Liquidity Crisis Coming: Here, There, Everywhere

Mike Mish Shedlock

Jim Puplava thinks a liquidity crisis is on the horizon. I agree, adding that the problem is global.

Please pay attention to Jim Puplava at Financial Sense. He says a Liquidity Crisis Looming.

In total, index funds represent $7 trillion of U.S. stock funds that have no active manager. All buying and selling are done automatically. Active management has gone out of fashion, Puplava noted, and as this sea change occurs, the market's ability to price companies diminishes.

Ownership of stocks in the S&P 500 is concentrated with three companies; Vanguard, BlackRock, and State Street. They represent about 88 percent of the S&P 500, and if we include Schwab and Fidelity, over 90 percent of the S&P 500 is basically now in the hands of five companies.

“It's really mindless investing,” Puplava said. “The crux of the problem is that mutual funds own more bonds that seldom trade than ever before, but they're still promising to pay out investors within seven days of redemption, a promise they may not be able to fulfill in the next downturn or crisis.”

Global Problem

The problem is global.

Central bank actions explain most of what you need to know. Italian bonds provide a good example.

Despite the recent, massive selloff in Italian bonds, 10-year Italian bonds still trade at roughly the same yield as US 10-year bonds.

Is there no default risk? No eurozone exit risk?

Of course there is. But those bonds trade where they do because the ECB is engaged in QE to a far greater extent than the the Fed ever did. How nuts is that?

88% of the S&P is with Vanguard, BlackRock, and State Street. How nuts is that?

Close to $7 trillion in bonds trade with a negative yield. The figure was close to $10 trillion at one point. How nuts is that?

According to LCD, covenant-lite loan now account for a record 75% of the roughly $970 billion in outstanding U.S leveraged loans.

Covenant-lite agreements vary, but they allow things like paying interest with more debt rather than cash or skipping repayments entirely for periods of time. How nuts is that?

Totally Nuts

This is totally nuts, across the board.

Puplava calls it "mindless". I suspect he would be the first to admit that he seriously understated the concern.

My "totally nuts" position is also too mild, but I also struggle for the precise words.

Crisis Looms

A global liquidity crisis looms. It is entirely central-bank sponsored.

Just don't expect me, Puplava, or anyone else to tell you precisely when the crisis will hit. But it will. And when it does, don't fool yourself into believing that you can necessarily escape in time.

Mike "Mish" Shedlock

Comments (19)
No. 1-19
Stuki
Stuki

“Index” funds, are the public’s best (still shitty, but it’s all that’s left) attempt at getting what a proper currency, like Gold, would offer for free: An “index” on the economy as a whole. Such that they get risk free participation in the overall growth of the economy. Without the kind of childish, ridiculous, and ultimately never more than self serving pretensions to “being clever,” that is being pushed by active managers, promising better than random results at picking random numbers.

All the nuttiness is due to the Fed’s promotion of “assets” as a whole. It’s not as if passive vs active management makes a lick of difference. Both groups are just picking random numbers, after all. The ones contributing meaningfully to price discovery, are insiders; people with access to non-public information they can trade on. None of whom have any particular incentive to share their edge with some pointless Fed welfare recipient in New York. For the rest, it’s all random anyway: Their best buy is their cheapest buy.

FelixMish
FelixMish

I'd be curious to know what percentage of ownership in the S&P companies their trade-able stocks represent.

And, am I reading correctly that Puplava says 88% of the total S&P trade-able stock value is held by Vanguard, Black Rock, and State Street?

Where does that leave all these often-repeated assertions about who owns the "wealth" of the US? As in, how does one know who owns shares of V, BR, and SS funds?

OkieNomics
OkieNomics

Wait a minute. I've traded equity positions with three of the companies list among the five in the article (Vanguard, Schwab & Fidelity). They were the trading platform and custodians of my positions. But my trades were my decisions, a few in index funds but mostly individual equities. Is there data on what percentage of the S&P 500 is owned via index funds? Just identifying the custodians doesn't necessarily translate into a liquidity crisis.

shamrock
shamrock

"88% of the S&P is with Vanguard, BlackRock, and State Street": the article provides no source or proof of any kind for that assertion. On it's face, it is simply not possible. False, fake, whatever you want to call it.

