September 4, 2015 / 2:09 PM / 4 years ago

INVESTMENT FOCUS-Market sell-off yet to reach breaking point

* Despite panic indicators, system holding up -fund managers

* Liquidity worries still acute

* Global economic environment, central banks supportive

By Lionel Laurent

LONDON, Sept 4 (Reuters) - Despite a brutal sell-off of financial assets last week and volatility that reached its highest since the 2008-2009 crisis, predictions of a systemic market breakdown have proven wide of the mark so far.

After six years of lobbying from the financial industry warning of the unintended consequences of a post-crisis crackdown on risk-taking, especially in the primarily over-the-counter bond market, markets are so far holding up in the face of a rising number of short, sharp shocks to the system.

Last week’s market moves were not small beer. U.S. blue-chips saw their biggest intraday tumble on record, China suffered its biggest sell-off since 2007 and the VIX volatility gauge rose back to crisis levels.

Even reliably liquid stock market instruments such as exchange-traded funds were caught up in last week’s perfect storm of thin summertime trading, crowd-following automated strategies and China-led slowdown fears - so much so that U.S. regulators and stock exchanges are looking again at rules designed to ensure orderly trading.

But despite several bouts of such turmoil in recent months, warnings of an imminent liquidity crunch from heavyweights like billionaire activist investor Carl Icahn, bond guru Bill Gross and the head of the U.S. securities regulator are premature, according to investors and analysts.

“I don’t see that we are heading towards a cataclysmic liquidity shock,” said Philip Poole, head of research at Deutsche Asset & Wealth Management.

“But it is a reality that liquidity is reduced.”


In the ‘new normal’ world of fragmented markets, hugely popular passive index investing tools and booming asset prices supported by years of easy central bank cash, investors and markets are getting used to shocks to the system.

Volatility has snapped back since last week - though it remains above levels seen for most of 2015 - and the latest fund flows data showed the first equity inflows in three weeks, according to Bank of America-Merrill Lynch, with ETFs still flavour of the month at 9 percent of total private-client equity holdings.

“Mini-crashes appear to be the ‘new normal’...People seem to be taking it in as a fault condition they can tolerate,” said David Weiss, senior analyst at research firm Aite Group.

“But much fault can people tolerate?”

The post-crisis landscape has its fair share of detractors. Banks have lobbied hard against new rules raising capital requirements and curbing risk-taking; asset managers complain of the consequences of shrinking dealer inventory, with BlackRock warning last year that corporate bond trading was “broken”.

While years of plentiful central bank cash have helped paper over the cracks, the Bank for International Settlements has warned that persistently low interest rates pose a growing risk to financial stability and economic growth.

“The risk of global liquidity conditions swinging is real for the markets, justifying a significant reduction in exposure for all asset classes,” said Didier Saint-Georges, managing director at Carmignac, in a note to clients.

But what is striking about the recent market slide is that investors were prepared to step back in. While structural factors like trend-following automated trades and evaporating liquidity exacerbated the sell-off, bets that the world was still growing and central banks still supportive returned.

When that snap-back fails to happen is when the music will have truly stopped, said Stephen Jefferies, head of currency and emerging markets at J.P.Morgan.

But for now, markets are clearing individual hurdles rather than breaking down at a systemic level.

“This is more in the line of a series of tests rather than a big liquidity crisis,” said James de Bunsen, multi-asset portfolio manager at Henderson Global Investors. “The financial system as a whole is in a better state than before the crisis.” (Reporting by Lionel Laurent; Additional reporting by Jamie McGeever; editing by John Stonestreet)

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