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Flight from Liquidity


Yeah, well, now you're on MY list!


One of the indicators I discussed at MIM2 was something I call the Liquidity Premium. It's an indicator which compares volume in the popular exchange-traded funds to the volume in the underlying stocks in the funds.

The theory is that as traders become uncertain as to future risk, they "hide" in the liquidity (and lack of short-sale rules) in the ETFs as opposed to individual equities. I don't have much use for theory unless it can help me make buy and sell decisions, but fortunately the theory is supported by hard data.

The chart below shows the Premium values for SPY averaged over the past week. Note the spike higher in the latest figures. This is actually an inverse scale, which means that the Premium has been extremely low, which in turn suggests that traders are overly confident in holding equities.

It is true that SPY has been on the Reg-SHO list since August 25th, however I have gone back over the past few months of data and can find zero correlation between SPY appearances on that short sale restriction list and its volume. It would make sense if volume dropped off a bit when it was on the list, but I can't find any evidence for that.

The week following September option expiration has been negative every year since 1999 (excluding 2001 which I think we can all agree was an outlier). With many of the readings that have been popping up on my radar lately, it seems that a sustained rally in the next couple of weeks is looking less and less likely.

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No positions in stocks mentioned.

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