Bank of America asked 65 investors their biggest fear — and the top response shows just how vulnerable markets are right now

• Bank of America Merrill Lynch surveyed 65 credit investors about their biggest market fear, and the most popular response is something that hasn’t been a top concern in years.
• It feeds into a broader global story about liquidity drying up, and how that makes markets more vulnerable to sharp downturns.

The more that people cram into an investment position, the more violent the stampede to the exits will be at the first sign of trouble.

It’s a relatively straightforward dynamic that’s played out countless times throughout market history, across a wide range of asset classes.

And even though such a risk seems obvious, traders still have a tough time knowing when to cut and run. After all, if they get out too early, they could miss more potential gains.

Luckily, in the spirit of preventing a mass exodus, investors in the credit space seem acutely aware of the risks associated with crowded positions. According to a Bank of America Merrill Lynch (BAML) survey of 65 credit investors, a sharp loss of liquidity is now their biggest worry of all.

“It’s not trade wars or an equity market correction that look to be keeping credit investors up at night, the concern is a more pervasive rush for the exit at some point in the future,” Barnaby Martin, a credit strategist at BAML, wrote in a client note.

Reduced liquidity makes it difficult for investors to trade without distorting markets. When it’s constrained, volatility increases. And when price swings get crazier, that’s when huge losses happen. 

To that end, simply recognizing that the market could potentially experience a liquidity crunch is one thing. Actually positioning oneself to avoid the fallout is another. And based on what’s transpiring in other asset classes around the world, the market remains highly vulnerable.

Goldman Sachs recently published a study suggesting that a lack of liquidity in the stock market was at least partially responsible for the S&P 500‘s 11% drop in February, and that it remains dangerously low.

Morgan Stanley looked more broadly — looking at 14 assets across four major market groups — and found that a lack of liquidity is causing the highest cross-asset volatility in a decade.

And that’s just scratching the surface.

The primary cause of reduced liquidity at the moment, at least in the US, is the tightening of monetary policy by the Federal Reserve. As other global central banks look to also look to end accommodation, the situation will compound.

Stay tuned.

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