2022: The Most Bearish, Illiquid Year Since Lehman?
Over the years, I've dedicated quite a bit of coverage to the feedback loop between liquidity, volatility and systematic flows.
Conceptually, the dynamic isn't difficult to appreciate, despite the somewhat esoteric nature of the details.
Volatility is negatively correlated with liquidity, or market depth. Thin markets are conducive to outsized price swings, and extreme volatility can adversely impact liquidity provision, in a self-referential loop. Large moves in spot can trigger mechanical fl
Part of the reason that one might judge markets to be more fragile since the great unpleasantness, is that we know less than we would like about their inner nature, as a result of increased complexity more than any attempt at obfuscation. When what we don’t know rises we lose power and often make mistakes.
Meaning, that we’ve unintentionally created an interdependent system that is complex and not truly understood? The unintended consequences would be at least similarly misunderstood, no? Then, our responses to stimuli, consequences, may compound both unintended results and additional complexity …. Same goes for policy makers, and large pro traders? T-bills, anyone?
Pretty much. Especially for policy makers. Today’s many entanglements make for unexpected accidents … imo. In the old days it wasn’t so complex. My first serious publication was about how fixed income investment managers made investment decisions. Today, I’d be laughed off the stage. One of my best mates in OSU’s Finance doctoral program left with the same education I did and in four years he was managing all the Treasury’s short-term money. I can only imagine what that job is like today (or maybe I can’t). In 2009, oversimplified, who saved the banks? AIG with a huge pile of Treasury funds. We’re really lucky that worked. Now what would it take?
H-Man, while markets are driven by sentiment, data determines sentiment ( positive data reinforces positive sentiment while negative data does the reverse). Data comes in two forms – economic and political. How we interpret the data determines sentiment. Economic is empirical while political is subjective. But on occasion political transitions to economic as in the case of COVID. And economic can transition to political as in the case of a new President or control of the Senate or the House.
So trying to decipher the course of the market is simply a game of understanding current sentiment vs future sentiment.
Which is why we subscribe to Heisenberg.
My career as a trader started in 1983, after 3 horrible years trying to be a retail registered rep. I started in a low liquidity environment. Further, I worked at small private partnerships, so I was a rowboat trying not to get squashed by ocean liners. Today’s conditions are not a complete aberration, IMO. You need to know what your time horizons are, and you need to adjust these when the market tells you to. Also, you need to adress the question of leverage. There are many more, but let’s start with that….
Good article, good commentary