If you think flows, liquidity, market depth and positioning matter, the outlook for US equities is somewhat foreboding.

As most readers are likely aware, August can be challenging. For one thing, VIX seasonality’s bullish, and what’s bullish for vol tends to be bearish for stocks.

Remember, volatility’s inversely correlated with market depth. Liquidity dries up into vol expansions, setting up a self-fulfilling prophecy: Illiquid markets can exhibit a wider distribution of spot outcomes, which in turn pushes up volatility, and around we go.

The risk of that’s higher in August. Goldman’s Scott Rubner mentioned “liquidity and vacation schedules” in a list of 11 key dynamics to watch as the dog days drag on. “Top book on the S&P 500 futures already dropped by 50% [and we] would expect even tougher liquidity from here,” he wrote, adding that from a dealer positioning perspective, “index gamma is no longer max long, which has been a market buffer.”

The tables below show you the equity seasonality on a day-by-day basis going back nearly a century.

As Rubner put it, there are “no more neon green days in the upcoming summer future.”

On the flows side, you’ll recall that on EPFR’s data, equity ETFs and mutual funds saw more than a quarter-trillion of inflows over the first half of 2024. Last week’s inflow marked the 12th straight, in fact. (We’ll get an update from EPFR later today.)

Behind that wall of money is the same epochal active-to-passive shift that’s defined the investment landscape in the post-GFC era. The split on the $299 billion of net inflows illustrated below (i.e., cumulative net inflows through mid-July) was $525 billion to ETFs and $224 billion from mutual funds.

As Rubner noted, that split “means passive inflows into the largest capitalization companies and long momentum.”

So: The composition of flows in an active-to-passive world is conducive to ever higher prices for the leadership — that’s Howard Marks’s “perpetual motion machine” dynamic.

But as the figures below, from Goldman, show, the environment “changes completely in August,” when flows are the least bullish of any month.

If a rising tide of inflows is disproportionately bullish for the mega-cap leadership given the breakdown of those flows (i.e., “inflows” actually means more going into passive funds than going out of long-only, active mutual funds), a turn of the flows tide should (or at least could) be bearish for the leadership and, in turn, the market more generally.

“August is the month with the largest outflows of the year,” Rubner went on. “The most important dynamic here is that passive inflows will stop as buyers run out of ammo.”

Oh, and it’s worth noting that the first half of August is the fifth- and second-worst two-week period of the year for the S&P and Russell 2000, respectively, looking back to 1950, on Goldman’s data.