Barclays’ US equity strategist Jonathan Glionna is worried about bond market liquidity.
Or, if Glionna isn’t exactly worried about it, he’s at least writing at length about how bond market liquidity could matter to equity investors in the future.
In a note to clients on Monday, Glionna looks at the role stocks play in hybrid mutual funds, which hold both stocks — which are liquid, or easy to buy and sell — and corporate bonds, which present more challenges when buying or selling and are more or less ground zero for concerns about bond market liquidity.
As a quick primer, the “liquidity” of an asset roughly approximates how easily an investor could buy or sell that asset without a material change in that asset’s price. For the last many months, people have been worried about liquidity specifically in the bond market, which has seen yields steadily grind lower despite prognostications from many a Wall Street forecaster that rates look set to rise.
Ultimately, liquidity is sort of a “you know it when you see it” kind of thing and making a claim about a market’s liquidity or illiquidity is something you can (more or less) proclaim without necessarily needing to provide good proof that that claim holds up.
But so as Glionna sees it, there are two things we know for sure: the size of the corporate bond market in the US has grown significantly in the last several years while turnover in that market has also decreased, implying that though there are more corporate bonds outstanding it is harder to sell them.
And in tandem with this — though not necessarily related in a chicken-egg kind of way — the amount of money under management in hybrid mutual funds in the US has exploded from around $US500 million in 2008 to over $US1.4 trillion in 2014.
In these funds, the asset mix is about 60% stocks, 20% corporate bonds, 10% Treasuries, and 10% cash, more or less.
And so given that these funds promise daily liquidity to investors, meaning that investors can redeem their shares in the fund at any point, it’s worth thinking about what might be at risk here if everybody wants out at the same time.
The cash is the first line of defence in the face of a wave of redemptions, but Glionna speculates that the stocks might be the next thing sold down because it’s simply much easier and cost-efficient to do so.
Among the most widely-held stocks in these hybrid funds are, as might be expected, high-yielding stocks that get the notorious moniker of “stocks that act like bonds.”
Large S&P 500 members widely-included in these funds include Microsoft, Wells Fargo, JPMorgan, and General Electric. S&P 500 stocks not among the index’s largest 50 members, but that get wide representation in hybrid funds include Lockheed Martin, Eli Lilly, and Danaher.
Glionna notes, however, that these funds seeking liquidity in the equity markets instead of the credit markets is seen as an “extremely low probability event.”
Though if you own any of the aforementioned stocks, Glionna’s point is that it’s at least worth thinking about who else owns these stocks and under what conditions they may be forced to sell them.
But above all else the point here is that the existential worries about what problems the US bond market liquidity may or may not pose at some future date doesn’t simply end at the corporate bond market.
The late-August sell-off seen in the stock market happened quickly and violently and, at the time, was attributed to some vague handwaves regarding “China” which, frankly, seemed overblown then as now. But something happened in global financial markets, something panicky, and the lesson, it seems, is that everything is vulnerable and worth worrying about.