Market liquidity is usually a pretty banal subject, garnering little attention. But in the last year, it has gone from being a dry afterthought to being the subject of frequent articles claiming it’s a major concern, particularly in the bond markets. So much so, that Bloomberg’s Matt Levine had a running section of his daily link wrap titled, “People Are Worried About Bond Market Liquidity” for months and rarely ran low on articles to share. It is now bigger news when there aren’t “People Worried About Bond Market Liquidity!” So what is market liquidity, and are the recent fears justified—or overblown?
Market liquidity refers to how easily an asset can be bought or sold without dramatically impacting the price or incurring large costs. It’s a defining feature separating asset classes, a key consideration for investors. Some financial assets, like listed stocks, are easy to buy or sell with little price impact and small commissions—they’re “liquid.” Conversely, commercial real estate takes time to sell and likely includes high commissions and significant negotiations—it is “illiquid.” For most investors, particularly those with potential cash flow needs, liquidity is an important facet of any investment strategy.
Bonds are among the more liquid investments available for investors, though liquidity varies among different types. Treasurys, among the deepest markets in the world, are highly liquid. Corporates and municipals are less so, and some fancier debt is actually quite illiquid.
Flags fly in front of the Parthenon in Athens. Photo by Bloomberg/Getty Images.
After five years of Greek crisis, two defaults and going-on three bailouts, many still fear a contagion across the eurozone. While default and “Grexit” risk persist, the risk of a contagion has fallen significantly over the last few years. The eurozone economy is improving, foreign banks hold less Greek debt, bank deposits aren’t fleeing other peripheral nations, and euroskeptic parties poll well behind traditional parties across the eurozone. Greece’s problems are contained and shouldn’t put the broader eurozone at risk.
|By Fisher Investments Editorial Staff, 03/27/2015|
In Friday’s third revision to Q4 US GDP growth, one thing that seemed to catch a few eyeballs was a drop in US Corporate Profits[i], which some hyperbolically labeled “the worst news.” Others claim a “profit recession”—whatever that means—looms. But here is the thing: A down quarter for corporate profits is not unusual amid a bull market. Here are two charts to illustrate the point. The first shows the Bureau of Economic Analysis’ measure of corporate profits excluding depreciation. The second includes depreciation. The gray bars indicate bear markets and the blue dots denote a negative quarter of profits in a bull market. As you can see, such dips aren’t exactly rare and occur at random points throughout a bull market and expansion.
Exhibit 1: US Corporate Profits After Tax Without Inventory Valuation and Capital Cost Adjustment
Thursday marked the beginning three days of voting across the 28 EU nations in the first European Parliamentary (EP) elections since 2009. Also, the first pan-EU elections since the eurozone’s debt crisis and 18-month long recession that ended in mid-2013. When the polls close, voters are expected to add more euroskeptics—members of parties favoring less federalism and, in some cases, leaving the euro. With euro jitters still lingering in the background, some suspect this will rekindle breakup fears anew. However, polls suggest euroskeptics gain some ground but fail to shift power away from more traditional European political parties. The movement toward a more integrated Europe likely continues and, with it, support for the common currency likely remains strong. Should polls hold true, the biggest influence I believe the euroskeptics may have is pressuring the pro-euro groups on economic policy.
European Union Government
European Council: Heads of each EU member state with no formal legislative power. The Council defines general EU political directions (and addresses crises).
European Commission (EC): Executive body of the EU, consisting of a President (elected by the European Parliament) and 27 commissioners selected by the European Council and the EU President. They are responsible for proposing legislation, implementing decisions and addressing day-to-day EU operations.
European Parliament (EP): Directly elected legislative body of the European Union (five-year terms). The EP is an approval body. They do not initiate legislation, instead voting on and amending European Commission proposals. The EP directly elects the European Commission President and confirms the European Commission after its formation.
There will be slight structural differences in Parliament, regardless of the voting. Between 2009’s election and this year’s, the EU ratified the Lisbon Treaty, altering the structure of the body, modestly reducing the influence of larger nations like Germany. The EP will consist of 751 seats, 15 fewer than before. Representation will still be based on population, but with certain caveats. The Lisbon Treaty caps each member state at a maximum of 96 and mandates a minimum of six seats to all. This will automatically reduce Germany’s standing from the present Parliament and slightly boost the power of small EU nations. However, national distribution isn’t really at issue in the race. It’s much more about pro-euro versus euroskeptic.
