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Nobody Home

Updated: Jul 20, 2023

The same fears we have been talking about all year— Brexit, trade, and more populist political shocks-- continue to roil world markets, and the unusual size of the moves is being stoked by a lack of liquidity. 1% - 3% moves in a day have become commonplace, and a contributing factor is that it’s increasingly difficult to find somebody to take the other side of any given trade.

Average daily trading in U.S. Treasury bonds (measured as a percentage of market size) has fallen by over 60% since 2007. Trading in traditionally less liquid corporate and high-yield bonds has shrunk by similar amounts, and the number of small trades (under $1 million) has grown, which suggests a lack of partners for larger deals.[i]

U.S. equity market turnover has also shrunk over that period. Goldman Sachs estimates that single-stock liquidity fell as much as 40% in 2018. Large intra-day moves, higher volatility of bid-offer spreads and the proliferation of flash crashes like at the end of 2018 and the Japanese yen crash in January 2019 are all indicators of a lack of liquidity.[ii]

What’s that illiquidity mean to investors? Traditional market-makers have become less active as algorithmic traders and ETFs have emerged. High-speed trading algorithms endeavor to scan news stories in order to quickly determine if there is any market-moving information that affects their portfolios. They don’t take much time to ferret out which news stories are real, and that can make for some funky gyrations.

For example, in 2011, Huffington Post blogger Dan Mirvish noted that when Anne Hathaway was in the news, Warren Buffett's Berkshire Hathaway's shares went up. More recently, we’ve seen that every time Ford Motor (stock symbol F) is in the headlines, Forward Industries (stock symbol FORD) stock goes up.[iii]

The increased number of these algorithms that trade based on posts and headlines has caused a disconnect between sentiment and macroeconomic reality due to the reinforcing feedback loop of social media. In other words, everybody’s chasing the same side of the trade at the same time.

The broader implication is that illiquidity may precipitate fire sales and large asset price moves. Now that algorithmic trading has replaced humans at the point of sale, the market is no longer the result of bets on the future. Rather, it's a market of what's happening right now.

Consequently, we would emphasize:

· Sticking to the plan by maintaining strategic asset allocation weights.

· Alpha-oriented, bottoms-up strategies over pure equity beta

· Income-oriented investing and alternatives as a response to moderating returns

[i] Das, Styajit; “Markets Should Be Worried About the Music Stopping,” Bloomberg Opinion; August 21, 2019.

[ii] Jessica Binder Graham, et. al; “Digging into Liquidity and Flash from the Low Vol Past,” Goldman Sachs Equity Research, May 30, 2019.

[iii] La Monica, Paul R.; “Confused investors keep buying FORD, thinking it's Ford,” CNN Business, August 12, 2019.

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