The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

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annarborgator
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Joined: Sun Jun 17, 2007 5:48 pm

The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

Post by annarborgator »

Hmm. I wish I had more sophistication in order to understand this stuff a little more robustly. Can anyone give any further insight? Snip below, but please go read the entire post and check out the charts for the full effect.
As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so... until it fails and we witness a repeat of the August 2007 quant failure events... at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.

So what happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades. When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility. Furthermore, high convexity names such as double and triple negative ETFs, which are massively disbalanced with regard to underlying values after recent trading patterns, will see shifts which will make the November SRS jump to $250 seem like child's play.

For readers curious about just how relevant liquidity is in the current market, I recommend another recent post that discusses DE Shaw's opinion on the infamous basis trade, in which their conclusion was that establishing a basis trade, which is effectively the equivalent of selling a put option on market liquidity, ended up in massive financial carnage as the market rolled from one side of the trade to another. Is it possible that what the basis trade was for credit markets (most notably Citadel, Merrill and Boaz Weinstein), so the quant unwind will be to equity markets?

So when will all this occur? The quant trader I spoke to would not commit himself to any specific time frame but noted that a date as early as next Monday could be a veritable D-day. His advice on a list of possible harbingers: continued deleveraging in quant funds as per the charts noted above, significant pre-market volatility swings as quants rebalance their end of day positions, increasing principal program trading by Goldman Sachs on decreasing relative overall trading volumes, ongoing index VWAP dislocations. One thing is for certain: the longer the divergence between real volume trading/liquidity and absolute market changes persists, the more memorable the ensuing market liquidity event will be. At the end of the day, despite the pronouncements by the administration and more and more sell-side analysts that the market is merely chasing the rebound in fundamentals in what has all of a sudden become a V-shaped recovery, the "rally" could simply be explained by technical factor driven capital-liquidity aberrations, which will continue at most for mere weeks if not days.
http://zerohedge.blogspot.com/2009/04/incredibly-shrinking-market-liquidity.html

I'm convinced that ZH is one of the best market blogs out there, but this is honestly a little over my head to fully digest.
I've never met a retarded person who wasn't smiling.
radbag
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Joined: Mon Jun 18, 2007 6:59 am

The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

Post by radbag »

wes - one point i'd like to add...there has been NO liquidity the last year and a half....none....so therefore, saying that liquidity is shrinking is somewhat of a falsehood.

you yourself have been very critical of the current administration in that they've not done anything substantial the last year to improve upon the capital markets liquidity.

the renaissances and the medallions of the world have been less of a market force the last year and a half to two years than they've been...look at this current market, as it relates to liquidity, as an extended 'work shortened friday before a holiday'...typically, fridays before holidays are half days, trading desks are usually half-staffed, and trading desks are usually just going through the motions....junior traders are manning the desks and are told not to trade unless the senior trader is abreast of the situation or the situation can not be avoided...markets don't typically move as the main market participators are usually home kicking off the holiday weekend...having said that, in this current market environment - we've got extremely high unemployment (less market participants), merging of institutions and trading houses (even less market participants), diminishing corporate gains (less capital dedicated to invest which negatively impacts liquidity), prevailing thought that the end to this economic malaise we are currently experiencing seems not to be in the immediate future (even less capital dedicated to liquidity and more capital to be hoarded)...it's no wonder liquidity has not improved...forget the fact that these participants still have toxic assets on their books precluding them from trading naturally....forget the fact that gov't has stepped in and handcuffed some of these participants from trading naturally.

as a result of the liquidity crunch the last 2 years, we've seen massive swings in the dow, massive swings in the spread markets, and massive swings on evaluations of everything...simply stated, the market affects of a market participants actions, either to buy or to sell (buys rally the market, sells lower the market), in this current market condition, are exaggerated and have a greater impact on the market as a whole.

i guess i'm arguing that less market participants have more to do with liquidity crunch than the effects of program trading
annarborgator
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Joined: Sun Jun 17, 2007 5:48 pm

The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

Post by annarborgator »

Your position makes good sense. I wonder if, since there are less mkt participants, the moves made by quants are also being amplified. Definitely possible.
I've never met a retarded person who wasn't smiling.
radbag
Posts: 15809
Joined: Mon Jun 18, 2007 6:59 am

The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

Post by radbag »

indeed they are AA. indeed they are.

but as the blog suggests...the quants are the only ones involved at the moment...real money is on the sidelines and awaiting better times, more confident times let's say...the real money is the money that supports the market and sustains good bull markets...the quants activites don't support the market...their activities don't qualify a good or healthy market...their affects either enhance it during good times or they mask the markets during the bad times.
annarborgator
Posts: 8886
Joined: Sun Jun 17, 2007 5:48 pm

The Incredibly Shrinking Market Liquidity: Upcoming Black Swan of Black Swans

Post by annarborgator »

And I guess the question at this point is: How long can the quants keep hiding the truth about this weak market? I'm guessing that at some point in the next few weeks, they will run out of steam and the market will test the lows and possibly make new lows.
I've never met a retarded person who wasn't smiling.
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