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|By Alden Abbott, Truth on the Market, 06/29/2016|
MarketMinder's View: A very interesting post highlighting some under-the-radar ways a Brexit could make the UK more economically competitive, contrary to the popular notion it reduces competitiveness. As the author summarizes, with appropriate modesty, “while Brexit’s implications for other economic factors, such as macroeconomic stability, remain to be seen, Brexit will likely prove to have an economic welfare-enhancing influence on key aspects of competition policy.” Now, even that remains to be seen based on negotiations, but it is an interesting counterpoint to consider.
|By Pradip Sigdyal and Mark Fahey, CNBC, 06/29/2016|
MarketMinder's View: Long-term US Treasury yields have been lower than the S&P 500’s dividend yield for much of 2016, causing some to suggest this makes stocks a better buy than bonds. And in some respects, it is true stocks’ dividend yield being higher than bond yields makes stocks more attractive on a relative basis. That said, this is more a gauge of sentiment than anything. It isn’t a call to dump your bonds and buy dividend-paying stocks, or something. For most investors with blended portfolios, bonds play a crucial role: mitigating stocks’ expected short-term volatility. Ramping up your percentage of stocks when your goals haven’t changed is dangerous to your financial health, dividend or no. There is nothing—and we mean nothing—“safe” about high dividend-paying stocks. They are stocks, with all the volatility of stocks. Treating them as a bond replacement is a mistake.
|By Adam Creighton, The Wall Street Journal, 06/29/2016|
MarketMinder's View: We don’t think this is really all that surprising, considering we’ve written for years that ratings agency opinions are, to use their term, puffery. The title quibble aside, this is a very sensible take on why credit rating agency downgrades, especially for sovereign nations, don’t tell investors anything liquid markets don’t already know. Since the financial crisis, credit-rating agencies have downgraded the US, the UK, Japan, France, as well as a host of other European nations. But yields on those countries’ bonds mostly fell afterwards, and in many cases the cost of insuring against those countries’ default barely budged as a result of the downgrades. In fact, this is also the norm as it pertains to sovereign ratings, not a post-2008 change. Markets generally move in advance of credit-ratings agencies, as they price in all widely known opinions and thoughts in real time. Ratings agencies respond to those opinions and, often, market movement. Considering Gilt yields fell to historical lows after the Brexit vote, we sort of think markets are suggesting Britain won’t have problems servicing its debt, at all, no matter what S&P and Fitch think.
|By Andrew Roberts, Monami Yui and Sam Chambers, Bloomberg, 06/29/2016|
MarketMinder's View: Speculation abounds about the economic impact of Brexit. The same source ran this anecdote-supported account of potential economic woe today. This article takes a different angle—that Brexit could spur a tourism and foreign-spending based boom due to the weak pound—but is equally speculative. Maybe, just maybe, this ends may up being true, but a lot can potentially happen to thwart such a scenario from coming to fruition. The pound’s drop may be end up being temporary, particularly as the initial shock reaction to the vote wanes. But also, even if the pound remains depressed for some time and UK tourism and exports spike, this likely wouldn’t materially boost UK growth, as domestic consumption accounts for about 80% of overall output. Don’t get us wrong: If the pound remains weak, and foreigners line up in droves to visit Big Ben and “snatch up Burberry trenchcoats, Harrods Stilton and Liberty scarves,” all the better! But predictions based on four days’ market movements are pointless speculation for investors.
Market Wrap-Up, Tuesday, June 28, 2016
Below is a market summary as of market close Tuesday, June 28, 2016:
- Global Equities: MSCI World (+1.8%)
- US Equities: S&P 500 (+1.8%)
- UK Equities: MSCI UK (+4.0%)
- Best Country: Italy (+4.2%)
- Worst Country: Japan (-1.1%)
- Best Sector: Energy (+2.5%)
- Worst Sector: Materials (+1.0%)
Bond Yields: 10-year US Treasury yields rose 0.03 percentage point to 1.46%.
Editors' Note: Tracking Stock and Bond Indexes
Source: Factset. Unless otherwise specified, all country returns are based on the MSCI index in US dollars for the country or region and include net dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.