Well, Marko Kolanovic is back, this time in an interview with Bloomberg.
Lately, Kolanovic has been in the habit of frustrating the bears (who, you’re reminded, have adopted him as one their own, maybe against his will) with persistent “buy the dip” calls and ongoing reminders that he was correct to make a similarly bullish call in the wake of February’s “technical” downdraft. In a piece out midway through last month, “Gandalf” (or, “half-man, half-God”, depending on your penchant for flattery), reiterated the notion that recent weakness was likely down to technical factors on the way to presenting a game theoretic approach to thinking about the Fed and the possibility of a trade war escalation.
I think it’s fair to say that results have been “mixed” as regards that call. Marko seems to have underestimated Trump’s willingness to push the envelope on the protectionist lean, although Kolanovic’s contention that the trade war threat is largely a political gamble designed to bolster the GOP ahead of the mid-terms could still ultimately prove to be some semblance of correct. Meanwhile, markets are in the midst of some wild swings, as 1% moves in either direction continue to be more “norm” than “exception”.
Anyway, Kolanovic is now warning about market liquidity. “Liquidity was a big problem in the market meltdown of early February, and hasn’t really recovered since then,” he cautioned, in a recent interview with Bloomberg, before suggesting that “buyer’s strikes” could emerge amid ongoing trade worries and tech turmoil.
To be sure, Marko isn’t the only one to warn about a potential dearth of liquidity lately. In fact, his colleague Nikolaos Panigirtzoglou raised the issue early last month, writing the following about HFT critics’ long-held contention that the proliferation of algos actually sucks liquidity from the market at critical times – that is obviously the polar opposite of what HFT proponents will tell you. Here’s Panigirtzoglou rehashing the argument:
These agency traders tend to show lower commitment and tend to withdraw from market making more quickly than principal traders once order flow imbalances emerge and uncertainty and volatility rises. The more frequent occurrence of so called “flash crashes” in equity markets is often blamed on the opportunistic behavior of these market makers. There is high likelihood that a more defensive behavior by market makers has worsened market liquidity, exacerbating market movements over the past weeks.
In addition to that, there’s now a new problem – MiFID II. To wit:
The restrictions imposed on off exchange trading and dark pools by MiFID II might have also had an adverse impact on market liquidity this year. We argued before that the high share of off-exchange trading, a phenomenon that has persisted in both Europe and the US, suggests that there is genuine high demand for off-exchange or dark liquidity to reduce the market impact of large trades by big institutional investors. To the extent that MIFID II induces too much shift away from less transparent or off-exchange trading venues to fully transparent real-time on-exchange reported trading, then liquidity could be potentially impaired also.
The indicator JPMorgan uses to track liquidity had improved as of the most recent update from Panigirtzoglou, but one of the important things to note about the chart shown below is that the recent deterioration seemed to look more like a trend than a momentary spike (i.e. more enduring than what happened around the yuan devaluation in 2015):
In addition to that, you’re reminded that Goldman recently penned a missive that encapsulated everything market structure critics have been warning about for the better part of a decade. We profiled that critique in “Goldman Delivers Ominous Message: ‘Markets Themselves’ May Pose The Greatest Risk.” Here’s one key passage:
In particular, new regulations and new technologies have caused a dramatic evolution of the post-crisis ecosystem for providing trading liquidity. In this new market structure, machines have replaced humans, and speed has replaced capital. While such changes have greatly reduced the need for equity capital, and are thus efficiency-enhancing, the same was also true about leverage and structured products during the run-up to the financial crisis. While the new ecosystem for providing market liquidity has arguably freed up equity capital for more efficient uses, it has also depleted the pools of capital that will be available for liquidity when the cycle turn.
Essentially, Kolanovic is just suggesting that these long simmering issues will be thrown into stark relief if we get more selloffs characterized by the kind of cascading, forced de-risking that typified the action which wreaked havoc across global markets following the short vol. implosion on February 5.
“The only real problem now is low liquidity and market volatility,” Kolanovic told Bloomberg, reiterating the notion that trade war risk, inflation concerns, and Fed jitters are probably overblown.
It’s the same story – a sustained spike in vol. causes systematic, rules-based strats to deleverage into a falling market, exacerbating the situation. Meanwhile, traditional sources of liquidity provision have dried up, as detailed by Goldman in the piece mentioned above and as folks like value investors are reluctant to stick their necks out after being burned so badly by the self-feeding loops that have driven momentum strategies and growth in a perpetual motion dynamic over the past several years.
So I don’t know. It sounds like Marko is hedging his recent BTFD call a bit. Make of that what you will, while bearing in mind that none of this is really “new”.