Goldman: 2019 – Reduced Liquidity, Better Vol, Extra Fragile



In June 2018, Doug Cifu, co-founder and CEO of Virtu Monetary, bragged to Goldman Sachs about the liquidity, performance, and transparency that the new industry composition sent to market place individuals…

“If you’re a buy-aspect institutional investor comparing your liquidity to, say, 15 a long time back, you need to have to look at not only how a great deal liquidity you had been having back then, but also what spreads you were spending and the information you have been giving up.”

Since then, markets have tumbled and with them, liquidity has utterly collapsed recently 

…and regrettably, in a perverse feedback loop, the more equities fall, the even worse the total S&P liquidity, as the pursuing chart from Barclays present, depicting the collapsing bid/ask sizing in the Emini, which is now do to the cheapest on record.

So six-months just after Cifu’s responses, Goldman asks – Where by we stand now:

  • Volatility rose all over again and stayed elevated. A period of very low volatility article the technically driven spike in February—when the VIX achieved 50—ended in October, as waning expansion expectations helped set off an equity market market-off. Irrespective of a around 14% decrease in the S&P 500 due to the fact its September 20 peak, the VIX did not best 30. Nonetheless, equity market volatility has remained elevated, likely signaling a far more sustained period of larger volatility.

  • Inverse VIX ETPs – just one of the principal drivers of the February VIX spike – stay diminished. Without a doubt, these goods now make up considerably less than a quarter of all VIX ETPs (versus extra than 50% in December 2017). That means a re-operate of the ETPdriven February VIX party continues to be unlikely, at least in the in the vicinity of expression. Nevertheless, development in investments that need nearinstantaneous liquidity continue to operates the risk of occasional liquidity mismatches—and the corresponding marketplace influence.

  • Enhanced vol of vol has remained a crucial feature of 2018, especially in the US. In other phrases, several asset lessons have endured a lot quicker and larger sized cost swings relative to background right immediately after intervals of relative calm. Illustrations contain the February/October equity current market drawdowns the Italian government bond promote-off in June and oil’s value swings this fall. In a different noteworthy trend—and a break with previous norms—European fairness markets have been fewer unstable than their US counterparts in 2018.

  • Deteriorating liquidity ailments surface to be a essential driver of higher volatility. Best-of-e-book depth—a measure of marketplace liquidity—has been declining: the regular bid/request depth for E-mini S&P 500 futures in 2018 was reduced than in any yr considering the fact that 2011, and has ticked down more because we printed in June. This pattern is significant, as realized volatility tends to rise when market depth falls. Without a doubt, prime-of-e book depth has outperformed current understood volatility, current implied volatility, and volumes in predicting realized volatility.

  • Technical factors and market place composition may also be contributing to erratic cost motion. These incorporate professional-cyclical financial investment procedures, this kind of as Commodity Buying and selling Advisors (CTAs), vol targeting, and chance parity levered or liquidity-constrained exchange-traded merchandise significant frequency traders (HFTs) and gamma outcomes from extraordinary alternatives positioning, these kinds of as WTI oil puts in October or S&P 500 calls in February.

And extra importantly, what to appear for in 2019 (and past):

  • Elevated volatility… Our forecasts for financial progress suggest a baseline amount of S&P 500 regular realized volatility of 13.4 in 2019 liquidity metrics by yourself place to a larger stage of 19.1. We count on volatility in this vary early upcoming yr, with the positioning of expert investors as a essential indicator of no matter if volatility will be closer to the reduce or the increased conclusion.

  • …but fundamental support stays. Even with slowing world-wide macro progress and deteriorating liquidity, a 2019 economic downturn however appears to be unlikely. Likewise, a considerable acceleration in US corporate earnings appears to be not likely to us. We consider this would make extraordinary one particular-year results much less very likely than the SPX options marketplace is pricing (+/- 16% complete return).

  • Opportunity for liquidity-driven dislocations. We feel lower liquidity raises the danger of limited-expression current market dislocations without considerably impacting assets’ lengthy-expression fundamental value. Hence, our equity derivatives investigation team likes owning direct sorts of short-term volatility (e.g., ahead commencing variance, VIX) and selling fastened-strike strangles to posture for a variety-sure marketplace more than the for a longer time expression.

  • Challenges that “liquidity is the new leverage.” We have cautioned that very low marketplace liquidity could demonstrate to be an crucial and underappreciated possibility, analogous to surplus leverage in the last cycle. For illustration, proof suggests that in periods of pressure (especially close to macro catalysts) HFTs may well withdraw liquidity much more aggressively than human traders, triggering liquidity to dry up when it is desired most. Top rated of Intellect interviewees have also cited expanding equity sector fragmentation—as nicely as the regulation aiding to drive it—as a element contributing to current market strain this will be important to observe in the decades forward.

  • Favourable returns for threat property, but with motives to hedge. We feel above-craze financial development nonetheless details to constructive hazard asset returns over the medium term. But specified raising tail risks and the liquidity/volatility fears mentioned in this article, we recommend hedges these as gold and the Japanese yen, as well as an obese in income in our asset allocation.

  • A desire for excellent. In addition to hedges, we endorse buyers place for a additional volatile, late-cycle natural environment by shifting up in top quality. In the fairness and company credit space, that means looking for out companies with reliable stability sheets and pricing power, which really should help secure versus cyclical headwinds.

So less liquidity, much more volatility, and the looming enamel of fragility increasingly existing…and ideal on plan, VIX is commencing to keep track of the Treasury produce curve to greater volatility.



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Goldman: 2019 – Reduced Liquidity, Better Vol, Extra Fragile

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