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 Justin Fox, Bloomberg, 06/24/2016|
MarketMinder's View: This piece mostly focuses on experts who predicted a “Remain” victory in the Brexit referendum, and while we aren’t here to pile on (no one forecasts with 100% accuracy), we believe there are some salient points here that investors can apply to any media take. The big one: Know that anyone, pro or no, can be wrong—and wrong often! Expert takes aren’t infallible, and they should be viewed with healthy skepticism. Their forecasts are opinions, and any forecast is only as good as its inputs. That said, we aren’t recommending outright ignoring or disregarding experts’ opinions, either. As this piece points out, “Experts have biases and make mistakes, but the very act of gaining expertise usually makes them less vulnerable to misinformation. Most people don’t have time to develop that sort of informed skepticism—which is one reason why experts are so essential.” We don’t know about “essential,” but more information for markets to digest and price in reduces the overall surprise power of an upcoming event.
|By Jim Yardley, The New York Times, 06/24/2016|
MarketMinder's View: With Britons deciding to leave the EU, many have begun speculating about the fallout Brexit will have on politics around the world. Will this embolden populist movements in Austria, France, Germany and elsewhere on the Continent? Could it affect upcoming votes, like Spain’s parliamentary election this Sunday? Or even the US presidential election in November? While all possible, we can’t definitively pinpoint how one election will influence another—it may be a factor, it may not be at all. However, we do urge investors to put aside any blinding political biases they may hold and avoid extrapolating the Brexit result into a blanket statement about the entire state of global politics. Yes, populist movements have been grabbing headlines recently, but they have yet to grab substantial power that could break the gridlock present in most developed economies—preventing radical legislation from becoming reality. That is what matters most for markets.
|By Paul R. La Monica, CNNMoney, 06/24/2016|
MarketMinder's View: The titular bubble question is based on a Fed statement from earlier this week that stock valuations “have increased to a level well above their median of the past three decades.” Some interpret that to mean stocks look frothy and the Fed’s “easy” monetary policy is to blame. We have some serious qualms about that notion. For one, let’s review how a financial bubble actually works. Bubbles tend to inflate quietly as investors overlook fundamentals and expectations begin surpassing reality. Fear deflates them, and if everyone sees bubbles forming in every single sector, that’s a sign skepticism exceeds optimism. Pointing out bubbles has been commonplace throughout this entire bull market, and correspondingly, persistent uncertainty has weighed heavily on investor sentiment—these bubble fears are self-deflating. Oh, and though the Fed is filled with smart people, we wouldn’t put a whole of stock in their market forecasting abilities. For instance, Fed head Janet Yellen observed that the biotech and social media industries were a bit frothy in summer 2014 … yet that froth was from earlier in the year and markets had largely recovered by the time Yellen made her statement. Plus, there is little evidence that the Fed has inflated any sort of bubble during the current expansion, either in stocks or the broader economy, so we aren’t buying that claim, either. Folks, given how dour investors have been for most of this bull market, we fail to see how broader bubbly conditions can form in the first place.
|By Ron Lieber, The New York Times, 06/24/2016|
MarketMinder's View: For investors rattled by today’s sharp spike in market volatility and considering selling stocks to prevent further portfolio declines, here is some very sage advice. Though the UK’s exit from the EU is an unusual event, market volatility isn’t. It’s normal, and one day’s decline, however steep, doesn’t mean stocks will no longer grow over time. Withstanding short-term volatility is the price you pay to achieve growth over the long run. If you need any exposure to stocks to reach your long-term financial goals, and those goals haven’t changed just because of Brexit, it probably isn’t prudent to radically alter your allocation to stocks today. If you do, determining when to get back in is fraught with peril—stocks will likely be up sharply by the time you feel comfortable re-entering the market. Also, for investors in or near retirement, your investment time horizon is likely longer than you think, as folks are living longer than ever. Selling stocks now, especially if you remain out of the market for a prolonged period, may materially reduce your portfolio’s ability to meet your needs throughout your lifetime. Finally, we’ll leave you with this nugget of wisdom, though we humbly suggest you read the whole piece: “Nothing about the vote for Britain to leave the European Union suggests that the fundamentals of capitalism have changed. So neither should your confidence in very long-term ownership of the pieces of the for-profit enterprises that benefit from your fortitude.”
Market Wrap-Up, Thursday, June 23, 2016
Below is a market summary as of market close Thursday, June 23, 2016:
- Global Equities: MSCI World (+1.4%)
- US Equities: S&P 500 (+1.3%)
- UK Equities: MSCI UK (+2.1%)
- Best Country: Italy (+4.4%)
- Worst Country: Singapore (+0.2%)
- Best Sector: Energy (+2.0%)
- Worst Sector: Utilities (+0.6%)
Bond Yields: 10-year US Treasury yields rose 0.05 percentage point to 1.74%.
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.