It's Not Trade War Or A Market Drop That Is Keeping Credit Investors Up At Night

Two weeks ago, Morgan Stanley issued a report looking at the size of moves across all asset classes in the environment of declining market liquidity, and found that "It's not your imagination, large moves are becoming more common in the market."

One week later, Goldman repeated Morgan Stanley's warning almost verbatim, writing that "No - it’s not your imagination - earnings day moves are getting bigger." Specifically, the bank found that the moves in stocks post their Q2 earnings reports experienced the greatest absolute amplitude on record, and more than 50% higher than the long-term average of 2.4% over the past 15yrs.

What was the common link between these two observations? Simple: the vanishing liquidity in the market, which has resulted in increasingly greater bid/ask spreads, as well a sharp decline in market depth, that has collapsed to levels not seen since the February VIXplosion (something Goldman also touched upon in "Market Depth Has Collapsed".

Fast forward to today, when in the latest survey of European credit investors conducted by BofA's Barnaby Martin, the strategist observes that concerns about the market's ever shrinking liquidity have become the primary source of worry for professional investors, and as Martin writes, "it's not trade wars or an equity market correction that look to be keeping credit investors up at night." Instead, it is the fear of a "pervasive rush for the exit at some point in the future."

In other words, what is keeping bond traders up at night is the fear that when the selling begins, there will simply not be enough liquidity to absorb it all.

What is just as surprising, is that just last month the top investor concern was "Bubbles in Credit", i.e. excess liquidity, which one month later has now morphed into "Liquidity Vanishing", which according to Bank of America is the first time in 3 years that this has emerged as the chief concern.

"Perhaps it just reflects the usual holiday slowdown in trading" Martin writes, however, as discussed in the above linked articles "one clear characteristic of the summer rally is how big - and random - spread dispersion has been  (especially high-yield)." Meanwhile, the growing number of "corrections", or as Morgan Stanley calls them, "rolling bear markets", being observed across financial markets in 2018, portfolios remain a challenge for investors to risk manage.

To Martin, this bizarre market evolution of stocks back to all time highs with far less underlying liquidity reflects what he calls "Paranoia in Credit Markets", and leads to concerns of "a more pervasive rush for the exit by credit investors down the line."

Broken down by product, 22% of high grade investors participating in the survey said their biggest concern was the evaporation of market liquidity, a fear shared by 20% of junk bond investors. Both are a sharp reversal from June when credit bubbles were the biggest fear for both sets of investors.

While bond investors have been spared some of the most violent moves to emerge from the Q2 earnings season, they have been more than exposed to the record volatility observed recently in Italian bonds, where following the surprise formation of a populist government, Italian debt plunged by the most on record, resulting in massive losses for numerous macro funds. Meanwhile, even as high yield yields plumb post 2007 lows, the market depth has continued to shrink and as the WSJ recently noted the bid/ask spreads on both IG and HY bonds have consistently leaked wider this year.

Echoing these concerns, Academy Securities' head of macro strategy Peter Tchir told Bloomberg that "These sorts of moves are the basis of my concern about how little real liquidity there is in both directions, and how fragile the current market structure can be."

So what are investors doing to placate these "paranoid" liquidity concerns? While Bloomberg recently noted that there has been an increase in CDS trading, either for hedging purposes, with first half CDS index volume rising to the highest level in 5 years, and JPM adding that derivative trading volume jumped 65% Y/Y in the first half of 2018...

... the product generally remains a mystery for a generation of credit traders (Citi recently poached a 32-year-old trader from Goldman to "rescue" its junk bond desk as few others there had any familiarity with trading credit default swaps following its demonization after the financial crisis) and with dealer swap inventories virtually non-existent, the bulk of traders have continued to use ETFs as a method to hedge their exposure. In this context, it is perhaps not surprising that as JPM showed, the short interest on global junk bond ETFs just hit an all time high.

Which in turn opens up a whole new can of worms: instead of lack of liquidity at the single name bond level, the next bond crash would likely see the ETF sector go bid- or offerless, a "phantom liquidity" danger which Howard Marks has been predicting since 2015.

Meanwhile, the underlying bond market continues to shrink: according to JPM, only 32% and 41% of U.S. high-grade and high-yield daily trading volumes takes place in the cash bond market.

But what is more concerning is that while at least some bond traders are keeping an eye on the exit, the vast majority of the market has been lulled into complacency, with the CFTC reporting that the net short exposure for VIX has risen to the highest level since the February VIX debacle.

In other words, while increasingly more investors are concerned about liquidity, virtually nobody is doing anything to hedge against an abrupt market "event" which could drain what little market liquidity exists overnight, resulting in an wholesale market freeze.

Why not? Because as the past decade has taught traders, spending money on insurance or protection remains punished, and after all, "the Fed has everyone's back", right? In other words, why hedge when the Fed will have no choice but to bail everyone out when the next crash finally happens...

