Liquidity Vacuum Leaves Stocks Easiest to Sell for BofA Analystby
Savita Subramanian says S&P 500 will eventually bounce back
Hedge fund stocks again fall more than the broader market
Equity markets were paying a price for vanishing liquidity around the financial system Friday, with investors who face losses in things like credit and commodities trying to raise cash by selling assets they can find ready buyers for.
That’s according to Savita Subramanian, the chief equity strategist at Bank of America Merrill Lynch, who said in an interview that the withdrawal of Federal Reserve stimulus and curbs on bank risk-taking are contributing to the selloff. The Standard & Poor’s 500 Index slid as much as 3.3 percent Friday, the biggest drop in four months.
“You have to rank asset classes by liquidity,” she said in a telephone interview. “The most liquid asset class is the U.S. large-cap equity market, which has the largest trading volumes, is the easiest to sell, and bid-ask spreads are narrow.”
More than 8.6 billion shares had traded on U.S. exchanges as of 3:30 p.m. Friday after averaging 9.5 billion in the week’s first four days. That’s up about 40 percent from last year.
Concern has been percolating for months that trading curbs enacted after the financial crisis would jack up volatility across asset classes when speculators decided to sell. Subramanian, whose year-end forecast of 2,200 for the S&P 500 is 17 percent above its level now, says the same qualities that hurt large caps today will hasten their recovery.
“There could be more pain to go but the good news is bear markets without a recession are typically followed by a swift recovery,” she said. “What we’re seeing is a liquidity meltdown, positioning and some technical factors. If credit sensitivity is being punished and liquidity is being rewarded, the S&P should be favorable right now.”
Liquidity was working against bulls within the stock market itself, with selling heaviest in companies where ownership is most concentrated. The 20 stocks with the highest hedge fund ownership declined 3.4 percent while among the 101 companies in an exchange-traded fund tracking momentum stocks, last-year’s best-performing strategy, 96 declined.
The rebound Subramanian anticipates will have to come with equity valuations elevated relative to historical levels. At 21 times reported income, the S&P 500 traded 24 percent higher than its average since 1936, and at a level that exceeds those seen in seven of the last eight bull-market peaks.
A scenario in which hybrid funds carrying big slugs of both debt and equities could be hard hit in a liquidity crunch and pick the stock market to do their selling was described last October in research by UBS AG. Analysts at the bank estimated that such funds owned about $843 billion in equities at the time, most of it the blue-chip variety.
“Unlike the other two credit-equity links, which are a higher cost of capital for junk-rated heavily levered small caps and a general reduction in risk appetite, it turns out that the mutual fund link directly affects large-cap highly-rated equity,” analysts Ramin Nakisa, Stephen Caprio and Matthew Mish said.
Financial and technology companies led losses in the S&P 500 Friday as only 45 companies in the gauge advanced. Goldman Sachs Group Inc. fell 3.4 percent, Exxon Mobil Corp. slid 2 percent, and Citigroup Inc. and Wells Fargo & Co. lost at least 4 percent even after reporting quarterly earnings that topped projections.
In credit markets, the cost to protect against defaults by North American companies soared to a three-year high. The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, jumped to the highest since November 2012.
“The market is throwing a bit of a tantrum at the Fed call in December but what’s more problematic is the fact we’re in a liquidity vacuum,” said Subramanian. “I don’t think it has to do with the Fed as much as general need to lower risk exposure.”