Barclays | U.S. Equity Strategy7 January 2019 2No holiday for market volatility The last holiday season was one of the most volatile Decembers in recent history (Figure 1).The S&P 500 index dropped to an intra-day low of 2346, only to bounce back above 2500by the end of the year. In addition the VIX index, which had remained subdued, also brieflyspiked to above 35 (Figure 2).Other asset classes were also not spared, with rates, creditspreads and oil markets experiencing significant volatility.FIGURE 1 Unusually high volatility for the month of DecemberFIGURE 2 VIX broke out above 30Source: Bloomberg, Barclays ResearchSource: BloombergIn our opinion, this volatility was driven by a combination of “real” headlines (Figure 3)whose effect was exaggerated by poor liquidity and retail mutual fund outflows.FIGURE 3 Major headlines driving market volatility Source: Barclays Research, BloombergNote: Each bar represents the range of percent move from previous close with dot representing the close0% 10% 20% 30% 40% 50% 60% Jan -2 7 Jan -3 3 Jan -3 9 Jan -4 5 Jan -5 1 Jan -5 7 Jan -6 3 Jan -6 9 Jan -7 5 Jan -8 1 Jan -8 7 Jan -9 3 Jan -9 9 Jan -0 5 Jan -1 1 Jan -1 7 DecemberVolatilty 0 5 10 15 20 25 30 35 40 2,200 2,300 2,400 2,500 2,600 2,700 2,800 2,900 3,000 Jan -1 8 Fe b- 18 Ma r-1 8 Ap r-1 8 Ma y-1 8 Jun -1 8 Jul -1 8 Au g- 18 Se p- 18 Oc t-1 8 No v-1 8 De c-1 8 Jan -1 9 SPXVIX(RHS) -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 3-Dec7-Dec11-Dec15-Dec19-Dec23-Dec27-Dec31-Dec SPXReturnfrom PrevClose Trump threatens toshutdown governmentover wall funding US-China trade war truce Trump backtracks onUS-China truce tweets Huawei CFO arrest raiseUS-China tensions Bostic/Kaplan call for await-and-see Fed approachleads to rebound China trade surprise tothe downside Trade talks progress:China eliminates 25% tariff on US-made autos US-China tensions easeas Huawei CFO gets bail OPEC discord leads tosell-off in oil and equities China industrial productionand retail sales surprise tothe downside; Costco andAdobe lower guidance Futher US-China trade talksscheduled for January Markets sell-off as Fed dot plotforecasts 2 hikes in 2019; FedExand Micron lower guidance Mattis resigns, USgovernmentshutdown looms Reportsthat Trumpconsiders firing FedChair Powell Record holiday season exhibits consumer confidence; WhiteHouse confirms Powell's job is safe China Manufacturing PMIsurprises to the downside ISM falls to 2yr lows; Applelowers guidance on China woes Barclays | U.S. Equity Strategy7 January 2019 3Figure 3 shows the major news headlines that buffeted equities over the month ofDecember.Broadly these can be classified into three major threads:Concerns around potential Fed policy mistake U.S. China trade war & slowdown of the Chinese economyU.S political turmoilOver the next few sections we examine the first two threads in some detail, but we first turnto fund flows and poor liquidity, which significantly impacted the price action in ouropinion.Fund-flows and poor liquidity were key drivers of marketvolatilityFigure 4 shows that the mutual fund flows were significantly negative during Decemberafter being relatively benign during the fall when the current selloff started. We showestimates of weekly flows from two sources: EPFR and ICI.Note that the funds reportingflows on a weekly basis to EPFR is a smaller fraction relative to the monthly flows, and weadjust these based on a historical regression of actual monthly flows and monthly flowsimputed from weekly flows.Interestingly, the flows from EPFR were much more negativebut even the flows from ICI show a similar trend. On the other hand, ETF flows (which havebeen a more robust contra indicator) remained positive. FIGURE 4 Mutual fund flows turned negative in December after remaining moderate duringOctober and NovemberSource: Barclays Research, Haver, ICI, EPFRNote: Weekly flows for EPFR are adjusted for the bias in lower coverageFigure 5 shows that retail sentiment as measured by AAII bull/bear indices has also turnedquite bearish. -50 -40 -30 -20 -10 0 10 20 30 40 Dec-08Dec-10Dec-12Dec-14Dec-16Dec-18 Weekly Flows ($B) ETFMF.EPFRMF.ICI Barclays | U.S. Equity Strategy7 January 2019 4FIGURE 5 Retail sentiment indicators have also turned extremely bearishSource: Barclays Research, BloombergFigure 6 and Figure 7 show that retail interest in “recession” and “Fed rate hikes” alsospiked during December based on Google searches for these terms. Note that the recentpickup in interest in “Fed rate hikes” was much more significant relative to similar spikesduring the past eight Fed hikes. Interestingly, although the interest in “trade war” did notreach the same level of intensity as earlier in the year, it did spike again during December.FIGURE 6 Retail concerns about Fed hikes has spiked…FIGURE 7 …perhaps driven by concerns about recession and trade warSource: Google Trends, Barclays ResearchSource: Google Trends, Barclays ResearchAlthough retail fund outflows only picked in December, outflows from hedge funds(especially for macro funds) were quite significant during October and November ($39.1Band $20.7B, respectively, according to BarclaysHedge). The numbers for December arenot available yet but a continuation of the trend over the past few months might explain thevolatility in asset markets.The effect of these flows was compounded by poor liquidity. As we show in Figure 8, thefutures bid/ask contract size for the S&P 500 Emini declined significantly in December.But we can see that there have seen similar sharp declines on prior occasions like theFebruary 2018 selloff, August 2015, and in 2008. Said differently, liquidity naturally declinesduring “fast” markets as market makers scale back the size of their bids and offers, and thus-60 -40 -20 0 20 40 60 80 Jan-01Jan-03Jan-05Jan-07Jan-09Jan-11Jan-13Jan-15Jan-17Jan-19 AAII.BULLvsBEAR 0 10 20 30 40 50 60 70 80 90 100 0.00 0.50 1.00 1.50 2.00 2.50 3.00 Jan-14Jan-15Jan-16Jan-17Jan-18 Fed Fund Rate (LHS)Google Srch:Fed hike Interestover timeFDTR 0 10 20 30 40 50 60 70 80 90 100 Jan-14Jan-15Jan-16Jan-17Jan-18 Google Srch:Trade WarGoogle Srch:Recession Interestover time 。。。。。。