“If Democrats take control of the Senate after the January 5th Georgia runoff elections, our economists expect a larger fiscal package of about $2.5 trillion,” Goldman said, in a Friday evening note.
The bank’s baseline expectation for stimulus in 2021 is just $1 trillion. The disparity between the two figures underscores just how crucial the Georgia runoffs really are, and it’s not just the size of the next virus relief package that’s at stake. If Democrats somehow manage to prevail, markets would face a realization of the “blue wave” risk that was so readily priced out earlier this month.
The New York Times describes Georgia’s runoffs as a “vestige of segregationist efforts to dilute Black voting power” and notes that “such contests have heavily favored Republicans because of a drop-off among Democratic voters, particularly African-Americans, after the general election.”
This time could be different, though. “Demographic and cultural change has led to rapid shifts in the state, and Democrats have made concerted efforts to energize and turn out their voters, work that paved the way for Joe Biden’s strong showing in the state,” the Times went on to write. (You’re encouraged to read the Times article in full — it’s informative.)
Between those runoffs, the proliferation of new lockdown measures aimed at containing a mind-boggling surge in US coronavirus infections, and worries that with Donald Trump disengaged, Mitch McConnell will continue to balk at any stimulus package carrying a price tag in excess of $500 billion, there’s scope for more volatility into year-end, some say.
For Morgan Stanley’s Mike Wilson, the Georgia runoffs are crucial. “We recommend investors keep their head on a swivel as this market likely has a few more cheap shots in it,” he said last week.
The VIX hasn’t been below 20 since prior to the pandemic, prompting articles about a “high vol regime.” I suppose I would just attach a caveat about there being more to implied vol than simple angst — there’s always nuance, and this discussion is no exception.
In addition to political uncertainty, some fret that fresh COVID containment measures pose a risk to earnings. For their part, Goldman doesn’t see that threat as particularly pronounced, but it goes without saying that the services sector could do without another wave of restrictions on operating hours, drink service, and capacity.
When it comes to cataloguing risk factors, one thing that often goes unnoticed is liquidity. Perusing this weekend’s coverage from financial media outlets turns up no prominent mention of the potential for any prospective swoon catalyzed by the myriad headline risk factors to be exacerbated by poor market depth.
This subject is always described as “esoteric” but by now, it shouldn’t be confined to the realm of arcana. The point here isn’t to recap the entire discussion. Rather, just note (and I’ve mentioned this repeatedly), that market depth never recovered from the February 2018 VIX ETN “extinction” event.
SocGen’s Sandrine Ungari delivered an extensive take on this dated November 11. The scope of her exposition isn’t amenable to summary treatment, but the key points are straightforward.
“Liquidity supply and demand come and go as a function of the market environment,” Ungari wrote, adding that “a shift towards lower visible liquidity started in February 2018, with the VIX ETNs crash.”
This is glaring on any number of visuals (I added the blue arrow in the chart below to show the impact of the event affectionately known to market participants as “Volpocalypse”).
This becomes extremely problematic during swift, large drawdowns. Market depth is inversely correlated with volatility. And volatility is the exposure toggle for a universe of systematic strats controlling hundreds of billions in assets.
Lackluster liquidity generally makes markets more vulnerable to fragility events, and the accompanying volatility triggers mechanical de-leveraging from vol-sensitive strats. That’s the fabled “doom loop,” which too many otherwise intelligent market participants claimed didn’t exist prior to February 2018. That was the month when legions of armchair, stay-at-home vol traders were summarily wiped out quite literally overnight.
Anyway, SocGen’s Ungari notes that back in March, very thin liquidity collided with very high volumes amid the pandemic panic. “Demand from liquidity takers was strong… but supply collapsed,” she wrote, adding that “the first lockdown measures ignited [a] now quite common feedback loop.”
Do new lockdowns threaten to ignite the same self-fulfilling spiral? Likely not, for a variety of reasons, some of which are structural, but at a more simplistic level, market participants are now somewhat desensitized to lockdown headlines. At the same time, vaccine optimism helps inoculate sentiment (sorry — I realize that’s a terribly obvious pun).
Still, this is worth keeping in the back of your mind as we head into year-end. After all, the December 2018 crash was exacerbated by lackluster liquidity.
In the same vein (and I don’t have an update on this, so I’ll just use the same chart from October), Goldman recently observed that the difference between index liquidity during the final 30 minutes of trading and that available during the whole session has dissipated.
As of early last month, the trend was towards an environment where virtually no extra liquidity is available in the last half-hour.
Thank you. This gives me a better understanding of what goes into the VIX. I see now that liquidity is a factor. Despite your having written about this before, it didn’t dawn on me until now. Appreciate it.