Money managers are saying that it’s increasingly difficult to trade due to a lack of liquidity caused by huge swings in asset prices.
“I have yet to find liquidity,” Richard Hodges, a money manager at Nomura Asset Management, told Bloomberg. “There is none.”
What this means in practice is that even in normally extremely liquid markets, sellers can’t find reliable bids. Their decision then becomes don’t sell at all or sell at whatever price the market might be offering–even if a seller doesn’t know what that price might be until the sale is completed.
For those of us old enough to remember the Black Monday crash of October 22, 1987, this is really scary territory. The Dow Jones Industrial Average fell 22.6% that day–still a record percentage drop. I remember talking to traders who had just sold a normally liquid blue chip such as Procter & Gamble (PG) at a price $5 a share below the last trade. And who were glad to get out at that price. Once traders on that day felt that the best move was to sell as fast as you could not matter what the price, the crash was on.
That crash was exacerbated by the widespread use of portfolio insurance, which was supposed to prevent exactly this kind of plunge. But traders and investors that day discovered that insurance is only as good as the willingness and ability of the other end of the trade to live up to the bargain. When counterparties began walking away from their promises, portfolio insurance turned out to be worthless.
In some ways the current market is more dangerous than the 1987 bubble created by a belief in portfolio insurance thanks to the proliferation of exchange-traded funds. ETFs, which track particular asset classes or instruments, have to sell when the price of the underlying index and assets fall. And this can lead to a frantic search to sell even when prices are tumbling.
“People are asking for bids and then dealing when they see them,” Luke Hickmore, a money manager at Aberdeen Standard Investments, told Bloomberg. “You can definitely sell for sure, you just might not like the price.”
The strains to liquidity are unleashing “deep-seated fears that the coronavirus crisis could lead to the same dislocation of financial markets that we saw over a decade ago,” wrote Steven Barrow, head of foreign-exchange strategy at Standard Bank, in a note to clients. “The worst-case scenario for the market is that dollar liquidity shortages start to emerge, putting leveraged borrowers in jeopardy.”
Which, Bloomberg notes, means that volatility has spiked. The Bank of America Merrill Lynch MOVE Index, which measures price swings in Treasuries, jumped today to the highest level since 2009. The CBOE S&P 500 Volatility Index (VIX) climbed 29.85% today to 54.41.
These measures of volatility and lack of liquidity in the markets have, I’m sure, made a big impression on the Federal Reserve. The Fed has already said that it will put billions into the over-night short-term funding market. I think that’s only the first move.