“A complete disaster was averted by fixed-weight portfolio rebalances that were buying a significant amount of stocks during the last week of the year”, JPMorgan’s Marko Kolanovic wrote, on January 3.
He was describing the rebalancing flows that helped US equities bounce in a post-Christmas rally that at least partially offset grievous losses precipitated by, in order, the December Fed meeting, the threat of a government shutdown, Steve Mnuchin’s epic self-own and, of course, Donald Trump’s shrill tweet about Jerome Powell’s golf game. Those unfortunate events, along with generally sour sentiment, triggered a veritable “retail flush” in mutual funds. Those outflows hit amid impaired market depth. “Already fragile sentiment was undermined by political uncertainty from the US administration, the December FOMC meeting, a slowdown in economic data, and a viciously negative news and social media cycle”, Kolanovic not-so-fondly recalled. “Those developments brought a large amount of selling from mutual fund investors in an environment of poor liquidity.”
Fast forward to May and, after one of the best starts to a year since 1987, stocks are on track to post their worst month since the December rout. Through Friday, the S&P was off more than 4% for the month and had logged three consecutive weekly declines.
Headed into what will be a holiday-shortened week in the US, market participants are once again looking to the rebalancing bid as a potential source of equity demand. “Pension rebalance may be a tailwind for the market into month-end”, JPMorgan’s Bram Kaplan wrote this week. He and Marko call the current setup “similar but less acute” than December.
A simple way to look at the situation is to note that the S&P has underperformed bonds by roughly 5% in May. That’s one of the larger performance disparities of the past several years, although it’s clearly nowhere near as stark as December.
Credit Suisse estimates the pension rebalance bid at roughly $7 billion. JPMorgan says it could give the S&P a 1.5% fillip. That of course needs to be balanced (no pun intended) against any countervailing flows tied to… oh, I don’t know… an errant tweet or forty. “Eventually investors may give up because they are not going to be guessing the tweets”, Kolanovic told Bloomberg in an interview on Friday, describing the extent to which fundamental/discretionary investors can become exhausted with Twitter policymaking.
To be sure, the pension rebalance story probably isn’t something that anyone should get overly excited about, although it makes for a nice headline. The $7 billion figure cited by Credit Suisse is a far cry from the “historically large” $60 billion that helped catalyze the post-Christmas bounce. You might recall that a few days previous, Wells Fargo’s Boris Rjavinski, Mike Schumacher and Zachary Griffiths noted that their projections for the December quarter-end rebalancing where “among the largest we have [ever] seen” (the screengrab on the left is from the bank’s December note). When that hit, the NYSE Uptick Minus Downtick index touched 1,662, representing the fourth-highest reading of the bull market at the time. Although the month-end flow into equities in May won’t be the kind of tailwind it was in December, beleaguered investors, war-weary from the trade conflict, will take whatever they can get.
It’s worth noting (because it always is) that market depth still hasn’t recovered to the “highs” seen in September despite this year’s rally. “As volatility subsided in April, SPX futures’ top-of-book depth did not quite get back to the level they reached in September, just before the Q4 sell-off”, Goldman’s Rocky Fishman wrote earlier this month. Next week, liquidity could be thinned by the holiday, making any bid more likely to push prices around. That could amplify the effect of any rebalancing flows.
Really, though, over-analyzing the prospective impact of a projected $7 billion buy is probably making a mountain of a molehill. The real question is whether the Trump administration gives any sign that the US side is willing to take its foot off the throats of the Chinese. The “Trump put” may not be in the money yet, but you’ve got to think the president read the headline about the worst streak of weekly losses for the Dow since 2011.
So, who knows, maybe Trump will come around. As Kolanovic told Bloomberg in the linked interview above, “the trade war is not a positive for the US, the world, consumers or markets.”
“Ultimately”, it’s not a positive for Trump either, Marko added.