Bottle shock is a wine term that describes a temporary condition characterized by muted or disjointed fruit flavors that sometimes present a cloudy display. This can occur when you uncork a newly bottled wine, or with a wine that’s been shipped a long distance. The idea is that after being handled roughly wine sometimes needs time to settle before being opened. With time, another bottle of the same wine could be perfectly fine to drink, and even go on to win awards.

The May 6th Trump trade-related tweets re-imposing tariffs on Chinese imports roughed up global equity markets, puncturing the equilibrium that the year-to-date rally had been bottled in. Global equities fell by over 6%, posting their worst May return since May 2012.

So, will this merely be a bottle shock scenario where the market gets roughed up, but eventually the sentiment (or in the case of wine, sediment) settles as calmer heads prevail? Or is the 2019 market rally vintage really just sour grapes?

It’s bottle shock. The volatility regime has changed. Risk levels will likely continue to spike briefly, and then quickly subside. It’s now a market featuring episodic microbursts of volatility—idiosyncratic short-term clusters that sneak up on you like a 99-point wine at the liquor store—unexpected and hard to predict.

Asset class ETF flows: Equities are red…red, red wine

As a result of the trade-induced market drawdown, equity ETFs posted their highest level of outflows for a given month ever, totaling over $19.9 billion. Outflows in May are not that uncommon, however. Over the last ten years, equities have had outflows in the month of May 45% of the time—the third highest percentage for a given month. Perhaps that historical trend and this month’s flows suggest that the “sell in May and go away” theory has been put into action by ETF investors.

The chart below depicts the monthly flow totals since 2009 as well as the percent of time those flows were negative during the month.

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of 05/31/2019 based on data from 06/2009-05/31/2019. Past performance is not a guarantee of future results.

Equity sector ETF flows: Thrown down in the cellar

With equity ETFs—particularly US equity ETFs—bearing the brunt of the selling, sectors were in the red once again. It is the sixth time in the last eight months where sector funds had net outflows, ranking 2nd in terms of all-time monthly net outflows—an indication of investors’ unwillingness to tactically express risk through precise sector bets.

For May, selling was once again concentrated within the cyclical economically-sensitive segments of the market: Financials, Technology, Industrials, Materials and Energy. The defensive-oriented Health Care sector also had outflows in May, largely a result of ongoing political headlines impairing sentiment.

Introducing sector ETF frog-in-pan flow momentum

We’ve implemented a new process of examining flows, basing the analysis on the well-regarded frog-in-pan (“FIP”) momentum theory that discusses targeting areas of the market with a series of frequent gradual changes (e.g. daily positive returns). The FIP theory finds that this continuous information induces strong persistent return continuation that doesn’t reverse in the long run.

Consistent with this theory, we’re no longer just looking at flows on a net basis, since this figure might not be the most accurate reflection of investor sentiment. For example, the best flows over the last month could just be the result of a single large inflow on one specific day. This is why we also examined sectors based on the number of days with positive inflows to capture gradual frequent changes, which enables us to better understand where there may be agreement within a sector from multiple investors. The objective is not to identify the sector with potential to outperform, but to discern where there may be current consensus from consistent inflows over a time period.

The key takeaway from the chart below is that only three sectors had inflows on more than 50% of the days over the last one or two months. The low number of sectors with figures above 50% indicates sentiment skewed to the downside.

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of 05/31/2019. Past performance is not a guarantee of future results.

Fixed income ETF flows: Only some good aromas from bonds

With the market striking a risk-off tone, bonds were largely allocated to less-equity-sensitive sectors such as government issues, while credit-oriented or higher-volatility sectors such as high yield, bank loans and emerging market debt witnessed sizeable outflows.

With the government category receiving the lion’s share of the total fixed income flows, the maturity buckets within the government space all had inflows. Those flows, however, were skewed towards the shorter end of the curve; with a flat yield curve, investors can generate similar income compared to the long end, all the while seeking to position defensively. With the MSCI ACWI breaking through its 50- and 200-day moving averages, there was renewed interest in the ultra-short and short-term bond category as investors sought to de-risk portfolio allocations.

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Source: Bloomberg Finance L.P., State Street Global Advisors, as of 05/31/2019. Past performance is not a guarantee of future results.

Will it be a good vintage this year?

Bottle shock moments have become more common due to slowing corporate profits, mundane economic growth and unconstructive broad-based valuations that cannot backstop the macro and geopolitical forces acting as the noble rot to the crops of “rally grapes.” So how will this bottle shock of volatility settle down? The current political environment is unlikely to change. In fact, gridlock is now commonly sprouting up on the vineyards beyond the US, exemplified by the recent Brexit developments and renewed concerns of a “Quitaly” after the Italian government put plans in motion to launch a parallel currency. Global central banks may not provide a respite either, as they already preach ultra-accommodative policies. A Federal Reserve rate cut is also unlikely given that the US economy is in a “good place,” with labor markets robust and consumer confidence at all-time highs.

Look for things to settle down for the same reasons tension started in the first place: Trade. A trade deal that fulfills President Trump’s campaign promise and stems current concerns of trade-induced fading growth and falling markets will provide him momentum ahead of the 2020 election.

The volatility regime has definitively changed to be more episodic and we still have a secular decline in growth and fading corporate profit margins juxtaposed against valuations that are above long-term averages. To capture potential upside while mitigating the shocks in this type of market, target quality stocks but don’t overpay—just like that 97-point wine that costs just $13.99.

Stay current on what State Street Global Advisors is seeing in ETF flows: Follow SPDR® Blog and check back monthly for my ETF Flows post. You can also access the full May ETF Flows report here.


50- and 200-day moving averages
A moving average is a popular technical indicator which investors use to analyze price trends. It is a security's average closing price over a specific number of days. The only difference between a 50-day moving average and a 200-day moving average is the number of time periods used in the calculation.

Bottle Shock
A term related to a movie with the same name based on a 1976 wine competition termed the "Judgment of Paris", when a California wine defeated a French wine in a blind taste test.

A term for the withdrawal of the United Kingdom from the European Union.

Flat Yield Curve
A flat yield curve is a yield curve in which there is little difference between short-term and long-term rates for bonds of the same credit quality. This type of yield curve is often seen during transitions between normal and inverted curves.

The MSCI ACWI Index captures large and mid-cap representation across developed and emerging markets countries.

Noble Rot
A fungal disease caused by Botrytis cinerea that results in dehydrated and shrivelled grapes that are high in concentrated sugar. Noble Rot grapes are an essential component of many Austrian and German wines.

A term for the potential withdrawal of Italy from the European Union.