Liquidity Matters: Katie Martin, Financial Times

 

A regional banks crisis. A recession that always seems just around the corner. And inflation figures that refuse to budge. It’s no wonder that many investors and allocators are stepping back from taking major macro positions, keeping their powder dry, or only making highly selective calls.

In this episode of our Liquidity Matters season, Katie Martin, Markets Editor at the Financial Times, joins Robyn Grew to discuss US equity’s reluctant rally and how this peculiar market environment affects the way investors are thinking about liquidity in their portfolios.

Recording date: June 2023

 

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Robyn Grew:

I am delighted to be joined by Katie Martin, the FT's markets editor and writer of The Long View column. Katie, it's a pleasure to see you again and thank you for joining our podcast.

Katie Martin:

My pleasure. Happy to be here.

Robyn Grew:

Let's just dive in. I'd like to start at a broad level and focus on, I think the topic of fun, which is US equities and what can probably be described as the world's most reluctant rally of all time. Everything's going up. It seems like nobody's happy about it. In fact, I think you described it as everybody's miserable about it. What do you make of this strange environment we're in?

Katie Martin:

It is quite weird, isn't it? Because on paper, you look at US stocks, the S & P's up about what, 14% so far this year. Everyone should be kickback, relaxing, yay, nailed the first half. This has been great. But instead everyone is just worried about everything. If you look at what was in the year ahead outlooks at the turn of the year, from all the big banks and all the big investment houses, everyone was saying negative to maybe neutral US. Everyone was wrong because nobody saw this AI thing coming and nobody saw this massive leap ahead, particularly in this clutch of seven AI tech-focused stocks. Magnificent seven, seven up, various names have been proposed to us to describe the phenomenon.

Robyn Grew:

Please don't. Yeah.

Katie Martin:

But it's really something. Nobody can figure out at this point whether it's a good thing or a bad thing, whether the rest of the market's going to catch up or whether the AI stocks are going to fall back down to earth. So, we're just caught in this state of limbo where if you're an investor who is bearish, you can cherry pick enough data to back up your case. And if you're an investor who's bullish, you can cherry pick the data. It's a mess.

Robyn Grew:

Yeah. Certainly, you are seeing both sides coming to the fore.

Katie Martin:

Yeah.

Robyn Grew:

I think it's funny right now to watch so many people be quite surprised over and over again by positive job numbers, month after month. Henry Neville, who's a PM in our solutions team, he owns a hat gifted to him in 2018, so he tells us, that reads the Phillips Curve is dead or something similar to that at least. Here we are in 2023. It's steeper and some might say more alive than ever. So what's your view on this recession piece? It seems to be always just around the corner. I heard you on a podcast saying, "No, no, no, it's not just around the corner." I think there was a beer involved in that conversation, actually. It's somewhere 18 months away. Do you still hold that view? Because it can change by the day, perhaps even by the hour, Katie? So help me with that.

Katie Martin:

I'm definitely allowed to change my mind, but I did bet a colleague a beer that we wouldn't get a recession in the US until the back end of next year. Which I don't know, maybe I'm being a bit too optimistic or daft.

Robyn Grew:

I say as an optimistic, I don't know where optimism and recession comes in a sentence together, but go ahead.

Katie Martin:

I can change my definitions as I go along, but there was a certain element of that. So everybody went into this year again expecting a US recession, just saying there is no way you can get through 500 basis points of rate hikes in pretty much a straight line from the Fed without the system creaking, without us entering some sort of recession. It's just not happened. The jobs numbers are always a bit of a coin toss. We used to have a sweepstake in the office, when I was at the Wall Street Journal. You would just put a number in a hat and whichever one came closest to the actual payrolls number won the pile of pound coins that were in there because it's a fool's errand in trying to predict payrolls. But the direction of travel, nonetheless, this year is interesting. The market is consistently underestimating where the jobs market is going to be, every single month. So, it comes in below where the actual number prints. So something has gone wrong in terms of the ability of the smartest minds in the business to predict what is going on with the jobs market.

