My favourite data is out again and since it has been a long time that I have not published my fancy charts and that we are at the 11th hour of debating the debt ceiling in the US this could be quite topical. Agree or disagree about what the typical US investors does and its predictive value I think they are right so far. Clearly the pattern of selling bonds is an on-going theme and favouring foreign equities against domestic one is now an established trend for US investors as can be seen from the charts below. The one on the right shows how significant has been the inflow/outflow in each of the asset classes across different time periods whereas the one on the left shows the inflow / out flow in US mutual funds so far this month.
So what now ? I guess if we get some kind of resolution it will be good short term for those treasuries as it will support the US credit rating (what does Fitch know about it anyway ?….) . Clearly it should be good for risk appetite so I still think long international equities is a good bet and get ready to sell some dollar after the next couple of days of exuberance …else I guess it is the idiocy that Buffet refers to…god save us all….nowhere to hide this time….
Not that I am a great believer in using past market patterns to forecast the future, I however think that it may be helpful to put things in perspective bearing in mind the current debate on the US debt ceiling and the possible outcome of tonight’s vote. So I have used an R script posted on the “Systematic Investor” to look at what the S&P has done over period of 125 days and to compare it to period in the past where it exhibited the same type of behaviour whilst posting also the following 125 days…..
Looks pretty much middle of the range to me, so there is plenty of room left to express yourself as a bear or a bull….I am of the later… 🙂
Seems like the markets have rallied top the idea that the budget ceiling limit is sorted out…so it is business as usual…buy equities ! and probably a little bit of dollar as the relief trigger some short term enthusiasm….but you know my view on that one. The ICI US mutual fund flow data definitely point out to some significant flows going into international equities, so the dollar weakness will come back….Anyhow I re-run my Regime Switching Markov model and there is definitely statistical agreement….Risk On sell the VIX !
Ok what is happening in the not so great US of A ? Markets were clearly coming to a lull and Capitol hill has decided to spoil the party by throwing us a curve ball with this on-going wrangling over the budget and debt extension ceiling. Can you imagine the US going into default ? No one has any real idea of the full impact of such an event and because of this we see the Roubini of this world crawling out of the woodworks. Even Buffet mention the event has being potentially “Nuclear”. Clearly the US has already partially defaulted in 1979 on some of its treasury bills, this moved the yields by about 60bps in one day which by European standards does not seem much. Anyhow Forbes has published a good column on this…So this time is it different ? Well from what we can observe in the equity markets the reaction has been somehow muted. We have seen some retracement over the last five days but it still leaves us with a very healthy performance since the beginning of the year (assuming you invested globally in equities).
Fig. 1: 5-day return of Stock Markets Fig. 2: 9-month return of stocks markets
Bearing in mind the nearing of the 17th of October which is when the US could potentially find themselves in default if the extension of the debt ceiling is not agreed upon I thought I would look at my risk indicators. The left hand chart shows that the VIX is still trading near its long term median, that the volatility of the VIX (Volga) is also close its median and that the ratio of the Volga and the VIX which is a good indicator of financial system shocks has remained close to its median also. In other words by these metrics we are still in a happy, long risk world.
However the chart on the right hand side shows the probabilities of being in a high risk or a low risk environment derived from a 2-state Markov regime switching model applied to the VIX. In simple terms the Markov model aims to split the sample under review into two distributions (low risk, high risk) and to establish the probability of moving from of distribution to another. Clearly it seems that something has changed (in fact it started to change on the 29th of September). The model does seem to indicate that a bit of caution may be a good idea……Let ‘s hope those guys on Capitol Hill get to some convincing agreement …..I ll keep my tin hat at close range, just in case….