Sunday, 22 July 2018

On the two faces of liquidity

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Anthony Peters sees through the Potemkin village in the bond markets.

Yippee! A few beacons of light! The “sea of red” yesterday, when all had been said and done, became no more than a pink pond, although the markets which did succeed in closing in the plus didn’t exactly run away with it. The Dax crept up by 0.13%, the Nasdaq by 0.05% and the S&P by 0.01% but let’s not be churlish, and let us be grateful for small mercies.

The VIX duly fell a small amount from 26.25 points to 25.20 points even though it did during the session trade north of 29.00 points on two occasions on its way to a better close. In other words, volatility is still alive and kicking and with it the now expected horrors of trying to trade in the market.

It should not be forgotten that amongst the panic stricken traders and hedge funds there are “ordinary people” who have a job to do. So it occurred that we worked with an insurance group where the execution of an asset liability management decision required the fund manager to undertake some fairly mundane portfolio adjustments.

Obviously it was not going to be easy, but when we asked a global bank for a bid on no more than a market size of one of its own 5-year benchmark plain vanilla senior unsecured bonds and were told (you’ve guessed it)… ”We’re afraid we’re not axed to bid…”, it is clear that the market is broken.

This is no longer about bidding to miss, of providing what we used to refer to as a “pfo” bid; it is refusing to bid. Where now is those clever regulators’ liquidity through transparency? Bond markets were built on one particular axiom and that is that there is always a bid; it might not be one that you like but there will always be one. Off that!

The global financial crisis was created by there being an excess of liquidity. The term “liquidity” of course covers two unrelated phenomena. The first is of course cash in the system which is the creation of, and in the hands of, the monetary authorities. The other is the ability to trade to either side of the spread in an orderly fashion and at a sensible cost. In 2006/2007 there was an excess of both which made the world a little crazy. Now we enjoy an even greater excess of one while suffering a near absence of the other. The result is a deeply unbalanced trading environment which looks great to the uninvolved do-gooders but is really nothing more than one large neighbourhood of Potemkin villages.

Chinese walls

Meanwhile, I dined last night with a chap who dabbles in commercial property in which he alone has possibly made more money than the aggregate of my entire readership put together. He is a modest man who loves his family and his cars (spot the common ground) but who has one of the sharpest, most incisive brains I have ever come across. What has, however, put him where he is, is not his technical ability, but his unfailing sense of timing.

I was made aware overnight of a video put out by Neil Woodford in which he speaks of his “gut feeling” and, likewise, my man was referring last night of his own “gut feeling”. Having not got too much wrong in the past thirty years or so, I listen to what he has to say.

To him, the teddy bear in the woodpile remains the Chinese real-estate market which he knows will blow in due course and he is quite intent on not being anywhere close by when it happens. He appears to expect the reversal in China’s property bubble to be quite cataclysmic and he is neither, just to be clear, talking his book, nor is he peddling snake oil in the shape of overpriced put options. In fact, it would appear, he is generally beginning to move his focus away from property and he is spending more time pursuing interests in very selective cutting edge and innovative technology. I take his views very seriously and have my reading cut out for the next few months.

US data with a grain of salt

Closer to home, US Industrial and Manufacturing Production figures for September were pretty smart, beating estimates in all divisions. Initial Claims were also good, down at 264k, the lowest reading since September 1973. However, adjusted for the increased size of the workforce, yesterday’s number is in a different ballpark.

One must be careful in this environment not to get too excited about backward looking indicators or ones, like employment, which are natural laggards, but it would be equally wrong to dismiss them entirely as yesterday’s news as they deeply influence attitudes and intentions when it comes to planned future purchases of consumer durables.

The current market correction is healthy and long overdue but it is not, in my humble opinion, the end of the world as we know it. It is not another 2008 or another 1987. It is just time to blow some froth off the top of an overpriced asset complex.


Alas, it is that time of the week again and all the remains is for me to wish you and yours a happy and peaceful week-end. May your waterproofs be waterproof as you spend the week-end in the garden cutting back, and may the rain hold off long enough to permit you to happily kipper yourself in the smoke of that autumn bonfire. I, myself, will be making and freezing apple sauce and looking for victims to whom I can offer some of my pretty looking but disappointingly sour grapes.

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