One of the best ways I’ve heard people describe the stock market is as a Complex Adaptive System. Meaning the stock market is a network of various actors with their own unique motivations and incentives who need to come together in order for the system to work. From the exchanges, depositories, clearing corporations, banks, regulators, central banks, market makers, dealers, hedgers, traders, and investors.
Most people typically have a view that all there’s to a stock market is that there is an exchange and there are buyers and sellers who transact. This isn’t incorrect but it is just an extremely rudimentary view. What really happens in the financial markets and the players behind it are far more complex and extremely fascinating if you are into this kind of stuff.
Newfound Research is a US-based quantitative asset manager. They run a few really cool strategies and their blog is one of my favorites.
Corey Hoffstein recently published a paper titled Liquidity Cascades which just fascinating to say the least. This paper is particularly relevant because, during the corona crash the US Treasury Bond market, the largest in the world froze and experienced a severe illiquidity episode. Even the corporate and high yield bond markets saw liquidity pressures that fed into ETFs and mutual funds.
The other thing is that globally, most of the major global markets have rallied.
And often in the media, you’ll hear narratives that the reason for this is the central banks are pumping liquidity, or index funds are disproportionately buying and pushing indices higher among others. All these arguments have some truth to them but not in isolation.
In the paper, Corey looks that the following arguments:
- Impact of central banks and their accommodative monetary policies on the equity markets
- The rise of passive investing
- Impact of HFT traders/trading desks and interplay with hedging and liquidity