Robyn Grew:

There's something in the manufacturing piece here, in the supply piece here, which is, it's off. Something feels off. Let's turn to bond markets. We talk about equities, but let's turn to bonds.

Katie Martin:

Yeah.

Robyn Grew:

That that'll take us into this broader discussion, which is what we're here to talk about, around liquidity. What's your perspective on this divergence in the markets? Where companies who are solid, excellent ratings, some might say household names even that, no problem getting access to capital yet anybody who's got anything a little funky, anything a little different, anything a little... well, they're having a very different experience it seems to me. What do you make of that? What do you make of the expectations around defaults or the nervousness, absent those real high quality credit risks?

Katie Martin:

Yeah. Yeah. The way bankers in the debt capital market space put it to me is that it is very much a two-tier market now. So, exactly as you were describing. If you are a big, reliable company with a good rating, then sure there are plenty of investors out there who are more than happy to give you their money. Everyone loves investment grade. There's a bullish camp and a bearish camp around stocks, particularly in the US, but there's a pretty consistent voice coming from the buy side, which is that everybody loves investment grade debts. These things don't really default and unless something truly terrible happens. People are just loving scooping up that yield. There is yield available on IG debt for the first time that people can remember for a long time. They're not having to go too far down the credit curve, too far down the Looney Tunes risk curve to get some returns that they're happy with. They can just sit in that triple A debt and get what, four, five?

Robyn Grew:

Four? Five? Yep.

Katie Martin:

That'll do. That'll do nicely. Companies are also, from what I understand, bending over backwards to keep hold of those investment grade ratings. You do not want to be a fallen angel at this point. You don't want to fall into junk ratings because whoo boy, when you next come to refinance your debt, the borrowing cost is going to really hurt. So, companies are working hard to make sure they're doing stuff that is friendly to investors, which is another part of this virtuous circle. So, the inflows into investment grade debt are pretty extraordinary, and the support for that asset class is pretty extraordinary. But yet, if you are in any way any kind of sketchy borrower, the door is pretty closed. It's very difficult out there. There is a widespread expectation that there will be a big pickup in default rates among high yield borrowers. But also, if you talk to people who invest in the credit space, they're like, that's kind of how this stuff is supposed to work. This, back in the olden days, when interest rates were higher.

Robyn Grew:

When they used to be interest rates.

Katie Martin:

When they used to be interest rates and money costs something, this was how it worked. So, actually people are pretty comfortable with that. So yeah, it is a really two speed market in credit.

Robyn Grew:

I think that's right. I think the other piece that's interesting is there's a lot of precision in looking at where the credit risk really lies. There's the danger of saying it's a corporate real estate piece. It might not be all of a corporate real estate piece. It might be at a certain level and below and held in a concentration in certain regional banks. We'll get to that. You recently wrote about how fund managers and allocators alike are increasingly wary around market liquidity. Maybe they've been burned by their positioning earlier in the year and they're avoiding taking directional bets until the macro picture becomes clearer. Though clarity on the macro picture, as we've talked about, might not come for some time. How do you think the effects around liquidity in the market, how do you think that is impacting liquidity? If everyone takes a step back, as it were, does this create a self-fulfilling liquidity problem? Is this one of those moments which if you think it and you say it, it happens?

Katie Martin:

You'll make it true.

Robyn Grew:

You'll make it true.

