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 James Mackintosh, The Wall Street Journal, 05/24/2016|
MarketMinder's View: A classic critique of stock buybacks is that they soak up money that could otherwise go towards investment in growing the company, boosting future earnings. This article notes a key flaw in this model: New capital expenditures aren’t always the best use of cash reserves. “[W]hen shareholders cheer on corporate investment, it is worth paying close attention to the risk that they are merely driving up competition and so driving down future profitability.” Many Energy firms, for example, sunk profits into new drilling and exploration projects, only to see prices plummet. This is how markets work: In any industry, firms risk getting too far out over their skis. The lure of future profits drives investment, firms raise production (supply), they overshoot, and trouble follows. Plowing cash reserves back into a business isn’t a sure ticket to ever-higher profits. Buybacks, by contrast, return profits to shareholders to reinvest elsewhere, perhaps to more efficient near-term ends.
|By Jeff Reeves, MarketWatch, 05/24/2016|
MarketMinder's View: None of these seven items is a sign of a bear market—they are just things, interesting observations and nothing more. Let’s go in order: 1) Stocks have risen despite, not because of the Fed’s actions, which flattened the yield curve (a headwind) for most of this bull market, and a hypothetical rise from today’s ultra-low short-term rates lacks the power to curtail the bull market. 2) Earnings are skewed downwards by Energy’s ongoing weakness, long priced into markets and lacking an economy-wide punch. Profits continue growing in key sectors like Health Care and Consumer Discretionary, and excluding Energy, S&P 500 revenues are rising. 3) Small business confidence is backward-looking, influenced by recent economic data like below-average Q1 earnings and GDP numbers. 4) Same goes for consumer confidence. Plus, recent strong retail sales show consumers often say one thing and do another. 5) GDP is also backward-looking, and slowdowns in Q1 2014 and 2015 didn’t last. 6) Mutual fund flows tell only half the story. Money leaving funds could easily have gone into individual stocks. Moreover, every share sold is by definition a share bought. There is no such thing as money flooding out of the market. It’s an auction market, folks. 7) Uncertainty over other factors like the Brexit referendum and US presidential election is just that—uncertainty. As these events approach, doubt should diminish, fueling stocks. All in all, bearish lists like this one are actually positive, as they show investors’ skeptical state: Even modestly positive news can surpass low expectations.
|By Staff, Reuters, 05/24/2016|
MarketMinder's View: This article is less about one day’s price movement and more about the very widespread expectations for oil supply to falter, boosting prices. Indeed, it seems like oil market disruptions are everywhere: Wildfires in Canada hit production, port closures in Libya reduced shipments and strikes in France are hampering refineries. Might these forces finally push oil supply down and prices up? Not so fast—the disruptions are one-offs, and supply increases elsewhere should counterbalance them. As the fires abate, Canadian oil facilities are coming back online; Libyan oil exports started up again on Friday; and French labor unrest should also prove temporary. Meanwhile, local officials in North Yorkshire approved the UK’s first fracking project in five years, potentially further boosting output down the road. With OPEC still unable (or unwilling) to freeze production and US producers standing ready to add capacity if prices go up, we think it’s still too soon to expect oil’s rise.
|By Luke Kawa, Bloomberg, 05/24/2016|
MarketMinder's View: We award a point for debunking a very silly toy model of the Fed’s influence over markets (Fed threatens rate hike --> stocks fall --> Fed delays hike --> stocks happy --> repeat), but we deduct it for the odd methodology. It takes the top 20 single-day moves in the S&P 500 over the last year, looks at the headline of one publication’s daily market wrap-up, observes the Fed isn’t mentioned, and concludes the Fed had no impact. This misses a couple things: First, Fed meetings are some of the most talked-about events in finance. Markets have plenty of time to dissect all the jawboning leading up to each and price in the likely outcome. Second, nailing down the impetus behind any single day’s stock movements is usually mere guesswork. Simply slapping together a daily gain or loss with the hot topic of the day doesn’t prove a connection, much less causation. Third, what about the many other days besides those 20? Investors should keep a broader view: Early rate hikes in a tightening cycle have no history of killing bull markets, and yield curve remains positively sloped, encouraging bank lending. Close readings of day-to-day headlines and stock fluctuations merely muddy the waters.
Market Wrap-Up, Tuesday, May 22, 2016
Below is a market summary as of market close Tuesday, May 22, 2016:
- Global Equities: MSCI World (+1.1%)
- US Equities: S&P 500 (+1.4%)
- UK Equities: MSCI UK (-0.7%)
- Best Country: Italy (+2.9%)
- Worst Country: Japan (-1.4%)
- Best Sector: Information Technology (+1.8%)
- Worst Sector: Materials (+0.2%)
Bond Yields: 10-year US Treasury yields rose 0.02 percentage point at 1.86%.
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.