether this "pull-back" marked the beginning of the big kahuna sell-off and a global recession. When the market goes up, we cry foul due to high valuations and tentative evidence of "bubble behaviour," and when it finally stumbles it stands to reason that it must the beginning of the big unravelling.
Traders and strategists on Bloomberg TV had one overarching message last week. It's boring out there, too boring. John C. Bogle's Vanguard and Larry Fink's Blackrock have turned passive investing into a volatility crushing monster. Indexation is an immovable force, which takes no prisoners, evidenced by the fact that the return on the main U.S. stock indices is driven almost exclusively by five major names. Trying to beat the tide by picking stocks—both long and short—is proving nigh-on impossible for active managers. Adding insult to injury, the bond market is a snoozer too. The curve can't figure out whether to steepen or flatten in response to the Fed' slow hiking cycle—I am betting on the latter—and yields have been range bound as a result. Clearly, investors aren't easy to please. When volatility is soaring, they assume foetus positions and cry for central banks to rescue them, and when low volatility finally arrives they deplore the lack of opportunities. Maybe it is just a question of the porridge being neither too hot nor too cold, but when punters start complaining about low volatility my spider sense goes off.
Markets raised a lot of interesting questions last week, and most of them had nothing to do with the French presidential elections. The main talking points were the stumble in oil prices—and other industrial commodities—and the growing anxiety that the stop-go cycle in China is edging towards the former rather than the latter. The main question everyone is asking when the market breaks key levels is whether it is the beginning of a more prolonged move. I am no expert, but if pressed I think oil and commodities will snap back. The chart below shows trailing flows of the DBC commodity ETF, which have been depressed recently. This doesn't preclude a further rout, but it suggests that investors' positioning and sentiment don't favour it. This story is corroborated by CFTC data, which shows that spec positioning in oil have been reduced significantly. This doesn't look like a market which is being caught out complacently long as was the case last time oil was routed.
Google informs me that the advice to "sell in May, and go away" comes from the tradition of British merchant bankers—I presume in the 19th century—to leave London for the country side in May and come back on St Leger's Day in September. I am partial to a good anecdote, but does it work? In order to check, I ran a little study using the S&P 500 going back to 1991. The first chart below shows the returns you would have foregone by selling in May and waiting 35 weeks and 17 weeks, respectively, before buying back. I have included both mean and median returns, because the outliers can skew the former when your sample size is not large. The second chart shows the results of a strategy which shorts the S&P 500 in May, buys the first week of October, and holds until year end.