The realization that there is, as of this moment, at best negligible and very often zero liquidity in bonds (or even stocks) is known by most: a topic we first discussed back in the summer of 2013 (a good place to start is Phantom Markets: Why The TBAC Is Suddenly Very Worried About Market Liquidity ) has become so pervasive that even the BIS admitted last week bond market liquidity has cratered, with some estimates suggesting that corporate bond liquidity is down 90% since Lehman, mostly thanks to central banks' unprecedented absorption of some $5 trillion in "high quality collateral" from the private market.
In fact, moments ago the head of the Bank of England himself, Mark Carney, warned about the risk of "disorderly unwinding of portfolios " due to the lack of market liquidity.
"Market adjustments to date have occurred without significant stress. However the risk of a sharp and disorderly reversal remains given the compressed credit and liquidity risk premia," Carney told a news conference after a meeting of the FSB.
"As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets ."
Liquidity, which is increasingly synonymous with the inverse of Fed counterparty risk because in a world in which the Fed has onboarded virtually all risk, there is no need for market-making since only buying is encouraged and any concentrated selling leads to an immediate market break, has become such a
buzzword, it is the topic of Howard Marks' latest letter.
We will skip the big picture of Marks' observations on how we have reached this sad state and what will eventually happen in a market devoid of liquidity, as most of it has been covered before, but we will focus on what Howard Marks thinks will happen in a far more murky and misunderstood aspect of modern markets: the synthesis between ETFs and underlying securities. Because while nobody doubts that liquidity in underlying cash instruments has rarely been worse, this is offset by substantially better liquidity in the ETF space if only superficially, thereby allowing amateur "analysts" to disregard the reality of systemic liquidity shortages and focus on what the red pill reveals: why, just look at how liquid the JNK is .
Well, no. This is what Howard Marks thinks about ETFs and the phantom liquidity impression they create. For the impatient ones, here is a spoiler alert: think Auction Rate Securities.
ETF-like vehicles, sometimes known as “tracking shares,” began to appear in the early 1990s, and they proliferated significantly after 2000. According to Wikipedia, “As of January 2014, there were over 1,500 ETFs traded in the U.S. with over $1.7 trillion in assets.” (Several years ago I cited Wikipedia in a memo, and Oaktree co-founder Richard Masson – a stickler for correctness – told me in no uncertain terms that it wasn’t a respectable source. I think things have changed enough since then, Richard: I’m citing it!)