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Dwindling liquidity set to remain a ‘concern’ for stocks as long path to normality lies ahead for economy



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With a long road to normality for the U.S. economy still ahead, investors may need to turn their attention again to the scarcity of liquidity in financial markets.

The link between liquidity and volatility has become tighter, creating feedback loops that can see elevated uncertainty prompt liquidity providers to rein in trading and thus exacerbate market turbulence, quant analysts at Société Générale say.

That could mean investors basking in the euphoria of positive vaccine developments are sitting in a more precarious situation than they might think.

According to analysis by Sandrine Ungari, head of cross-asset quantitative research at Société Générale, in a Tuesday note, liquidity remains at the bottom of measured levels since 2014, and has closely tracked levels of the ups and downs of the market.

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Société Générale measured liquidity by looking at the average difference between the price offered and the price bid among orders to buy and sell the S&P 500 index at the best available price.

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Yet amid the buoyant mood in risk assets, many have overlooked how this lack of liquidity could prove troublesome in future market selloffs.

See: Dow tops 30,000 for first time as stocks extend rally on COVID vaccine optimism

The CBOE Volatility IndexVIX, which measures the implied volatility for the S&P 500 over the coming 30 days, pushed above 30 in the run-up to the U.S. presidential election on Nov 3, but has since steadily declined.

Muted volatility has accompanied double-digit equity gains. The S&P 500 has advanced 10.7% in November, while the Dow has risen 13% over the same stretch.

But months of economic uncertainty still lie ahead until a viable COVID-19 vaccine is widely distributed and this means “a path to normality is probably going to be a long one, with bumps along the way,” Société Générale’s Ungari said.

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