|Stocks are flying high. Buying and selling them can be tougher than it seems.
Liquidity—how readily sellers can find buyers and buyers can find sellers—has been on the decline. That can mean higher costs and more volatile prices. The problem can touch traders big and small, from pension funds looking to hedge positions to retail traders jumping in and out of individual stocks.
Liquidity is difficult to measure, but it is likely to be a theme for investors in 2020.
“The number one client question in 2019 has been on liquidity,” Goldman Sachs analysts wrote in a December note to clients. The firm said earlier in the year that measures of liquidity have shown “high predictive power” when estimating volatility. The Federal Reserve also weighed in last year, listing falling liquidity in its compendium of risks to the U.S. financial system.
Liquidity in S&P 500 stock-index futures—a crucial market for hedging and making directional wagers—remains weak after dropping substantially during the late-2018 market swoon, according to Goldman. Among single stocks, it hovered near some of its lowest points of the decade in August, one of the latest periods of market turmoil. And an unexpected spell of turbulence also hit money markets in 2019, leading the Fed to flood the system with temporary funding.
It can even be onerous to trade shares of individual companies around the time of their earnings reports, according to a Goldman analysis of stocks in the Russell 3000, a broad U.S. stock-market gauge. Liquidity has dissipated on those days over the past four quarters, according to the bank, which measured how many shares are available to trade without having a significant impact on prices.
“You’ve got to have a stronger stomach than you used to have,” said Bill Smead, chief executive of Smead Capital Management, an investment firm. “When there’s no liquidity—how low it can go before it hits bottom—it can shake you up. It’s been a vicious circle for years.”
A corporate announcement these days can lead to a bigger stock swing than it would have in the past, he said. Mr. Smead says that means he can sometimes buy stocks for lower prices than he expected. That was the case when he picked up shares of Occidental Petroleum, which were punished in 2019 during a fight with activist investor Carl Icahn.
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