Wall Street Prepares To Reap Billions From Another Main Street Wipe Out

Tyler Durden's picture

On Monday evening, we noted that market participants are reducing the size of their trades and turning to derivatives in order to avoid the perils associated with what are increasingly illiquid markets. 

While we’ve been pounding the table on bond market liquidity for years, the rest of the world (operating on the standard 2-3 year time lag) has just begun to wake up to how thin markets have become. Now, pundits, analysts, billionaire bankers, and incorrigible corporate raiders alike are shouting from the rooftops about the pitfalls of illiquidity. The secondary market for corporate credit has received the lion’s share of the attention (for reasons we outlined yesterday) and as Carl Icahn was at pains to explain to Larry Fink last week, ETFs are a large part of the problem. 

The story is simple. Shrinking dealer inventories (the result of a post-crisis regulatory regime wherein the term "prop trader" is taboo) have made it harder to transact in size without having an outsized effect on prices for corporate bonds. Meanwhile, artificially suppressed borrowing costs and the attendant hunt for yield have led to record corporate issuance and voracious investor demand. In short, the primary market is booming while the secondary market has become a veritable no man’s land. If you need an analogy, try this: the crowded theatre is getting larger and more crowded while the exit keeps getting smaller.

The proliferation of ETFs has made it easier for the retail crowd to chase yield in corners of the bond market where they might not have dared to venture before, and this has only served to create still more demand for things like high yield credit. 

Now, with the US staring down a rate hike cycle, and with some corners of the HY market (see HY energy for instance) facing a number of insurmountable headwinds going forward, the fear is that the retail crowd will all head for the exits at once, leaving fund managers with a very nondiversifiable, unidirectional flow which will force them to sell the underlying assets into illiquid markets. Due to a generalized lack of market depth, that selling pressure has the potential to trigger a rout. Of course a sharp decline in prices would send still more panicked retail investors to the exits necessitating even more asset sales by fund managers and so on, and so forth.

But don’t take our word for it, here’s WSJ with more on how Wall Street is preparing to profit from an unwind in Main Street’s ETF and mutual fund portfolios:

Wall Street is preparing for panic on Main Street.

 

Hedge funds are lining up to profit from potential trouble at some "alternative" mutual funds and bond exchange-traded funds that have boomed in popularity among retirees and other individual investors.

 

Financial advisers have pushed ordinary investors into those funds in search of higher returns, a strategy that has come into favor as Federal Reserve benchmark interest rates remain near zero. But many on Wall Street worry the junk bonds, bank loans and esoteric investments held by some of those funds will be extremely hard to sell if the market turns, leaving prices pummeled in a rush for the exits.

 

Concerns about such scenarios have been escalating for some time. Now, investment firms such as Leon Black’s Apollo Global Management LLC and Oaktree Capital Management LP are laying the groundwork to cash in if they come to pass.

 

Apollo has been raising money from wealthy investors and portfolio managers for a hedge fund that snaps up insurance-like contracts called credit-default swaps that benefit if the junk bonds fall. In marketing materials reviewed by The Wall Street Journal, Apollo predicted: "ETFs and similar vehicles increase ease of access to the high yield market, leading to the potential for a quick ‘hot money’ exit."

 

Guided by a similar outlook, Reef Road Capital Management LLC, led by former J.P. Morgan Chase & Co. proprietary trader Eric Rosen, has been betting against, or shorting, exchange-traded funds that hold junk bonds and buying options that will pay off if the value of these high-yield securities falls.

 

The hedge funds are taking aim at what is regarded by many on Wall Street as a weak spot in the markets. "Liquid-alternative”" funds have emerged as one of the hottest products in finance, fueled by a promise to deliver hedge-fund-style investing to the masses. They use many of the same strategies as hedge funds, with wagers both on and against markets, but are open to less-wealthy investors with fees closer to mutual-fund standards.

 


 

Liquid-alternative funds manage a cumulative $446 billion, according to fund tracker Lipper, up from $83 billion at the start of 2009. High-yield bond ETFs, another popular product, manage more than $38 billion, and in the week ended last Wednesday took in their biggest inflows on record at $1.5 billion, Lipper said.