Comments

lock-stick GoHillary2016 Tue, 08/07/2018 - 12:32 Permalink

It's all ONE SICK, PATHETIC SPAMMER!!!

•• ssk81646 (above)

•• Adolfsteinbergovitch (above)

•• Free This (below, in all his 7th grade glory - JACKASS  as new icon!)

....and all the while, the pathetic little SPAMMER sits in his leaky, moldy, smelly single wide in Western New York, surrounded by garbage and dirty clothes, trying to find his dick amidst rolls of fat, talking to his ACTION FIGURES and wondering where his life went.

 

It's all ONE SICK, PATHETIC LIDDLE SPAMMER!!!

In reply to by GoHillary2016

lock-stick Adolfsteinbergovitch Tue, 08/07/2018 - 23:50 Permalink

It's all ONE SICK, PATHETIC SPAMMER!!!

•• roea.rita (above)

•• Adolfsteinbergovitch (above)

•• Sanctificado (above)

•• Free This (coming soon, in all his 7th grade glory - JACKASS  as new icon!)

....and all the while, the pathetic little SPAMMER sits in his leaky, moldy, smelly single wide in Western New York, surrounded by garbage and dirty clothes, trying to find his dick amidst rolls of fat, talking to his ACTION FIGURES and wondering where his life went.

 

It's all ONE SICK, PATHETIC LIDDLE SPAMMER!!!

In reply to by Adolfsteinbergovitch

Last of the Mi… spastic_colon Tue, 08/07/2018 - 11:55 Permalink

illiquidity is the absence of available fiat to service the debt. We're at a point now where unfunded liabilities now dwarf GDP. (Try filling out a financial report for a loan without your own unfunded liabilities.) And the new socialist democrats are basing everything they can on more government spending for the vote purchase which is what they need to maintain their power. Ultimately the majority of our debt through entitlement programs was created to buy votes. This is what big government does. Sound and fury costing trillions to convince the terminally stupid that utopia is just one vote away.  

In reply to by spastic_colon

new game Tue, 08/07/2018 - 11:43 Permalink

liquidity? the keg ran dry? the bar is closed?

deck chair scramble next OR doom porn to sell their books?

less liquidity is an algorithm orgy of moar profits from larger spreads-duh...

spastic_colon LawsofPhysics Tue, 08/07/2018 - 12:22 Permalink

from what I can see on the SOMA report is last week the fed sold treasury bonds and FRN's and bought TIPs and agency/mtg for a net of -23B..........this tells me they see bond values in jeopardy, do not want to pay upcoming adjustments on the FRN's, and will accept the inflation compensation from TIPs..........all told they are expecting rates to rise further.

In reply to by LawsofPhysics

taketheredpill Tue, 08/07/2018 - 11:50 Permalink

In other words, while increasingly more investors are concerned about liquidity, virtually nobody is doing anything to hedge against an abrupt market "event" which could drain what little market liquidity exists overnight, resulting in an wholesale market freeze.

Why not? Because as the past decade has taught traders, spending money on insurance or protection remains punished, and after all, "the Fed has everyone's back", right? In other words, why hedge when the Fed will have no choice but to bail everyone out when the next crash finally happens...

 

EXACTLY...

1. Hedges lower returns in a low-yield world >> Career Death

2. It doesn't matter if you under-perform benchmark so long as you don't do worse than the average

3. Worst case scenario is Fed saves the world. Again.  Until it doesn't or can't.

 

Don Sunset Tue, 08/07/2018 - 11:53 Permalink

Why is the USG piling on huge new debt during "economic boom" years?  Why aren't we paying off major (or any) debt during these "great" economic times?

 

FreeEarCandy Tue, 08/07/2018 - 11:54 Permalink

If one holds solid stock in companies that this country cannot do without, then the only way one can lose in the market is if the whole country fails. In which case, everyone is a loser. But until this country fails, the only losers in the US market are those who sell their solid positions and liquidate their holdings.

Amended: Also, those that buy on credit.

 

taketheredpill Tue, 08/07/2018 - 11:54 Permalink

 

Also problem of ignoring risk since risk doesn't matter.  Until it does.  And EVERYBODY seems to think they'll be the ones to get out in time.

Or you can always invest in ETFs, since they are very large and liquid and you can always sell if you need to.  That's why EVERYBODY owns them....

BOTTOM LINE...if you think you will be able to "time" the market, you've already fucked up.

Fundamentals have negatives and positives.  Negatives means you will get out too early.  Positives means you will get out.

 

 

Sonny Brakes Tue, 08/07/2018 - 11:56 Permalink

These creditors deserve to lose their money. Extending credit to people who are not creditworthy hurts those that are responsible borrowers. I contend that easy money is mostly made available not to benefit the consumer, but to keep moving refrigerators and colour TVs, otherwise, the refrigerator and colour TV pushers would be the ones to take the hit creating the very 'creative destruction' this economy requires.