Katie Martin:

Liquidity means a lot of different things to a lot of different people, and the context matters here. But certainly one of the things that is generally accepted to contribute to good liquidity, good market functioning is good two-way flow. People who take one side of a bet, people who take another side of the bet, good volumes, good flows, it tightens prices, it creates a well-functioning, healthy system. At the moment, everyone is very nervous. So as we were saying at the top of this conversation, pretty much everyone went into this year short or neutral US. They've been ironed out. Everyone went into it short Japan, ironed out. Everyone went into it short Europe, ironed out. So everyone has been wrong about everything, basically, which is not a super place to be. But in addition, so again, everyone ran into this year thinking, okay, we're going to get a recession because you can't have 500 basis points of hikes without getting a recession. Then boom, along came January payrolls, which were massive. So the market, particularly the rates market, has to completely recalibrate and say, "Okay. We got this wrong. The Fed's going to have to keep on hiking, so let's move back into a inflationary bet, back into a rate-hiking bet." Then all of a sudden banks start failing everywhere, on both sides of-

Robyn Grew:

That's right. With the bank failing piece it's interesting that that didn't. Despite bank failure it didn't trigger that cascade and liquidity crisis that perhaps was thought of. Is that because we're expecting intervention?

Katie Martin:

Yeah.

Robyn Grew:

So is this going to be one of those moments where each one of the trigger points gets stemmed at source by some intervention? Do you think that's the story?

Katie Martin:

Difficult to say. I agree. It didn't cause cats and dogs living together, end of the universe awful, just an economic train wreck, but it did catch the market offside. So, on that bit about the liquidity element, it just upset everyone's portfolios and created a lot of volatility in the market, which probably isn't great for liquidity broadly defined. But in terms of the lack of a economic hellscape on the back of what happened with banks in the US and Europe, there was this expectation that this is going to absolutely stamp on lending. This is going to make a bad situation much worse. But also, there was a genuine fear that it could become a sprawling banks crisis because everyone just has that muscle memory from 2008 and thinks, are we going to get this all over again? My acid test for things being bad is when I get asked to go on telly because when-

Robyn Grew:

Okay. Noted, everyone.

Katie Martin:

When I'm telly you know things are bad because the Channel 4 or BBC or whatever it is says, "Quick, we need to get someone from the FT to tell us whether we're all doomed."

Robyn Grew:

Yeah.

Katie Martin:

So on the Credit Suisse weekend, I was doing a few TV bits. I was on Channel 4 News. They asked me the question I really did not want them to ask, which was, "So, are we going to get a banking crisis in the UK?" They didn't go as far as saying, "Should I get my money out of NatWest?," but it was, "Are we going to get a banking crisis in the UK?" I thought, there's no good answer here, but I thought-

Robyn Grew:

No pint of beer was better at that point. I don't know.

Katie Martin:

I thought that, look, it's theoretically possible, but if I were to say that, then I would be shouting fire in a crowded cinema. I didn't think it was that likely because of all the reforms we've had since 2008. So I thought, if I say it's all going to be fine, there's a risk that I'll end up looking like an idiot later on, but I'm willing to take that risk.

Robyn Grew:

It's the better alternative in that instance.

Katie Martin:

So I opted for idiot and it worked out because my gut instinct was that the reforms that we've seen since '08 just neutralized that risk.

Robyn Grew:

I think what it also showed was the demonstrable difference between the way that regulatory reform had been affected in Europe versus the response in the US, where you had this two-tier system. So not surprisingly, the phone calls for many were, where do I move my money out of the regional banks? JPMorgan Chase was...

Katie Martin:

Well, our door is open,

Robyn Grew:

Our door is open. You are welcome.

Katie Martin:

Yeah.

Robyn Grew:

What I should say though is, do we think... well, what I should ask is, do you think the story has stopped on the regional bank piece or are you somebody who's also thinking, hang on, there is this corporate real estate piece? There is a high concentration of some of that book of business on the balance sheets of regional banks in the US. We saw some stemming post-SVB, but do we think it's stopped or do we think that this is waiting to be in a different time maybe, but a very recognizable crisis?

Katie Martin:

Yeah. Look, if I knew I would probably be sitting on a yacht somewhere, playing around with my Bloomberg machine, putting on some positions.