 

Activist investor Carl Icahn brought the issue to the fore last week, saying at an investment conference that he feared a bubble was expanding in junk bonds thanks to the rush into high-yield exchange-traded funds run by companies like BlackRock Inc.

 

Managers of ETFs and liquid-alternative funds said they are well-protected against any tumult. Some have lines of credit to cover redemptions if needed and point to research showing that even during past crises, mutual-fund investors generally withdraw no more than 2% of assets each month.

When Reuters first reported that fund managers were lining up emergency liquidity lines like the ones mentioned above, we smelled trouble and were quick to note that not only did that not bode well for the market, but that funding redemptions with borrowed cash is a fool's errand and depends upon the market stress being transitory (see here and here). But beyond that, it betrayed the extent to which the country's largest and most influential ETF issuers have become worried about just the type of meltdown the hedge funds mentioned above are banking on.

If you want a candid take on just what the smart money thinks is ahead for all of the retail money that's been herded into esoteric ETFs, we'll leave you with the following from David Tawil, president of hedge fund Maglan Capital, who spoke to WSJ:

"They are going to be toast. It will be one of our first levels of shorting the moment we start to see cracks, because it’s ripe with retail, emotional investors."

 

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Dr. Engali's picture

People can afford to retire before 70? Who knew?

mijev's picture

The only jobs they'll get is volunteer work. Even walmart doesn't need any new greeters.

Wahooo's picture

Better get that part-time WalMart or McD job now, so you have it when the economy crashes.

GeorgeHayduke's picture

When do we get to the part where bankster slime and financial sector assholes are jumping out of skyscraper windows? Anything I can do to help this process along? It's taking forever and my patience is wearing thin...

thecondor's picture

I hear ya bro, but I just want it to wait a little longer so I can take advantage of Ms being on sale. 

To Hell In A Handbasket's picture

They'll walk out with their head held high, with no shame and no remorse and claim everybody was doing it and most importantly, they did nothing illegal, because the SEC, OKed it all. Regulatory capture!

Redart's picture

Buy the down dip tomorrow during the day. were going higher, at least higher than todays close. Heavy hands bought the dip on S&P, again. it's incredible but one must go with da flow. If caution is very needed stay out, dont short either at least  for now. I closed a short term short and bought a bit and another bit tomorrow for the last potential short term up swing. cheeers

q99x2's picture

Prepare to quit making money in financial markets. Things are getting dangerous.

ThrowAwayYourTV's picture

My next investment will be gated cemeteries with no markings and guard towers for Wal*Street Bankers and Managers who have passed on.

And the ad will read. "Don't let millions of main streeters piss on your grave for the next 2000 years. Purchase a plot with us and become invisible when you're gone."

ONLY $1 million dollars....in gold.....per year.

Buy Now! This offer ends when all plots have been sold!

Sorry! We just sold out.

 

HungryPorkChop's picture

@ThrowAwayYourTV : Hilarious!!  However I think you need to raise the ante some since the grave robbers might be on the prowl.  Think of the urinal potential for some of these bones? 

I'd suggest $2 mil in gold to make sure this didn't happen to anyone's loved ones.  Pity when you think about it, eh?!

ThrowAwayYourTV's picture

Yes, you're right! The lines to get in could get quite long and crowd control may become an issue. Then there's all that flood insurance.

Thanks for the tip :)

old naughty's picture

for a 3-5% commission, i can get you a wallymart plumber to help with flood @ 1M per; or a fe ma vet to help with crowd control @ 2M per.

Fair inflationary-ing price, be quick interested, exits are closing.  ;-p

eeaton's picture

I'm long TZA, Short FXI, any other suggestions?

Bitcoin Meiser's picture

The countdown has begun. Get your positions ready.

Omega_Man's picture

 

 

Gold mining ETF's should therefore act the opposite and force miners higher, as they have to buy as investors pile in... driving it ever higher.