I live in a small northern Ontario community of less than 10, 000 people and somehow we are able to support 2 car dealerships and only 1 grocery store. Two of these businesses offer credit, the other one does not.

If free money is the solution then why not simply flood the world with dollars. Oh, they have already done that. The poor bastards who have saved for their retirement going to work every day for the last 40 years are having there purchasing power confiscated on a daily basis.

Is it any wonder people have lost their faith in government and that the only solution that the government can come up with is to pressure social media to shut us, the people who are the most vocal about this injustice, down.

Dumb, Fucks.

MusicIsYou Tue, 08/07/2018 - 12:01 Permalink

Oh I'm sure the fed will just get the printers going to create false liquidity. Of course that is not going to bode well considering that millions of elderly rich people are going to be taking their money out of capital markets in order to spend a lot of money before they die someday. So, I guess some intense stagflation will be coming. Lol, society is going to crash.

Fantasy Free E… Tue, 08/07/2018 - 12:11 Permalink

Simple things are the hardest for folks to grasp. Elevating stock prices is only what is visible out of a larger agenda. It is clear that low volume is a critical ingredient for manipulating the market. As ownership of stocks becomes more and more concentrated within the upper 1% of the food chain, keeping volume low gets easier and easier. With ever decreasing volume and yes low liquidity, stock prices over all are getting easier and easier to elevate.

http://quillian.net/blog/can-the-united-states-survive-a-bear-market/ 

Dolgoruki Tue, 08/07/2018 - 12:14 Permalink

I'll go out on a limb and say that this is going to be a giant fucking problem. It's going to show up in ETFs, where the largest retail cohort of investors don't understand what they have exposure to, and young traders and PMs, on the other side of the trade, that are using CDS to manage risk, but have no practical experience of how severe illiquidity impacts the ability to execute trades.

Batman11 Tue, 08/07/2018 - 13:18 Permalink

Were the high valuations of US stocks in early 1929 a good thing?

Everyone believed in the markets and the US stock market showed things were going well.

It took until 1980 before everyone forgot this valuable lesson about markets.

A Chinese regulator has looked at the fundamentals and has realised US stocks are at 1929 levels again.

When you believe that high market valuations are a good thing you inflate the markets.

1929 – Margin lending by the banks

2018 – The FED’s wealth effect from QE

stubb Tue, 08/07/2018 - 14:12 Permalink

It's WILFORD BRIMLEY!! 

Paragon of evil, sinister puppet master pulling the strings of conspiracy behind the Bilderberg Group, etc., etc., etc.

itstippy Tue, 08/07/2018 - 14:30 Permalink

"In other words, what is keeping bond traders up at night is the fear that when the selling begins, there will simply not be enough liquidity to absorb it all."

"Liquidity" is bond-trader speak for "buyers at the price they have the bonds valued at on their books".  If no one wants to buy their over-valued shit paper, they become upside down on the trade and insolvent.

Years ago an old friend of mine had a large collection of porcelain collector dolls called "Humbles".  She'd purchased them over the years at various high-end retail stores.  She had a Humble price guide that showed her collection was worth many thousands of dollars.  She wanted to sell some of them, but where?  I told her about eBay, and we had her over for lunch and to see what eBay online auctions were about.

Great Googly Moogly!  Her Humbles were selling on eBay for 1/10 the value of what her price guide said they were worth.  A Humble "worth" $120 acording to her price guide book sold for $12 on eBay.  When you add in the eBay listing fees she'd only clear about $10 on a $120 Humble!  

She certainly wasn't going to sell any at those low prices, so she just kept them.  She still thinks her collection is worth many thousand of dollars.  In reality, it's worth a few hundred bucks.  I hope she doesn't leave Mrs. Tippy those ever-so-cute fucking things in her will (she's in her eighties).

MrSteve silverer Tue, 08/07/2018 - 14:51 Permalink

A serious friend said that is why he always bought mutual funds and not ETFs. The mutual funds cash you out at the end of the day NAV. You may not get nearly as much as you planned, but you will get out.

Note than in early February's panic, Vanguard and Fidelity websites went down due to traffic volume and Vanguard could not price some ETFs because pricing was so chaotic. There are several ways "it don't work" if you wait until it is too late.

In reply to by silverer

Let it Go Tue, 08/07/2018 - 20:59 Permalink

Most investors think that even if things go downhill fast that they will be smart enough to get out of the markets. After the debacle in 2008 where they saw the market take nasty and violent swings they learned a few things, this time, they figure they will make the right moves before it is too late. But what if it hits like the flash crash on steroids?

Imagine a scenario where the if the market falls like a flash crash on steroids investors are trapped. They have been assured that can't happen because circuit breakers have been put in place to arrest panic style moves but if trade is halted, and the market simply does not reopen for days or even weeks suddenly it is a new game. As remote as this might seem the article below explores this possibility and the far-reaching ramifications.

http://Flash Crash On Steroids html