Robyn Grew:

I love this playing around your Bloomberg machine on a yacht. Excellent. Right. Marvelous.

Katie Martin:

So look, I don't know. I don't think anyone else knows, but I think everyone is very conscious that it took a few months after the failure of Bear Stearns for anything else terrible to happen. So again, there's this muscle memory that several times in that '07, '08 buildup period to Armageddon, that people thought, okay, this is sorted now. It wasn't sorted. That said, the policy response has been forceful and there is, as you say, a two-tier system in the US. The big US banks and they are enormous, appear fine. So, this is one of the funny things, is that a lot of people in the UK were, "Silicon Valley who now? Never heard of them."

Robyn Grew:

Yes. Hello.

Katie Martin:

These banks are as big as a really top-tier European bank. They just happen to be in the States and happen to be regional, so we've never heard of them. But the absence of an immediate hellscape in commercial real estate is quite comforting. I don't want to say crisis over, mission accomplished, but I do want to say that it could have been an awful lot worse.

Robyn Grew:

Yeah. Let's talk about managing liquidity. There's this excellent golden rule I think you've mentioned before, about how in times of crisis or crises even, managers sell what they can sell, not what they necessarily want to sell. Do you think that's a mantra that's been absorbed by the industry since the LDI crisis or the Covid selloff, or is it something that the market just knows to be true and would rather not have to face?

Katie Martin:

I think it's always been true. I think everyone has always known it's true. I think it was particularly the case during the Covid crisis, when treasuries started to sell off really hard. That was my head in my hands moment, explaining to news editors that this is really bad. There's no way back from this. We need some sort of intervention here. The LDI crisis is your perfect example of everyone trying to get out of a rates product all at the same time. It's never a good look. So, I think this has always been an issue, but what I think exacerbates it now, when I speak to senior traders, they say, "One of the problems we have as banks now is that asset management firms are much bigger than us. It used to be that they could throw pretty much any order at us and we could say, 'Fear not, I'm a massive bank. I can handle this. I can warehouse the risk.'" They can't do that anymore, again, because of the reforms that we saw after '08. So, the risk effectively gets shunted to the buy side. It gets shunted to the asset managers and investment firms and away from the banks. All things being equal, that's probably healthy. But it does just mean that when everyone is running to the exit all at the same time, that banks are stuck. They can't keep spreads as tight as we all like them to be on normal days in the office because their ability to absorb this is just gone.

Robyn Grew:

Let's be clear, banks are not only liquidity providers, period. I mean, that is what we have seen post-crisis.

Katie Martin:

Yeah.

Robyn Grew:

It's an interesting place where we think about how we trade and where we execute.

Katie Martin:

Yeah. Yeah. So do the banks. Right?

Robyn Grew:

Correct.

Katie Martin:

So again, this is something that I've heard, is that banks know which clients are nice human beings and which clients are less nice human beings. Which are the funds that have messed us over in the past by placing orders that are particularly unfriendly to us or placing the same order with five different banks and not telling us, and then we end up getting egg on our face? What I've heard from them is that the clients that they know and trust were taken into a circle of trust. It was like, "Okay. We can get through this period because we know that you're not going to try and do us over and you know that we're not going to try and do you over. Let's just try and get through this few days without anything breaking." So I think there's a real, what goes around comes around thing, in terms of your relationship with banks at those moments.

Robyn Grew:

I agree. It is about the quality of your banks, the quality of the liquidity, the providers, the quality of the scale of your organization, to be able to have the elasticity in your own ecosystem to manage these things.

Katie Martin:

Yeah.

Robyn Grew:

We talk about liquidity. We talked about it a little bit in the sense of a negative thing. Right?

Katie Martin:

Yeah.

