{"id":4080,"date":"2014-09-10T17:42:50","date_gmt":"2014-09-10T17:42:50","guid":{"rendered":"https:\/\/fundamentalis.com\/?p=4080"},"modified":"2014-09-10T17:42:50","modified_gmt":"2014-09-10T17:42:50","slug":"9-11-14-evaluating-bond-markets-liquidity-risk-the-silent-killer","status":"publish","type":"post","link":"https:\/\/fundamentalis.com\/?p=4080","title":{"rendered":"9.11.14: Evaluating Bond Market’s Liquidity Risk – the Silent Killer"},"content":{"rendered":"
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High blood pressure is widely known as “the silent killer” for good reason. This blog post is a continuation of our blog post <\/a>from 8\/5\/14 on liquidity in the bond markets.<\/p>\n

Today as an RIA managing individual investor money, and reading more about liquidity risk in the fixed income markets, I’m wondering if moving client’s fixed-income to predominantly a cash \/ municipal strategy at this point isn’t the right approach as taper ends.<\/p>\n

Despite the weekly August employment report last week, Fed Governor testimony seems to have become progressively more hawkish. Seriously, only Janet Yellen’s opinion matters in terms of the timing and degree of rate hikes, but despite\u00a0little indication of an acceleration\u00a0in the various inflation measures, the drumbeat grows\u00a0for “normalizing” interest rates.<\/p>\n

Is the end of QE3 and the end\u00a0of taper impacting liquidity\u00a0in the bond markets ? It could\u00a0be. I think “quantifying or measuring liquidity” or lack thereof\u00a0is difficult, particularly at the retail level, and even the bigger firms might try to\u00a0measure it, but there has to be a degree of uncertainty around all of it. As one Supreme Court Justice once said\u00a0around adult entertainment, “I can’t define it, but I know it when I see it.”.<\/p>\n

Here is the point of all this: last May ’13, when Fed Chair Ben Bernanke announced the Taper, and then again in late July, early August ’14, the taxable high yield market, as evidenced by the iShares, IBoxx HYG (taxable corporate high yield ETF) hit two sizable air pockets where the bottom just fell out of the market.<\/p>\n

In 2013, the HG suffered a 7% drop in a little over 6 weeks, as the HYG fell from a little over $96 to $89 in that time period. The drop in 2008 was far greater in absolute terms, from $100 in early May ’08 to $65 by December ’08 or roughly 35% in total, but a 7% drop in 6 weeks, if allowed to continue seems\u00a0equivalent to\u00a0a 35% drop over a 7 month time frame.<\/p>\n

A long-time friend and former colleague runs a $2 billion taxable portfolio here in Chicago. I asked\u00a0this individual for\u00a0their comments about liquidity (understandably,\u00a0this person\u00a0and the firm would prefer\u00a0anonymity\u00a0). Also Blackrock did an excellent whitepaper on the topic in June ’14 which they sent to me for usage and attribution on this blog. Here is a quick highlight of the Blackrock whitepaper’s important points (as I see them):<\/p>\n