The VIX Is Near An All-Time Low

C&I lending is one of the most important indicators used to determine the health of the economy. I was questioning the importance I give this metric because it predicted a recession, yet nothing happened. With the report which was released Friday, the C&I lending had a sharp move higher, passing the previous peak in November. This signals the economy is strong. It removes fears of a recession. The previous analysis I did was that either a recession was coming this year, or the indicator is broken. The longer it stayed below the November, peak the stronger the indicator got. There have been several periods where the indicator fell for a few weeks, but 6 months was an unusually long period. This latest report makes me think a recession in 2017 is highly unlikely.

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Just because a recession isn’t in the cards doesn’t mean the economy will reach the growth rates seen in previous cycles. In the 1990s growth cycle there were 0 quarters with below 2% real GDP growth. In the 2000s cycle, there were 5 quarters with below 2% growth. In this cycle, there have been 16 quarters of below 2% growth.

As you can see in the chart below, the GDP Now report is showing 2.7% growth for Q2 which is down from the 2.9% growth rate seen in the previous update. The estimate fell because of the advanced inventories report and the international trade report. The NY Fed model sees 1.91% growth. This means it has only moved 0.05% in the past 3 weeks making this a more stable period than any other one in the prior 2 quarters. There are only 4 more weeks until the advanced Q2 report I released which means the range between the NY and Atlanta Fed forecast is likely to be where the GDP growth rate falls.

As I have said in previous posts, the risk of reflexivity is an important concern for the economy as a stock market crash could hurt the economy. The VIX is the exact opposite of what it proposes to be. While a high VIX is supposed to mean high risk and a low VIX is supposed to be low risk, the reality is the opposite. At market peaks, the VIX is low and at bottoms it’s high. As you can see from the chart below, the 12-month rolling average of the VIX is near an all-time low. This doesn’t mean the stock market is at a top, but it does mean the VIX will likely go higher from here. That’s a dangerous position to be in.

I have reviewed the Bloomberg Consumer Comfort index and the University of Michigan Consumer Confidence index. One was positive and one was negative. To break that tie we have the Gallup economic confidence index which is now -4 which is the lowest level since the election. At face value, this doesn’t mean anything for the economy because it was negative in 2016 which didn’t mean much. However, it could spook investors into taking profits in their winning trades like did in technology in June. Anything can potentially spook a market which has valuations which are above historical norms. However, it seems like nothing can knock the market down. Even the initially very weak Q1 advanced GDP report of 0.7% didn’t cause a selloff.

Given the expensive valuations, it’s very interesting to follow the money flows to see who is buying stocks. It would seem a rational individual would increase their cash position at a time when the Shiller PE is at 29.66. The chart below shows that the biggest buyers of stocks remain corporations. Buybacks were down 13% in Q1. The chart annualizes the figures to show the comparisons, but I think that gives an unrealistic picture since I’m expecting buybacks to increase in the second half. As I have said previously, ETF buying and foreign investors buying stocks have made up for the decline. It’s interesting to see the mutual fund buying only decline by $7 billion or 6% considering the large outflows from mutual funds to ETFs. This signals mutual funds are very bullish on stocks.

It’s also interesting to see individual investors putting money to work after two straight years of declines. Individuals are very bullish on stocks, but they have decided to move into ETFs instead of picking them. Individuals’ results on stock picking are actually worse than mutual funds, so it was probably a good idea for them to make the switch. When considering the 44% rise in brokerage accounts being opened in Q1 at Charles Schwab, it’s surprising to see only $11 billion in inflows from individual investors. The S&P 500 was up 5.53% in Q1 but was only up 2.57% in Q2 which means some of these bars will decline slightly. It may be the corporate buybacks because although I am bullish on buybacks in the intermediate term because of earnings improvements, the announcements for buyback growth in Q1 were weak. We will know if buybacks will improve in the second half of 2017 based on earnings season which starts in 2 weeks. The increase in buybacks and poor guidance from energy firms are two themes I’m expecting to see during earnings season.

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Conclusion

To summarize, the economy seems to be doing well despite the weakness seen in two of the three latest consumer surveys. Credit growth is the driving force behind economic growth. After a few months of weakness, C&I lending got back on track. Volatility is extremely low and stock valuations are extremely high because of buying from foreign investors, ETFs, and corporations. The only flow I can see switching by the end of the year is foreign investors. This chart above gives you a sober look at how the day-to-day noise simply doesn’t matter. It can cause a short selloff, but money is begging to be put into the market. Until the liquidity dries up, the market will march higher.