Super Hans's picture

I lost my whole family! Fuck whatever street you want to call it!

SH

Deathstar's picture

The Butt Family? (SNL)

OH, you mean you lost your ass...

I get it now. Muahahahaaa

I am a Man I am Forty's picture

fuck that, main street is preparing for a panic on wall street

Herdee's picture

Maybe just before this happens?Extend and pretend only goes so far:

http://www.kitco.com/commentaries/2015-07-17/The-Fed-Has-Set-The-Market-...

You can pay me now or pay me later but when it happens she'll be a biggy.

fromthinair's picture
fromthinair (not verified) Jul 21, 2015 9:58 PM

zerohedge, did it happen like this in 2007? did the big banks and main news outlet told people of how to prepare for the inpending crash? 

Renfield's picture

IIRC, the crash was underway from March of 2007, when the first hedge funds started experiencing some major trouble. Bear Stearns brought it to the mainstream in July 2007, and after they were bought by JPig (I think it was?) the markets kind of staged a 'recovery' over the following year until the double whammy of Lehman and AIG to kick off the Panic of '08, until central banks rode to the 'rescue' and began socialising all losses.

So, it wasn't so much the MSM not warning of an impending crash, as it was the MSM saying, "That was the cleansing crash and now it's all over, don't panic, the markets have recovered". I remember reading a lot of "We're protected because CDS" nonsense thru the '07-'08 period.

Then, of course, during the Panic, it was "Nobody saw this coming". Meanwhile the blogosphere -- including Zero Hedge at blogspot -- had been lit up with the truth the whole time.

"Impending" doomsayers were more 2005, 2006. There were a few earlier, but alas, I was still safely grazing back then...

MisterMousePotato's picture

"Halcyon days," I think they're called.

I am a Man I am Forty's picture

i'm confused, is the smart money the hedge funds that have gotten their ass kicked by the index funds?

DipshitMiddleClassWhiteKid's picture

its pay back for all the losing years they had

 

they will profit immensely from the ETF down fall

Deathstar's picture

I just hope everyone gets their asses kicked equally(except the Bugz), a 10.9 earthquake hits san fran, lost angeles, and a titanic meteor breaks apart hitting NYC, DC and city of London simultaneously.

A fresh start would be refreshing. One can only dream *shrug*

DipshitMiddleClassWhiteKid's picture

so..buy way OTM puts on a bunch of ETFS? lolz

Farmer Joe in Brooklyn's picture

Theta is a bitch...but at least you get a tax loss carry-forward on expired puts. I've been loading up on ETF puts for 7-8 months now. 

Tick tock, tick tock...

Renfield's picture

<<When Reuters first reported that fund managers were lining up emergency liquidity lines like the ones mentioned above, we smelled trouble and were quick to note that not only did that not bode well for the market, but that funding redemptions with borrowed cash is a fool's errand and depends upon the market stress being transitory (see here and here). But beyond that, it betrayed the extent to which the country's largest and most influential ETF issuers have become worried about just the type of meltdown the hedge funds mentioned above are banking on.>>

Tyler, some great articles tonight. The big banks are mostly out of this market, correct? So a stampede out of these assets would not affect them so much, as retail who has been running into these in a chase for yield, yes? (ETA: You seem to say that further down.) The 'type of meltdown' in this case might see the word 'risk' back on the MSM in a big way, since it's their audience who would mostly be affected. (To be followed by 'no-one could have seen this coming'.) If you're saying that the fact that this is now showing up on REUTERS is a big red flag, then I agree.

<<While we’ve been pounding the table on bond market liquidity for years, the rest of the world (operating on the standard 2-3 year time lag) has just begun to wake up to how thin markets have become. Now, pundits, analysts, billionaire bankers, and incorrigible corporate raiders alike are shouting from the rooftops about the pitfalls of illiquidity. The secondary market for corporate credit has received the lion’s share of the attention (for reasons we outlined yesterday) and as Carl Icahn was at pains to explain to Larry Fink last week, ETFs are a large part of the problem.>>

Only thing worse than being laughed at for being a 'perm-bear', is pounding the table for years and being ignored until it hits and 'nobody saw it coming'. You've been warning about anorexic volume the whole way.