CautiousObserver
CautiousObserver

Regulators better be doing a good job ensuring these custodians are not fraudulently managing client funds. There will be riots if another MF Global is allowed to happen.

RonJ
RonJ

"This is totally nuts, across the board." As Chuck Prince said, you have to keep dancing while the music is playing. To strike up the band, congress told FASB to allow banks to lie about the value of assets. The bull current bull market began immediately after. Corporations have been borrowing hundreds of billions of dollars collectively, to artificially pump up stock prices. The Swiss and Japanese central banks have bought up bought up billions in stock. Interest rates are supposedly at 5,000 year lows, with some rates having gone negative. 5,000 years ago, that is effectively the dawn of civilization. Yes, this is nuts, across the board.

CautiousObserver
CautiousObserver

Mish said: “My ‘totally nuts’ position is also too mild, but I also struggle for the precise words.”

The words you might be looking for are “Control Fraud.”

abend237-04
abend237-04

FUBAR is the term you're looking for Mish. We always used it in communicating when a large system's quickest recovery path involved power off and re-boot. Now, all that's needed is for all politicians and their central banks to admit their actions have led to a state of FUBAR...

AWC
AWC

Yup, any day now, maybe even in the next 20 years.

AWC
AWC

Vanguard, Black Rock and State Street would be nationalized before being allowed to fail. Moral Hazard, dontchaknow? It’s, like, in the interest of national security, or some such authoritarian BS.

TSPsmart.com
TSPsmart.com

Using Yahoo holdings data, while institutional investors hold 65-80% of larger companies, these 3 firms hold 15-20% of the institutional holdings meaning only about 15% of the SP500. Some of the institutional holdings would be in active ETFS and mutual funds.

thimk
thimk

misleading data as pointed out by El_Tedo. The point to be taken is that etf's can trade at a discount or premium to NAV. large,rapid swings in prices can exasperate this disparity. Normally these differences are arbitraged away. Will the middleman V;BR; and State street absorb the losses if they can't be reconciled in an illiquid market? that's my take. etf's are the tail wagging the dog.

kpmyers
kpmyers

More fuel for the liquidity crisis...let's not forget about the $13 Trillion in consumer debt that was acquired when interest rates were 200 bps lower...how will that get rolled over in a rising interest rate environment? The non-bank lenders/Shadow Banking Fintech Billions of dollars in real estate loans will also be an accelerant.

TheWindowCleaner
TheWindowCleaner

Yeah we can wallow in the disgraces of the paradigm of Debt Only or we can turn capitalist economies around with the price deflation that a discount/rebate policy at the point of retail sale will effect. It's either pain, chaos and collapse or greater profit, joy and rejuvenation.

truthseeker
truthseeker

I don’t think most people understand what a liquidity crisis really is and think that no matter what happens, they’ll b able to sell their stocks and bonds when they want. When they are told this means there r no bids, no buyers for their investments at any price, except for maybe pennies on the dollar, they go into shock looking for someone to blame for stealing their assets. Yet I think what will b much more dramatic with regard to liquidity will b those assets where there are absolutely no sellers at any price in any currency. Of course that will cause governments around the world to rise up with an emergency response to blame and go after those they know who have hoarded food, medicine and precious metals as martial law takes effect and tanks come rolling down the street!

Advancingtime
Advancingtime

In a panic or crisis, one of the first things to go is liquidity!

We should not forget that a "liquidity trap" differs from the standard liquidity problem. In many ways, it is just the opposite. This causes a great deal of confusion in that it can be difficult to comprehend why too much liquidity is an issue.

This is why it is important to look a little closer at these two terms and what they represent. The article below looks at the ramification from each as they play out and how they affect the economy.

shum
shum

My pension provider just wrote to me saying that 'due to an efficient market...' .. 'we are no longer offering managed funds..' - they now give you a choice of passive funds.

When everyone's thinking the same, then no-one's thinking. Even worse, no-one now is even pretending to think.

Casual_Observer
Casual_Observer

Read John Mauldin's latest series talks about the next crises in the Bond markets.


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