Robyn Grew:

But actually, liquidity enables people to also take advantage of opportunity. As we think about, is there opportunity for new investment strategies, is there opportunity to take advantage of those dislocation or those credit events, how do you see the balance between liquidity as a necessity versus liquidity as an opportunity? As we deal with allocators all day, we try to ensure that flexibility exists so that when there is a dislocation or when there's an opportunity, liquidity is about being able to move dynamically into that space too.

Katie Martin:

Yeah. To my mind, liquidity is one of those things that is incredibly boring until it's not. It's very much like the plumbing in your house. You don't think about it. You don't think about how your toilet flushes and your shower works. No one knows how toilets work and showers work.

Robyn Grew:

I'm not sure I want to, but now that you've said it, maybe I should. Yeah. Okay.

Katie Martin:

It's a dark art.

Robyn Grew:

It's a dark art.

Katie Martin:

But it's nice and boring. You just know that it works. You can turn the taps on and it's all good. What you don't want is either for your house to flood or worse, for your house to catch fire and for you not to be able to turn the taps on and put the fire out. So, all of a sudden the plumbing becomes incredibly interesting, having previously been incredibly boring. We saw that writ large in the LDI crisis at the back end of 2022. What people on the buy side and the sell side say to me is that the way that they thought about liquidity management, there's before LDI and there's after LDI. LDI, if that whole crisis did any good for the universe at all, it was to act as that wake-up call to say to people, "You need to think about this. You need to think about how you would meet these margin calls in the worst of all possible worlds." No, nobody had stress tested LDI strategies for guilt yields adding 80 basis points a day because why would you do that? That's ridiculous. That never happens. Now, all of a sudden it's happened.

Robyn Grew:

Yes.

Katie Martin:

So, people are thinking, oh, okay, we need to rethink buffers. We need to rethink these dynamic hedging strategies. This is really cutting through to how investors think about their portfolios, I think.

Robyn Grew:

Couldn't agree more. I think what was interesting is we helped and managed and looked after clients, quite frankly in the LDI space in the UK. What was interesting is when you then took a look back and looked at the world, they went, "No, no, no, no. That's a phenomenon that's just in the UK." Then we had regional banks. And then, oh, not just a phenomenon in the UK. I think the interesting piece on liquidity is about not expecting just a repeat of something that's happened elsewhere. It's to look at liquidity in the round and say, and you heard us say before, liquidity shocks come from LDI for sure. They come from sovereign wealth or whatever. Sorry. They come from SVB. But they come from sovereign wealth funds suddenly getting a call from their government saying, "We need cash." It comes from every part of this. I think it's a very interesting place that liquidity, I think is very much in the minds of everybody right now.

Katie Martin:

Yeah. But also, not to keep banging on about post-'08 reforms, but there has been a big push, pulling all types of investment management firms, all different pockets of the buy side into cleared products, into products where they need to post margin, where that does create overnight calls for cash. We've just seen EU pensions drawn into these clearing requirements. That was a long time coming, and they were very well-prepared for it. But nonetheless, there was a whole universe of investors out there that have never previously really thought about margin requirements and selling this, that now have to. They need to be able to respond to it cleverly, in a way that doesn't eat away at their returns too badly. So, they are definitely thinking about this. As you say, LDI was LDI. It was, Brit's going to Brit. It's like, what are those crazy Brits up to you now?

Robyn Grew:

What are they doing over there? Yep.

Katie Martin:

Those jaunty Brits. I was looking at a note the other day from Absolute Strategy Research, who have very gamely looked through financial stability reports from all kinds of different organizations, the IMF, Bank of England, the whole nine yards, God love them. Thank you for your service. But what is coming out consistently from this is that all these kind of multilateral organizations and policymaking organizations are thinking about non-bank financial institutions like, "Okay. We've cauterized a lot of risks in the banking sector. We've let the buy side kind of run away with it since then and do its own thing. We need to think carefully about whether we're letting risks build up here." Some of the risks that they're talking about is around certain pockets of the buy side, all pointing in the same direction with their positioning, which is exactly what we saw in LDI.When that goes pear-shaped, there's only one exit and it's not pretty. They've talked about clearing requirements. They've talked about how that's a potential source of risk. So look, financial stability reports exist to tell people about things that could potentially go wrong, and 99% of them won't. Nonetheless, this is something that is reaching the radar of policymakers to think, we just need to be ready for these sorts of eventualities. Now, I think the good news is that the Bank of England played a blinder, honestly, around LDI. It didn't say, "Okay. Let's hit that big button marked cut rates because there's some sort of crisis going on here," because you can't when UK inflation is... I think at the time it was running in double figures or close to it.

