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JPMorgan’s annual ETF handbook landed final week, and as ordinary it accommodates some fascinating nuggets. The one which jumped out to Alphaville was the relative liquidity of ETFs and futures at occasions of economic tumult.
The financial institution’s analysts examined the well being of the respective markets within the wild swings of March and April, and noticed one thing very uncommon.
In the course of the bout of market volatility earlier this 12 months, we noticed a uncommon divergence between ETF and futures liquidity, with ETF liquidity steadily bettering whereas futures liquidity deteriorated.
In March, the market depth — outlined because the market order imbalance required to maneuver the market by 1% in a short while interval (e.g. 5 minutes) — of ES futures hit its lowest stage since 2023, a pattern that was additionally seen throughout asset courses and globally (outdoors of Europe).
ES refers to E-mini S&P 500 futures, which commerce on the Chicago Mercantile Alternate, and observe the identical market as SPY, the SPDR S&P 500 ETF that has spawned its personal wealthy ecosystem of derivatives.
You possibly can see this “uncommon divergence” within the chart under.
ETF liquidity — or at the least JPMorgan’s measure of it — did deteriorate, however solely modestly. In the meantime, futures liquidity fell off a cliff for some motive. As JPMorgan famous, this occurred in each the S&P and Nasdaq-related merchandise:
By the top of March, SPY ETF market depth was 61% above its 5y common. ETF liquidity did contract in April on the Liberation Day market volatility (SPY -37%, QQQ -30%), although SPY’s market depth remained in-line with its 5y common whereas QQQ’s was ~14% above its 5y common.
In distinction, futures liquidity contracted extra severely, with ES down 53% m/m and 61% under its 5Y common, and NQ down 46% m/m and 53% under its 5Y common. This shift in relative liquidity between futures and ETFs might point out altering investor preferences to commerce ETFs in risk-off environments.
For the uninitiated, QQQ is Invesco’s Nasdaq 100-tracking QQQ ETF, whereas NQ is the mini futures contract focusing on the identical index.
So what occurred? On the ETF facet, it principally displays an more and more various and vibrant ecosystem of members that guarantee wholesome two-way markets even when markets are just a little nauseous. SPY trades about $30bn of shares a day, and infrequently rather more at occasions of turmoil, with everybody from day merchants to quant hedge funds usually utilizing it to “specific their views”, because the argot goes.
Kenneth Lamont, Morningstar’s principal of analysis, reckons this growth is prone to be repeated throughout a wider vary of underlying markets as ETF adoption continues to speed up. As he advised Alphaville:
Futures will be extremely liquid, however they tend to dry up at sure occasions. ETFs typically have a broader investor base, so you’ve got liquidity coming in from completely different instructions.
It’s an enormous change. Futures have been the car of alternative for a while. If you wish to go extra unique, the ETF offers you a broader vary of merchandise with some liquidity.
The extra folks utilizing ETFs the higher for ETFs. The extra they’re buying and selling the extra liquid they’re, the extra they turn into the only instrument that everybody seems at. That improves the expertise for everybody who makes use of them.
Nevertheless, what brought about S&P 500 futures liquidity to atrophy, and was it an indication of a secular change or merely a passing glitch?
Fairly probably the latter. John Burrello, senior portfolio supervisor of Invesco’s Earnings Benefit ETFs — a set of options-based funds combining components of coated calls and buffer autos — argues the futures market got here beneath explicit stress due to their rising value.
As Alphaville highlighted earlier this 12 months, spreads for lengthy US fairness market publicity through derivatives hit almost 150 foundation factors in December, making it an costly approach for traders to get publicity to the US inventory market. (Sarcastically, the rise of leveraged S&P 500 ETFs is perhaps behind the elevated value of futures, as they’ve grown quickly currently and use E-mini S&P 500 futures for that additional juice).
The price of funding had fallen again considerably by the point of March’s market shenanigans, however at 70 bps it was nonetheless elevated in comparison with historic norms of round 40-50 bps, deterring many institutional traders in accordance with Burrello. This fuelled the seek for different buying and selling instruments equivalent to ETFs.
The divergence between futures and ETF liquidity might additionally merely boil all the way down to the truth that American retail traders — who overwhelmingly use ETFs — zealously purchased the dip when markets turned rocky. In the meantime, institutional traders, who’re heavier customers of futures, on the entire offered.
For Burrello, that is in all probability the perfect rationalization for the bifurcation, and implies it may not be a sturdy shift:
I don’t assume it’s fairly as clear minimize to say individuals are abandoning futures and adopting ETFs. It’s extra nuanced.
