As it stands, it looks like the markets may indeed have bottomed around the time of the March options expiry – as discussed in earlier posts. This, as we noted at the time, is not without precedent; the March futures and options expiry is often either a direction confirmation or a turning point for markets. The first major ‘roll’ of the calendar year, it is a time when risk aversion, either building or declining in January and February, has the option (sic) to either double down or quit. We saw  this most visibly perhaps as the turn in 2009 after the GFC, but also after the second gulf war. Indeed, a seasonality chart for the last 20 years on the S&P 500 would show on average mid to late March as being the low point of the first half.

If we look at the first chart, we can see Vix peaked (shown inverted) the day before expiry. Given Vix can be thought of as the price of put options, we can interpret this as a peak price for protection. Rather like the contango in Oil, the closing prices were reflecting liquidity needs more than fundamentals and with that out of the way, markets shifted back towards the latter from the former.

Chart 1. Vix (inverted) looks to have peaked just at March expiry

Talking of liquidity, the chart also highlights something else rather interesting. The aggressive sell off in two bond ETFs, LQD and NEAR. The first tracks the investment grade bond index and the second is a much shorter dated version (average maturity around 8 months). Both got hit very hard as the Covid-19 related market hits were taking place as shown in the second chart (indexed to 100 at the start of the year). However, this was not, as some might see it, about a sudden concern about corporate cash flow. It was rather more of a concern about investor cash flow.

The notion of an equity (ETF) with daily liquidity investing in assets without that liquidity (corporate bonds, especially junk) has always been troubling. After all this was essentially the whole problem with the CDS debacle; institutional investors were told that low volatility but illiquid derivatives were actually lower risk than equities. Following the crisis, when the Fed were obliged to buy and hold the CDSs to maturity to prevent a market meltdown, the same investors were then encouraged by the same ‘rules’ to buy illiquid bonds in a different wrapper pretending to be liquid, in this case bond ETFs. This time we had the additional frisson of issuer counterparty risk. As such, fears that investors would be gated in the manner of an illiquid fund led to a run.

Chart 2. The sell off in March was a classic liquidity panic – bailed out by the Fed

Which leads us to the point of the title. The ‘run’ on the ETFs raised some serious short term concern about the prospects for the providers, including the biggest fund manager in the system, Blackrock, whose multi-trillion $ business is clearly way too big to fail. In effect, the Fed just back-stopped Blackrock funds by offering to buy the illiquid bonds through direct purchase if necessary. In that, and the concept of using an SPV, this is very similar to the role they played as lender of last resort in the GFC, when the lack of liquidity in Credit Default Swaps (ultimately also a derivative of illiquid credit pretending to be liquid) threatened a disaster. Not surprisingly, Blackrock jumped sharply on the news. (chart is indexed for Blackrock, Blackstone and S&P 500 as March 20th =100)

Chart 3. The market immediately put the ‘Black-stocks’ back in the Black

Meanwhile, Blackstone, the giant private equity business also stepped up, announcing that (at last) they have something to spend their $150bn dry powder on. With the Fed backstopping junk bonds, the opportunity for them looks very sweet.

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