Robyn Grew:

Yes. Yes.

Katie Martin:

So you have to have these laser-guided missions to put out these little fires. Actually, the Bank of England has drawn a lot of praise for what it did in that moment for doing exactly that. It's like, here's our laser-guided mission. We're going to get rid of this horrible risk. And then we're going to pull out again and you're on your own. We are not going to cut rates just to make everyone's problems go away. So I think that's the playbook here, is that when you get these horrible liquidity blowups, policymakers, my hunch is will jump in, solve a discreet problem and jump out again.

Robyn Grew:

Let's close then with... we talk about liquidity, let's talk about illiquid assets and how their marked prices certainly can suddenly be written down, although we haven't seen a ton of that.

Katie Martin:

Yeah.

Robyn Grew:

Right? Not yet, anyway. But written down just at the moment that people probably want to sell them. I think there'll always going to be a demand for liquids. I'm not here to say there's not a demand for liquids at all and certainly from institutions who can hold them for a long time. You're good for 10, 20, 30 years.

Katie Martin:

Yep.

Robyn Grew:

Rock on.

Katie Martin:

Yeah.

Robyn Grew:

But do you think that the demand is going to be as large as it has been, certainly in the last five, 10 years?

Katie Martin:

Short answer is no. Yeah. So when I talk to asset managers, wealth managers, those sorts of people, around private assets, illiquid assets, one of the things that has slightly spooked them is the denominator effect. The value of all your lovely public market holdings got got put through a wood chipper last year. So all of a sudden, a much bigger slice of your portfolio is in infrastructure assets and car parks and dams and God knows what else, relative to the public markets that are typically more liquid. This is a bit of a problem. As you say, write-downs seem inevitable at this point. But the sense I'm getting is that there's not a huge demand to get out of these things because you'd have to take a big marked market loss on it. Maybe you can just sit on it for a few years and make the problem go away. Although there is quite a flourishing cottage industry in secondary market trading around private equity assets.

Robyn Grew:

That's exactly right.

Katie Martin:

Yeah.

Robyn Grew:

By the way, it's an interesting one because it's not necessarily that you're out distressed. These can be trading par. It's just another mechanism of attacking the denominator effect.

Katie Martin:

Yeah.

Robyn Grew:

It's getting yourself back into a position where your portfolio isn't too heavily weighted in assets that you don't have access to. Because at some point, even if you're secondary trading at par at the moment or better than, at some point you cut deeper. That's an inevitable part of this. Right?

Katie Martin:

Yeah. The mood music from that part of the market is, no, people don't want to sell. It's painful. It's embarrassing. It's all those other things. But do people want to take on more exposure to private assets over the next year or two? Probably not, given that skeweth nature of the portfolio makeup at the moment. So, I don't think it's necessarily a train wreck. I do think some of the easier times for things like the private equity industry are behind them. I also think they are incredible salespeople. So they are very, very skilled at telling you that everything is fine. Good luck to them. But yes, the bet has to be that that space will slow down markedly over the next couple of years.

Robyn Grew:

Brilliant. Katie, such a pleasure to have you. I genuinely could talk to you for the next hour. Then I'd get into trouble with your editors. Thank you again for taking time to join us. It's been great.

Katie Martin:

No. Thank you for having me. Nice to be here.