At Smith & Williamson we pride ourselves on the efficiency and skills of our dealing team, who processed over £9bn of trades last year, and saved clients millions of pounds by achieving excellent prices. But in recent weeks our team, with over 150 years’ combined experience trading, including during the 1987 crash, 9/11 and the Global Financial Crisis, have seen unprecedented and difficult conditions.
The extremely unusual behaviours seen in many markets are having an impact on pricing and valuation, as well as proving a challenge in maintaining orderly dealing operations. Our clients and investment managers need to be cautious when trying to trade, and wary of reading too much into market prices impacted by short-term trading issues.
In recent weeks we have seen intra-day index swings of 10% from high to low, and stock price swings routinely exceeding 30-40%. These have reflected the COVID-19 crisis and also extremely poor market making liquidity.
Many smaller UK Equity orders would normally trade electronically via market makers. However, as a result of the increased volatility, where rapid price changes can occur every second, they have reduced maximum order sizes or sometimes making neither a bid nor an offer.
That has meant a much higher percentage require dealer execution trying to source alternative liquidity via our electronic access to exchanges (including the London Stock Exchange) and other liquidity venues. So not only have our team been under huge pressure to source liquidity in a timely manner (while ensuring best execution), but also the whole market has become slower and less efficient.
The spread between buying and selling prices in FTSE 100 stocks (the bid-offer spread) increased by 46% last week, while for stocks traded in Paris and Frankfurt the increases were 44% and 70% respectively.
Last week volatility in the FTSE 100 index increased by 197%, by 249% in Paris and 229% in Frankfurt. Meanwhile, liquidity fell by 40% in London, 40% in Paris and 45% in Frankfurt.
Where before CO-VID19 market makers would make two-way prices electronically they are currently with fast moving markets either bid or offer or no price returned. For example, last Friday in Reckitt Benckiser, a FTSE company with a robust business model, market maker was offering to buy or sell shares. Similar problems were seen in other blue riband names such as BP or AB Foods.
And trading conditions have been worse in listed investment funds, with the most popular, such as FTSE 100 constituent Scottish Mortgage, seeing limited market maker liquidity while the more specialist funds have seen prices marked down significantly but with no, or few, actual trades. We discuss these issues in our note on property REITs here: Real Estate: Discounts and the long-term resilience of REITs.
These unusual conditions are not just being seen in equity markets. Liquidity in bonds has been at an all-time low. The large investment banks have limited risk capital and no risk appetite, even in the most highly rated AAA Government bonds in US and UK. Credit spreads are widening, particularly in higher yield, riskier bonds. Recent government interventions should help increase liquidity, but these will take some time.
Even passive investments, such as Exchange Traded Funds (ETFs), are experiencing odd conditions. In all the previous ‘crashes’ the ETF market didn’t really exist. The effect of the index hugging ETFs having on the market moves is not yet fully known. However, it can only self-perpetuate and exaggerate moves when have forced selling of illiquid names. Some ETFs are trading at a wider than normal spread and, on some occasions, not tracking the underlying index, with limited liquidity available.
While we continue to be able to operate in these unusual conditions, we also advise clients to proceed cautiously, avoiding trading in a rush or inflexibly. Our investment managers are working closely with clients and our dealing team, and having time to prepare to act opportunistically should be a great advantage in fast moving markets.
Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back, in total, the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice. Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
Smith & Williamson Fund Administration Limited is authorised and regulated by the Financial Conduct Authority.