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The Day Liquidity Died

Written by Doug Kass | Mar, 5, 2018

* A little discussed issue is the loss of market liquidity since the end of January
* This is one of the reasons I see more volatility and a widening trading range
* I offer this opener with sincere apologies to Don McLean (and “American Pie”)… but I hope you enjoy it!

There has been far too little discussion of the issue of the recent loss of liquidity in market commentary.

In large measure, reduced liquidity is the reason I see more volatility and a wider trading range (vis a vis prior years) in 2018.

Deutsche Bank embodies the policy decisions and other contributing factors that have led to the recent market drubbing in this diagram:

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In, “Beware, There Is No Liquidity” Zero Hedge highlights the markedly reduced liquidity that now exists. Here is a summary:

* With reduced size available and widening spreads (in equity futures and cash market) since early February — liquidity today is as poor as that existed in the center of the financial crisis.

* The February drop in liquidity is greater than is typically seen when volatility spikes. “Available size” in e mini futures are three standard deviations too low relative to VIX.

* There are four principal causes of markedly lower liquidity — Market makers losses have caused dealers to step back, less supply (“volatility moves higher faster as spot declines), a volume shift to closing auctions, tighter financial conditions (I recently highlighted the widening of FRA-OIS) principally due to a tightening in monetary policy. Here are some charts to support these observations:

Here is ZeroHedge’s summary of a recent Morgan Stanley report:

“… to some extent this selloff is following the usual playbook – when market participants feel enough pain from the initial shock, markets retest the lows and volatility stays higher for longer. The path forward in spot will be driven by:

  • How fundamental investors weather this storm – no signs of panic yet, but as they give up more and more performance their resilience will be tested
  • Financial conditions and whether market makers can get some relief

… given the instabilities and lack of liquidity in the market, investors should be wary to catch a falling knife and wait for some stability before aggressively buying.

With VIX already in the high 20s, QDS continues to think longer-dated and forward volatility is a better buy.”

My Real Money Pro Diary

For two decades my Diary has been committed to contributing hard-hitting, logically reasoned, analytically thorough and, at times, unpopular and outside of consensus analysis and commentary. My primary objective is to make the column value-added, informative and fun to read. Importantly, I try to deliver my messages and views in a style and format that is combined with pop culture and humor — and, hopefully, in an honest, transparent and self-deprecating way.

My columns, especially my opening missives, are often integrated with references from comedians, philosophers, poets, lyricists, etc., and include parodies and metaphors to slam home my views. I do this in an attempt to differentiate my output from the typically dry and commonplace commentary on the economy, individual companies and investment themes.

Having been the son of an extremely hip and complex jazz musician — secondarily, he was a doctor! — and having produced some rock and roll concerts, I have been especially drawn to music and their lyrics, and I often integrate the message of a song’s lyrics with an investment theme.

Here is my latest: “The Day the Liquidity Died” (to be sung to the tune of Don McLean’s American Pie“.) Have some fun and sing along!

The Day The Liquidity Died

A long, long time ago
I can still remember
How liquidity and an orderly market used to make me smile.
And I now know what investors do at any chance
Is to get themselves a margin loan in advance
And maybe add some more RIOT to the pile

But systemic strategies made me shiver
With every basis point the bond market delivered
A short volatility bubble and risk parity on the doorstep
Still the traders couldn’t keep from taking one more step

I can’t remember if I cried
When I read about last month’s CPI
But you could lose your capital and your bride
The day the liquidity died

So bye-bye, to your piece of the pie
Investors poured their money into leveraged ETFs
Now their equity account’s dry
It’s just five weeks from an all-time high
Singin’, Could we go back where we were last July?
Could we go back where we were last July?

Did you buy stocks you never heard of
Like Longfin at $55 or above
If the Twitter trolls told you so?

Now do you still believe in Bitcoin Investment Trust?
Were you in the last ICO IPO?
And will you continue to ignore the lack of free cash flow?

Well, I know that you were margined, too
‘Cause you always take an intermediate-term view
Even your Stratton Oakmont broker shut you down
No more buying power could be found

The traders never worried on the whole way up
Buying leveraged ETFs from the back of a pickup truck
But I knew some week they will all run out of luck
The day the liquidity died

I started singin’,
Bye-bye to your piece of the pie
Investors poured their money into ETFs
Now their equity account’s dry
It’s just five weeks from an all-time high
And singin’, Could we go back where we were last July?
Could we go back where we were last July? Now for ten years we’ve been on our own

And moss grows fat on a rollin’ stone
But that’s not how its always gonna’ be

Last year when the company executives sang for the king and queen
In suits they borrowed made of green
And with voices that didn’t come from you and me

Oh, and just as things were turning ’round
The President slapped free trade down
The courtroom was adjourned
A guilty verdict was returned

And when Jay Clayton’s SEC was falling asleep
Warren Buffett’s cash pile kept on rising in his Omaha park
While Peter Schiff sang dirges and gold came out of the dark
The day the liquidity died

(Refrain)

Helter-skelter in the upcoming summer swelter
The bulls flew off into their fallout shelter
The Dow was at 22,000 but falling fast

And in the business media the “talking heads” landed foul on the grass
Though Belski, Golub and Jeff Saut were still trying for a forward pass
With Ken Fisher on the sidelines in a cast

Fox Business News’ air was filled with sweet Palm Beach perfume
But Mr. Market wasn’t playing their marching tune
The bulls all got up to dance
Oh, but they never got the chance!
‘Cause the risk parity traders dominated the field
As the long bond climbed more than 150 basis points in yield
Was price discovery ever really repealed?
The day the liquidity died?

(Refrain)

Oh, with investment strategies and products all in one place
Bill Ackman still lost in space
Too old and with no time to start again

So come on; Fed be nimble, Fed ease again!
Is Chairman Powell still chanting amen?
‘Cause more cowbell and QE is the market’s only friend

Oh, as we watched the Dow Jones fall
Too many will receive a margin call
No broker born in hell
Could break that bear market’s spell

And as the futures dropped into the night
To douse the sacrificial light
I saw Boockvar laughing with delight
The day the liquidity died.

(Refrain)

Well I met an analyst covering Facebook, Google and Amazon
And I asked her to interpret the antitrust news
But she just frowned and turned away

The traders marched towards Morgan Stanley’s store
Where they made their fortune years before
But the brokerage demanded to see the cash before they could play

And on my Bloomberg, the ticker streamed – Bill Miller weeped and David Einhorn dreamed.
But not a bullish word was spoken
The market transmission mechanism was broken

And the three stocks the traders acquired last
Disney, Caterpillar and Comcast
Couldn’t catch a bid and faded fast
The day the liquidity died

And they were singing (sing it for me now!),
So bye-bye to your piece of the pie
Investors poured their money into a broken market
Now their equity account’s dry (everybody!)
It’s just five weeks from an all-time high
Singin’, Could we go back where we were last July?
Could we go back where we were last July?

Bye-bye to your piece of the pie
Investors poured their money into a broken market
Now their equity account’s dry
It’s just five weeks from an all-time high
And singin’, Could we go back where we were last July?
Could we go back where we were last July?


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Doug Kass

Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.

2018/03/05
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