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 Jason Zweig, The Wall Street Journal, 07/25/2016|
MarketMinder's View: While we are rather mixed on this article overall, it does contain some tried-and-true advice for long-term investors, especially those with fixed income exposure: Don’t invest for yield alone, as doing so can lead you to take outsized risks. An asset’s yield is just one part of total return to consider, and it alone shouldn’t determine its place in your portfolio. Higher yield intuitively means the investor must take on more risk to reap the reward, and those risks (e.g., higher likelihood of failing to return your capital, illiquidity) may put investors in a tough spot. As this piece advises, the more successful—and difficult—strategy is to remain patient and disciplined and resist the lure of short-term relief, opting instead to stick to your long-term plan. That said, we are much less high on the discussion of high-yield corporate bonds, which can still play a handy role in diversified fixed income portfolios. We wouldn’t go hog wild or anything, but it is a myth that they (or bonds in general) are in a bubble. Actually, considering credit spreads tend to narrow as rates rise, corporate and high-yield bonds might reduce volatility relative to a Treasury bond portfolio if rates rise from here. Also, while we are also fans of taking “homemade dividends” from a stock portfolio, it is a myth that you should only sell your “losers.” Price movement alone should never influence a transaction. Be more tactical, thinking about risk management (paring back positions that grew to comprise an outsized portion of your portfolio) and a company’s future potential.
|By Nicole Bullock and Philip Stafford, The Financial Times, 07/25/2016|
MarketMinder's View: Amid all the analyses spilled over the impact of the Brexit referendum last month, here is one positive story: Markets didn’t break despite record volumes for some trading venues, as electronic market makers stepped in to provide the needed liquidity. Despite trades happening at incredibly fast speeds due to the increased usage of algorithms, liquidity fears didn’t materialize, even though the traditional market makers providers—big banks—weren’t as prominent. As one analyst noted here, “The major banks have reduced appetite for making markets during these times of crisis. It was interesting to see that the major venues had tremendous volumes and there were no instances of negative feedback.” This should be a reassuring point in favor of algorithmic and high-frequency trading—markets operated just fine even after a well-known, sentiment-shaking event occurred.
|By Staff, Bloomberg, 07/25/2016|
MarketMinder's View: The China Minxin Manufacturing PMI, a private-sector measure of Chinese manufacturing activity, was just suspended for the second time in less than a year. Perhaps relatedly, the Chinese government has reportedly banned private-sector Internet news reporting, extending President Xi Jinping’s media crackdown as he consolidates power. For investors, these developments make it that much harder to glean actionable information from the Middle Kingdom, and they illustrate how political risks vary among different Emerging Markets. This isn’t a global market risk by any stretch, but it is something for anyone investing in Emerging Markets to bear in mind.
|By Sam Ro, Yahoo! Finance, 07/25/2016|
MarketMinder's View: We have qualms with the notion that the profits narrative for Corporate America “just got worse.” The rationale provided here: After Q1’s end, experts projected a Q3 2016 earnings growth rate of 3.3% y/y. This fell to 0.6% at Q2’s end, and today it is at -0.1% (per FactSet). Our issue isn’t with the numbers themselves, but rather, the broader narrative: None of this is new. Analysts have consistently ratcheted down their expectations, only for reality to beat them. For instance, at the onset of Q1 2016, earnings were expected to fall -8.5%. After all 500 S&P companies reported, earnings fell just -6.7%. Both figures are even better when you strip out the struggling Energy sector, which has detracted from the headline number for a while now. By no means are we saying negative earnings numbers are anything to cheer, but context is key—US companies are doing overall better than commonly portrayed. And that—the gap between reality and expectations throughout the economy—is what ultimately moves stock prices. Earnings and earnings expectations are far from the most meaningful driver, contrary to the assertions herein. Also, valuations don’t mean anything for stocks looking ahead. At best, the forward price-to-earnings ratio gives you a rough sketch of current sentiment—otherwise, it’s all just backward-looking gobbledygook that pundits spin to say something scary about markets.
Market Wrap-Up, Monday, July 25, 2016
Below is a market summary as of market close Monday, July 25, 2016:
- Global Equities: MSCI World (-0.2%)
- US Equities: S&P 500 (-0.3%)
- UK Equities: MSCI UK (+0.0%)
- Best Country: New Zealand (+1.2%)
- Worst Country: Norway (-1.8%)
- Best Sector: Consumer Discretionary (+0.3%)
- Worst Sector: Energy (-2.1%)
Bond Yields: 10-year US Treasury yields rose 0.01 percentage point to 1.58%.
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.