To Create Unlimited Liquidity or Not; That Is the Question Jan 29, 2015
Doug
Wakefield
“On
October 15, 2014 between 9:33 and 9:45, liquidity evaporated in Treasury
futures and prices skyrocketed (causing yields to plummet). Five minutes later,
prices returned to 9:33 levels.
Trading
activity was enormous, sending trade counts for the entire day to record highs
- exceeding that of the Lehman collapse, the financial crisis and the August
2011 downgrade of U.S. debt. Treasury futures were so active, they pushed
overall trade counts on the CME to a new record high.”[Underlined text my own, Nanex Research, Oct 15 ’14,
Treasury Flash Crash]
“In
what is likely an effort to comprehend whether the market is satiated with a
mere EUR 50 billion per month in printed money, this morning's leaked ECB QE
announcement (due tomorrow) sparked
total chaos in FX markets and, as Nanex notes, sending market liquidity to
near record lows. This is a problem. With the 'real'
volatility event not arriving until tomorrow, everyone has pulled out of the
market already... setting the scene for a gappy Swissnado replay tomorrow
morning.”[Underlined text my
own, All
Liquidity Disappears From Euro FX Market Day Ahead of ECB Announcement,
Zero Hedge, January 21, 2015]
Two
powerful ideas collide in our heads. The most dominant by the financial media
and central banks, is the relentless pursuit of “overcoming deflation” with
“unlimited money”.
The
other is a lesser known idea, that the more trades are pushed in the same
direction and the longer this takes place, the more apt markets are to reach a
point when either the demand to get in or get out produces a lack of liquidity
in that market.
History
has already left us a highly studied event that took place on May 6, 2010, that
most know today because it became the ultimate example of a new term known as
the “flash crash”, a topic I have mentioned in several articles.
“I.3. A LOSS OF LIQUIDITY - Since the E-Mini and
SPY both track the same set of S&P 500 stocks, it can be expected that
prices of these products would move in tandem during their rapid decline.
However, a detailed examination of the order books15 for each product reveals
that in the moments before prices of the E-Mini and SPY both hit their
intra-day lows, the E-Mini suffered a significant loss of liquidity during
which buy-side market depth16 was not able to keep pace with sell-side
pressure. In comparison, buy-side liquidity in SPY reached its low point for
the day a few minutes later, after prices in both the E-Mini and SPY began to
recover.” [
Securities and Exchange Commission’s joint paper with the Commodity Futures
Trading Commission, Findings Regarding the Market Events of May 6, 2010, released
Sept 30, ’10, pg 11]
Most
individuals, living their daily lives outside the world of trading and
financial systems, have probably never considered this critical question, must
less even know it is a question to ask.
Yet
think about it. If you continue to tell a crowd of people, “here comes another
bucket of QE (cheap money)”, why would the experience of the last 3 years tell
us anything but, “there is plenty of liquidity to speculate, and central
bankers want us to ‘feel wealthier, so we will go out and borrow and spend’, so
why worry?
A massive loss of liquidity during times of
extreme stress in markets is actually a consequence of creating too much
liquidity. The more people chase
the same trend, the higher the leverage and the larger the trade, the more
likely that at some point, the movements of the herd overwhelm the system.
If
this happens over a few minutes, like those seen in US Treasuries on October 15th,
or the euro on January 21st, then the public probably never even
knows anything happened.
If
the event makes history and brings about the most volatile day in US stocks on
record to date, the May 6, 2010 Flash Crash, thus creating documentaries and
investigations from the highest regulatory bodies in the US, then the public is
made aware that there is a problem. However, we forget quickly as long as
things return to “normal”, i.e., computers keep bouncing stock indices upwards
repeatedly at their “nirvana lines”?
But
what happens if the idea of “risk on/risk off” becomes so dominant in the
trading world, that an event escalates over several weeks into a crash, such as
the 3,000-point drop from the high on Friday, Oct 3 ’08 to the low on Friday,
Oct
10’ 08, or the largest percentage decline in a day (22%) on record, Black
Monday, October 19, 1987? I know, we have learned from those mistakes.
What
was seen as very good for rising stock markets, ever larger amounts of capital
pouring in, now becomes a very nasty part of creating the inverse as stocks
capital flows out, and the shift begins in earnest. Eventually, a critical
week, day, or even few minutes can be reached, where all that liquidity is not
available.
Eventually,
all that massive amount of additional liquidity creates enormously lopsided
trades in the largest markets in the world. A shift from one side of the boat
to the other, impacts the entire global business world.
So
while political and financial central planning leaders love to espouse the
power of the “liquidity bazooka”, we need to remember that there is a much
larger story developing, and it most certainly is not how a bunch of global
bureaucrats can make life and trading easier for the rest of humanity.
“In all, a massive bond buying bazooka of 1.1
trillion euros.
Markets were tipped off on the direction, but not
the scale, of the program thanks to French President, Francois Hollande: ‘On
Thursday, the ECB will take the decision to buy sovereign debt, which will
provide significant liquidity to the European economy and create a movement
that is favourable to growth.’” [ECB
Money Printing Now Expected to Top 1 trillion Euros, ABC News, Jan 21 ‘15]
I
still remember researching the archives of The
Investment Company Institute for capital flows into and out of stock funds
when I first started tearing apart the markets at the system level in 2004,
looking for patterns from the wild ride to the top and back to the bottom
between the late 90s and 2003. What I noticed was that the capital flows into
US based stock funds hit their highest on record in February 2000, the month
before the NASDAQ’s all time high that March, and the largest outflow the
summer of 2002.
Record
$36.5 billion flows into US- based funds in week: Lipper, CNBC,
Dec 27 ‘14
“Investors in U.S.-based funds poured $36.5 billion
into stock funds in the latest weekly period, marking the biggest inflows on
record as U.S. stocks surged to record highs, data from Thomson Reuters Lipper
service showed on Friday.”
“Money has been flowing out of the major ETFs
tracking the S&P 500. Over the past three weeks, more than $20 billion has
left the funds, the 2nd highest amount in the past four years.”
[Jason Goepfert’s Daily Sentiment Report, Jan 27 ’15, www.sentimentrader.com]
The question should have never been about the
“right” amount of liquidity, but why a system we espouse as “free markets”
continues to need so much constant intervention, now in its 7th year
since hearing the term “bailout”.
I guess some things will never change….until put
under enough pressure.
Being a Contrarian
I
have found that using the “nirvana trade”, one has been able to profit from
being a contrarian as volatility has picked up greatly since mid 2014.
January’s extreme volatility should be a warning to everyone. Change is always
inevitable, as demonstrated by centuries of market history.
The
Investor’s Mind was started in 2006, believing that asking questions was a good
thing. 2015 seems set to prove why once again, like 2008.
The
cost for procrastination continues to rise. The value for good research is
extremely low in comparison to the speed in which wealth can be destroyed. Click here to start the next
six months reading the newsletters and trading reports as we come through
this incredible year.
On a Personal Note
I
have recently started a blog called, Living2024.
It is a personal blog, not business. I wanted to have a place to write some
personal stories about where this entire drama seems to be taking us all. I
hope you will check it out.
Doug
Wakefield
President
Best Minds Inc. a Registered Investment
Advisor
1104
Indian Ridge
Denton,
Texas 76205
Phone
- (940) 591 - 3000
Best Minds, Inc is a registered investment advisor that
looks to the best minds in the world of finance and economics to seek a
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