How Liquidity Shortage is Fueling Explosive Stock Swings

Many U.S. stocks are seeing abnormally large swings - both up and down - as they announce results during the current earnings season. Goldman Sachs says these dramatic moves are due to falling liquidity, which is how easy or hard it is for investors to buy and sell shares of different companies.

“The relationship between liquidity and volatility has gained increasing significance,” according to a Goldman report this week, per the Wall Street Journal as outlined below. “Broad measures of liquidity have shown high predictive power when estimating forward volatility metrics.”

What it Means for Investors

Goldman found that shares with lower liquidity move 12% more than normal on the day of earnings. For stocks with higher liquidity, the moves are 4% less than normal. Generally, shares of the biggest American companies, mega-cap stocks like Microsoft Corp. (MSFT) and Apple Inc. (AAPL), do not face levels of low liquidity that might induce large price swings. 

Key Takeaways

  • Low liquidity is creating higher volatility this earnings season.
  • Stocks boosted by earnings beats are moving more than normal.
  • Liquidity has reached some of its lowest points in a decade.
  • Low liquidity preceded the 2007-2008 financial crisis. 

The broader lack of liquidity may be reflected by another pattern. Through last week, companies that beat analysts’ estimates rose 2% on average during the two days after reporting results. That’s twice as much as the five-year average. Single-stock liquidity fell in August and had reached some of its lowest points in a decade, according to Goldman’s analysis of Russell 3000 stocks, per a separate article by the Journal.

Smaller companies, a number of which have yet to report earnings this season, could see big swings. Noble Energy Inc. (NBL), Discovery Inc. (DISCK) and Air Products & Chemicals Inc. (APD) report earnings today. Agilent Technologies Inc. (A) and Tyson Foods Inc. (TSN) will be reporting over the coming weeks. All five are trading at low levels of liquidity. In these cases, “We see potential for liquidity exacerbating earnings-day moves,” wrote Goldman’s analysts. 

Looking Ahead

To many experts, falling liquidity has much more serious implications than earnings season volatility. They point out that evaporating liquidity in certain parts of the market in late 2007 preceded the 2008 financial crisis. And in 2019, this again could be one of the first concrete signs that a new crisis may be taking shape.

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