Liquidity Near Lowest Since 2008 Crisis in Key $200 Billion Market

Plunging liquidity in the $200 billion daily market for E-mini S&P 500 futures contracts is making it more difficult for smaller investors to hedge their equity positions or to speculate on broad market moves. This decline in liquidity was the result of the rise in stock market volatility in 2018, and the upshot is that it has become more difficult to trade without affecting the price materially.

“The weird thing is that markets haven’t been that volatile this quarter, but order-book depth hasn’t really recovered,” as Hovannes Jagaspanyan, an algorithmic trader at high speed trading firm Quantlab, told The Wall Street Journal. The table below offers a primer on E-mini S&P 500 futures contracts.

A Short Profile of the E-mini S&P Futures Contract

• $200 billion average daily trading volume (about 2 million contracts)
• Trading volume 8x larger than that for 3 biggest S&P 500 ETFs combined
• Contract size = $50 x S&P 500 Index value ($140,923 as of March 26 close)
• Standard S&P 500 futures contract is 5x larger ($704,615 as of March 26)

The hallmark of liquid securities markets is the participation of large numbers of willing buyers and sellers, leading to continuous trading and meaning that relatively large transactions can be executed at minimal, if any, impact on prices. During the Dec. 2018 stock market selloff, order book depth in S&P 500 E-minis sank to levels last seen during the 2008 financial crisis, per research by JPMorgan Chase cited by the Journal.

Measuring order book depth is measured by the number of price quotes publicly posted by trading firms, JPMorgan Chase finds that it has recovered somewhat since December, but is still below its level in September, before the stock market retreat began, and remains near its 2008 lows. With liquidity down, price swings in E-minis are up, and may become especially severe during a big stock market selloff. “Particularly if the market goes one way, that impact is going to be exacerbated in either an up or a down move,” a Hallie Martin, a New York-based derivatives strategist with Deutsche Bank, told the Journal.

Overseas trading in these contracts also is affected. “During the London session, liquidity has fallen dramatically in the last few months,” per Darren Smith, a U.K.-based derivatives trader with UBS, as quoted in the same article. As recently as 2017, hundreds of these contracts would change hands without moving the price, but no more, he adds.

Diminished liquidity in the E-mini market is symptomatic of broader trends. Analysts at JPMorgan, Deutsche Bank, and investment management firm Bernstein are among those warning that stock market liquidity is in serious decline, with growing dangers that a modest stock market selloff could snowball into a full-blown crash. Billionaire investment manager Stanley Druckenmiller worries that shrinking liquidity may trigger a major crisis in the markets and the broader economy.

Bernstein has offered three recommendations for investors, to protect against evaporating liquidity, as presented in a detailed report. These are: increasing cash, avoiding large positions in crowded stocks, and looking for active investment strategies that can profit in this environment.