📅 Day 56 — Liquidity Mirage in the Desert 🏜️💦

Ever been lost in the desert? (Metaphorically, I hope.) The sun bakes your skull, the sand stretches forever, and then you see it: a shimmer on the horizon. A lake, an oasis, salvation! You stumble forward, tongue swollen — only to find hot air and dry sand.

That’s a liquidity mirage.

On paper, certain assets look liquid. They trade daily, the bid-ask spread seems tight, and volumes appear respectable. But when stress hits, when everyone runs for the exit at once, the oasis vanishes. That “liquidity” evaporates, and you’re left clutching sand.

Think back to March 2020: corporate bond ETFs that boasted deep liquidity suddenly froze, spreads blew out, and buyers disappeared. Small-cap stocks, real estate investment trusts, even some Treasuries briefly became deserts. The mirage collapsed.

🔗 For context: Here’s a postmortem from the BIS on March 2020 bond market fragility.

The problem is psychological as much as structural. We assume that because something trades smoothly in good times, it will behave the same in crisis. But markets aren’t static — they’re dynamic ecosystems. Stress changes the rules.

So how do you avoid getting stranded at a mirage?

• Size matters. If you’re running a large position in a thinly traded security, you are the market. Don’t delude yourself into thinking you can slip out quietly.
• Test the desert. Look back at historical stress periods. Did the asset hold its liquidity in ’08, in 2020, in smaller drawdowns? Or did it evaporate?
• Don’t confuse ETFs with magic. Wrapping illiquid assets in a shiny ETF wrapper doesn’t make them liquid. It just hides the desert until the heat rises.

Liquidity mirages are dangerous precisely because they appear most convincing when you’re thirsty — when you need that exit.

Remember Day 55’s steel vs. glass? This is the same test, just at a different angle. A portfolio that looks like steel in calm times may turn to glass when liquidity vanishes. And if your strategy depends on escaping at the first sign of trouble… you’d better make sure the oasis is real water, not sand.