Inside Markets — VIX Levels

Equity markets have entered a challenging three-week window for fund flows with a supply/demand mismatch that’s skewed to the downside. Corporate buybacks have been the largest source of equity demand this year with ~35% of that demand sidelined until October 25. Total systematic equity exposure (Vol targeting, CTAs etc.) looks elevated at a time when hedge funds are looking to add short exposure into earnings season and uncertain election outcomes. Higher levels of realized equity volatility (VIX>22) would likely expose the supply/demand mismatch in a more dramatic way.

ISM and PMI manufacturing had been the best/most consistent forward-looking economic indicators for decades, but have seemingly lost their predictive power over the past two years. Both surveys have been in contraction territory (below 50) for 22 of the last 23 months without any bearing on US GDP growth or the performance of the Industrials sector. The XLI made a new All-time high yesterday after ISM manufacturing missed consensus at 47.2 Note that ISM is a diffusion index, which means it measures breadth rather than depth. The surveys may recognize a large number of respondents being in contraction, while a handful of very large companies have been pushing GDP higher. Massive amounts of fiscal stimulus could be another explanation for the apparent disconnect. US GDP growth was moving at a ‘normal’ pace of +2.3% before pandemic related lockdowns slowed the economy to -2.77% GDP growth in 2020 with $6T in fiscal stimulus and extraordinary monetary measures taking GDP growth to 5.95% in 2021. The deceleration from +5.95% to +2.9% in ‘23/’24 may only feel like a recession, when it’s actually a more normal pace.