<<The story is simple. Shrinking dealer inventories (the result of a post-crisis regulatory regime wherein the term "prop trader" is taboo) have made it harder to transact in size without having an outsized effect on prices for corporate bonds. Meanwhile, artificially suppressed borrowing costs and the attendant hunt for yield have led to record corporate issuance and voracious investor demand. In short, the primary market is booming while the secondary market has become a veritable no man’s land. If you need an analogy, try this: the crowded theatre is getting larger and more crowded while the exit keeps getting smaller.>>

I wonder how many retail investors 'own' bullion and other commodities in the secondary market? I wonder how many are aware of their ownership? And how many people are going to wake up to sudden risk in their safe pensions?

<<The proliferation of ETFs has made it easier for the retail crowd to chase yield in corners of the bond market where they might not have dared to venture before, and this has only served to create still more demand for things like high yield credit. Now, with the US staring down a rate hike cycle, and with some corners of the HY market (see HY energy for instance) facing a number of insurmountable headwinds going forward, the fear is that the retail crowd will all head for the exits at once, leaving fund managers with a very nondiversifiable, unidirectional flow which will force them to sell the underlying assets into illiquid markets.>>

My question is, can they afford NOT to raise rates, or is the market going to do it for them? With a UST 'dump' apparently taking on momentum (well, since last December?), is there any excuse they can find that can sound real enough? Because if there's any way they can avoid it, they will. They've postponed that moment for longer than most of us thought possible. I think they know what's likely to happen the first time they go anywhere near that hike button. After seven years of ZIRP, it could have a nuclear effect - these 'markets' exist only on 'free money'.

will ling's picture
will ling (not verified) Jul 21, 2015 10:26 PM

give it up. no blood, no justice.

p00k1e's picture

Xanax can fix this. 

Bitcoin Meiser's picture

Bloomberg TV stated about a half an hour ago that Jeffrey Currie from Goldman Sachs has forecasted the price of gold will go below $1000. 

http://www.bloomberg.com/news/articles/2015-07-21/goldman-s-currie-sees-...

optimator's picture

Means Goldie is buying gold and would like the price a bit lower.

TeethVillage88s's picture

Yes, You are focused where I should be focused more.

e_goldstein's picture

 Buy Credit Default swaps 

 Great idea. What could possibly go wrong?

GRDguy's picture

In simple terms, we are going to sell all the flood insurance we can before we blow the dam above the properties. Then claim the money is all gone and bankrupt the company. Sorry, folks.

reader2010's picture

Where is Bernie? 

theprofromdover's picture

... and they think that their 'debtors' will pay up ?????

 

Jack Daniels Esq's picture

Get Ayatolla to build a nuclear dildo for Krispy Kreme Yellen

Batman11's picture

Lack of liquidity just means a lack of bigger fools.

An overblown market always has to reach the poinnt where there are no bigger fools.

Is the biggest fool going to be you?

 

lucky and good's picture

Some of the rather bizarre market action recently has me wondering if we are in the middle of a bear market rally, and if so how violently it might end. Several stocks on an uptrend appear fundamentally unstable. We have witnessed massive moves in several speculative stocks like Tesla and Netflix that are hard to defend by any other reasoning than shorts being squeezed out of the market.

The higher the market goes the more vulnerable it becomes to a major collapse and sudden downward price move. A lack of short positions will bode poorly for the market if it falls rapidly because in such a situation as shorts take profit and buy back their positions they act as a floor under the market giving it support. The article below delves into how this could be a problem going forward.

http://brucewilds.blogspot.com/2015/07/is-this-bear-market-rally.html

PleasedToMeatYou's picture

High Bruce!  I see you got a new ID. 

Got house-cleaned by Tyler, but you are at it again? 

CitizenPete's picture

"Déjà vu all over again"

venturen's picture

Hillary will save the day