Investors are deserting markets and clawing back money from hedge funds - echoing the run-up to the financial crisis
- Evidence is mounting that market liquidity is drying up, a report from Deutsche Bank released in the final days of 2018 says.
- Slumping liquidity, or fewer investors buying and selling, raises concerns for 2019, a team of analysts from the bank wrote.
- Such a decline, they said, has echoes of what happened prior to the financial crisis.
- "We recall that the unwinding of quant funds in August 2007 and macro funds in October 2015 were harbingers of subsequent market turbulence."
Declining liquidity and a surge in the number of hedge fund redemptions have eerie similarities to events prior to the financial crisis and could be "harbingers" of further market turmoil to come in 2019.
Writing on December 28, a Deutsche Bank team led by analyst Masao Muraki said that liquidity has started to dry up in certain areas of the market, and that this is a concern for the already battered global stocks. Lower liquidity generally means bigger swings in market prices because fewer trades generate a bigger impact on the market.
As liquidity declines, Deutsche Bank's analysts write, so the number of hedge fund redemptions increases, something that could be not only a "harbinger" for further market volatility, but that also has echoes of the months before the financial crisis.
"News of hedge fund redemptions has emerged since October 2018," Muraki and his team wrote. "The sustained high level of volatility has worsened the profitability of consensus trades based on market momentum, and the fall-off in market liquidity has generally hurt their performance as well."
If the markets continue their negative trajectory, and early signs in 2019 are that they are likely to do so, then falling liquidity could help make downward moves even larger.
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"We recall that the unwinding of quant funds in August 2007 and macro funds in October 2015 were harbingers of subsequent market turbulence," they continue.
Evaporating liquidity in parts of the market in late 2007 is seen by many as one of the first concrete signs that the financial crisis was beginning to crystallize.
In August 2007, France's largest bank, BNP Paribas, froze withdrawals from three investment funds, citing "the complete evaporation of liquidity in certain market segments, which it said "made it impossible to value certain assets fairly regardless of their quality or credit rating."
The event was cited by Alistair Darling, the UK's Chancellor of the Exchequer at the time, as the moment he knew that a major crisis was on its way.
Deutsche Bank is not the first institution to warn about falling liquidity. Back in July 2018, Rick Rieder, the chief investment officer of global fixed income at asset management giant BlackRock said that tightening policy from global central banks is straining bond market liquidity and is starting to send shockwaves through markets
Muraki and his team's report ends on a somewhat reassuring note: things are not yet at pre-crisis levels.
"We believe the level of maturity and liquidity transformation in advanced economies is lower than before the global financial crisis," they conclude.