0. Preface
I am not a financial advisor, and I do not provide financial advice. Many thoughts here are my opinion, and others can be speculative.
TL;DR – Equity market liquidity has collapsed at the start of 2022 and the global political conditions are increasing the risk of a complete liquidity crisis.
1. Liquidity in the markets
Every earnings report for blue chip stocks seem to influencing the price of the underlying more and more. Volatility indexes have started to peak and have remained high and the health of the global economy is starting to show signs of illness. This volatility and lack of liquidity has meant that it is more difficult for financial institutions to exchange stocks for cash at the speed in which they might need to.
Liquidity evaporates when underlying value of your collateral experiences a harsh correction. When multiple major market participants experience this at once, it triggers a liquidity crunch. Profitable positions get sold off, in an effort to reach a net-neutral exposure. If this cannot be achieved, margin debt can be called back by creditors. Too many, or too many high-dollar, margin calls will inevitably lead to a credit crunch, where lenders risk-off (pull liquidity).
If the price of one of their holdings decreases rapidly, they need to come up with money fast. This leaves us with an issue as the lack in liquidity means that money is not as readily available. Bid/ask spreads are widening and fewer bid orders are in the order books. This means its harder to trade securities especially in larger quantities.
There is a second problem – if the institution needs to sell those securities to raise capital, if the other institutions are having the same liquidity problems – there is no buyer for the sell.
If no one has any money… The stock continues to tumble and the vicious cycle continues.
This is why we’re seeing huge swings in stocks that usually aren’t volatile (amazon, meta, nvidia, etc.).
02. Blue chip volatility
Amazon spiking 10% on earnings
03. Leverage
Margin debt and leverage have been used and abused with low interest rates. With rate hikes we are likely to see the stock markets inflated appraisals crash through the roof.
TLDR-TLDR – Equity market liquidity has collapsed at the start of 2022 and the global political conditions are increasing the risk of a complete liquidity crisis. The amount of leverage in the financial system, the risk of a war and the devaluation of the American dollar have accelerated a stock market crash and we are seeing the early stages of the biggest correction in history.