Wednesday, September 16, 2015


We're heading back East tomorrow for a christening so I may be off the air for a few days--except for commenting on what the Fed does tomorrow--but afore I go I wanted to come back to the issue of market liquidity on which I have been harping.

About a month ago, an analyst from Citibank wrote a thoughtful and interesting piece on the subject which I have been thinking about ever since.  Taking out the graphs and charts his thesis, reduced to simplicity, is that it is not so much the reduction or absence of market making functions about which we should be worried but the very nature of the financial markets themselves.  In his mind the individual investment decision making process has somehow become one of the herd concept of investing: one big cow moves in one direction and all the cows follow.  At the end of the day there is little distinction in the portfolios of the major players and as a result--having learned from the same playbook, if one moves, all move in exactly the same direction.  Or to put it another way, if you want to sell it's a pretty safe bet that so does everyone else.  Result?  No bids.

I think he's right but the theory, with a bit of a different take, is not new.  It is a variation on the theme that has worried many of us for years, especially when we hear the stertorous tones of the talking heads on TV telling us that the first rule of investing is to diversify.  Yeah?  With whom, since every mutual fund out there is holding the same thing.  Well, between different strategies is the answer--a little of this, a little of that.  Financials, emerging markets etc., etc.  OK that's fine but these days it seems when the market decides to move in one direction, everything moves.  Mind you, it takes a pretty big event to have that happen but...SURPRISE!...right after the publication of this paper we had one called China.  But on the way back towards stability, a funny thing happened.

I remember watching CNBC as the equity markets imploded and hearing their best and brightest breathlessly report that Treasuries had not moved...nor had Bunds, nor had any public sector fixed income.  "What illiquidity," was the cry.  "Surely there has to be a flight to quality but Treasuries have held firm."  In fact the 10 year hardly budged, nor did the 2 year and I said to myself, "boy, are you wrong about this liquidity thing."  And I forgot about it for a day or two and then I literally woke up with a start.  Dummy, the reason nothing is moving was that somebody was selling into the thing and doing it very well and with great care.  Yep, surely there were our old friends the Chinese unloading Treasuries and other things to raise cash--a lot of it--and obviously getting help in so doing.  DUH!  Candidate for dope of the year.

Now I couldn't find anyone to admit it but I'm as certain as I can be that it was the Fed, which as far as I am concerned is just fine.  After today's outburst from Goldman's Chairman Mr. Blankfein concerning the "ham-handed Chinese," I would also be prepared to wager some serious money that Goldie was not in on the trade.  In fact, I'd be prepared to further wager that Goldie was long and seriously wrong when all this went down.  Couldn't happen to a finer group of people.  In any case, there's your liquidity provider in the biggest mess we have seen in years, The People's Republic, and as we used to say in the old days, they deal in sizzzze.

But stop a minute.  In this case we had an entire market looking to buy and one big player looking to sell, a player so big that it provided the liquidity as a result of an event that had really very little to do with the market in Treasuries itself.  Kismet.  But if you have been keeping track, one of the unsettling changes that has occurred as of late is a reversal of conditions and behavior in all of the emerging markets.  For years this class has been doing reasonably well and accumulating reserves.  As of late they are doing not so well and seeing their reserves fall: from deliberate monetary actions to protect their currencies and through the switch from current accounts surpluses to deficit positions across the board.  In recent weeks, this trend has accelerated.  As of yet, there is no end in sight.  If it continues, will there be the buyers needed when the emerging markets all come looking for a bid?  And how would a Fed move affect this scenario?  Will credit spreads rise for this class of borrower (many are highly indebted) and  cause an acceleration of cash raising and capital flight?  More importantly, I wonder if anyone is thinking about this.  Certainly not the equity guys.  DOW was up 160 at the close.  OUT, OUT DAMNED QUARTER PER CENT!  The bet on the street is the Fed stays pat.  The New York Times has told them to do that, and today Larry Summers did the same.  You can be sure Janet and Billy the Dud are looking for cover and now they have it.  I bet no but what do I know.

Let you have a few brief thoughts tomorrow...or Friday.  Hard to get there from here.

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