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A Farewell to Liquidity


Random, thin and illogical. Name me three adjectives that described Monday's market.

Liquidity, that elixir of all bull markets, has simply vanished. We can expect some liquidity to dry up in the last week in August -- and in truth many players were on vacation -- but the absence of two-way markets in major names was a bit frightening.

I can try to enlighten about what liquidity means, or I can give you an example of what I am talking about. The latter works better. This morning, during one of the myriad SPX sell programs I described, I decided to bid "underneath" for


(IBM) - Get International Business Machines (IBM) Report

. That's trader talk for putting in a buy order at a price that is below the bid side of the market. The market in IBM at the time was 127.875 bid by 128 offered, about ten thousand up. (Meaning you could buy 10,000 shares at 128 or sell 10,000 shares at 127.875).

I was bidding 127.75. I got whacked immediately, and bought 15,000 shares there.

Later in the day, when the market looked like it was going to run out of gas, IBM was 128 bid, 128.125 offered. I decided to let go of my IBM at 128.125, the offered side. (If I wanted to just lose the stock I could have sold it at the market, but I figured I could hold out to make a few pennies per share after commissions.) Almost immediately upon offering the stock, IBM dropped by a quarter of a point. My offering actually affected the market. Let me go over that again. My ten thousand shares caused IBM to go down three-sixteenths of a dollar. IBM, one of the most liquid stocks in the world, had no liquidity at that moment.

Near the bell, a buyer showed up trying to buy 50,000 shares of IBM. That 50,000 share buyer not only took my 128.125 stock, he took stock at 128.25 and was taking 128.375 stock to complete his order, as an

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buy program simultaneously swept the market higher. For those of you who are new to the trading game this sequence makes sense. A seller knocked the market down and a buyer then took it up. Elementary supply and demand. But in a "normal" market, not characterized by kneejerk swings and a lack of buyers and sellers, none of these orders could impact the market. They would not have moved the stock up or down. IBM normally can trade hundreds of thousands of shares without being moved by a buyer or a seller.

This lack of liquidity is not per se bearish in a stock like IBM. By shrewdly bidding for stock and offering it later in the day, I can make a little money.

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But the lack of liquidity is tremendously bearish for the smaller capitalization stocks, all of which can be knocked down similar to IBM, BUT ARE THEN NOT TAKEN BACK UP BY THE BUY PROGRAMS BECAUSE THEY ARE NOT IN THE S&P 500. In fact, the only thing that will move small cap stocks back to their pre-Humpty Dumpty-had-a-great-fall status is a takeover bid. And not every stock can get a bid! So, everyday, accounts try to sell small-cap stocks and everyday there are no natural buyers. They simply can't get out.

Naturally, you ask, when will the liquidity come back to the market. Part of me says, wait till September. But part of me says, it won't come back to the small-capitalization stocks until the index funds start underperforming and right now, judging by the example I just gave about how, with patience, you can get out of IBM, but you can't get out of anything small, I don't see the liquidity picture changing any time soon.

Or to put it another way, if National Gift Wrap were a real stock, instead of my favorite small-cap straw man, there would be 10 sellers and no buyers, and it would go down everyday until it got to a point where a financial or corporate buyer could buy the company for less than its intrinsic value. Even if things were good at National Gift Wrap the story would be the same. That's no place to be.

Random musings

: Things must be really tough out there. I am getting emails from people calling me silly and stupid and arrogant, and I have seen it all, and am chalking up the gratuitous ad hominem attacks to the tough tape. Like this morning. I work my butt off to find out about these SPX sell programs and I get a handle on them and how they are knocking the market down. No sooner do I write it than someone pipes up that I am "silly" for thinking these had any effect and it's the bearish litany that is to blame for the sporadic selloffs. I blew my stack.

Do people think I make this stuff up to satisfy my editors? I don't ever have to write if I don't want to and I have no contact with my editors anyway, who are over at Two Rector across town in New York City. Do people think I write this stuff to confuse and stymie? Man, I don't pull the wings off flies and my goal is to make things clearer, not more obscure.

Do yourself a favor. Before you fire off a miserable riposte, ask yourself, could you say those mean-spirited things to my face and think I would not care or would enjoy it? Just cause it's email doesn't mean you can insult with abandon. Take it out on someone else. I am just trying to relay what I see as best as I can. I use the same memos I send you to be the talking points for most of my stuff at the office. We can be wrong, too, but we've been at it for 20 years and have learned a thing or two. I know this is a tough market. Please don't make it any tougher with insults.

James J. Cramer is manager of a hedge fund and co-chairman of

At the time of publication, he was long IBM, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to