Apparently, equities have rallied by more than 2% into month-end during months when bonds outperform stocks by more than four points. That’s according to Macro Risk Advisors. Their analysis goes back to 1989.
Barring some kind of positive news on the trade front or other readily identifiable catalyst, you can expect any strength that comes through in equities this week to be partially attributed to rebalancing flows. This is a story that’s grabbed some headlines, not least because of the December experience, recapped here on Saturday.
Read more: Markets Eye December Circuit Breaker To Save Stocks From ‘Massive’ 4% Monthly Slide
The “massive” characterization of stocks’ monthly loss for May was obviously sarcastic, but the disparity between equities and bonds this month is indeed notable. “The underperformance versus bonds in its highest decile over the past five years”, JPMorgan’s Bram Kaplan wrote, in a short note out Friday.
Whether or not this is going to matter is debatable, but as noted over the weekend, the holiday-shortened week and the fact that liquidity never fully recovered to September levels amid this year’s rally, means that the fixed-weight flows could have an outsized effect.
Of course, reading the intraday tea leaves might be complicated by the ongoing rally in Treasurys. 10 year US yields fell to a fresh “since 2017” low on Tuesday amid persistent growth concerns.
In any event, a market adrift without catalysts makes for journos adrift with no story hooks, which means there’s plenty of scope for whatever action there is to be interpreted through the month-end rebalance lens.
Given that, it’s worth noting that in addition to the 1.5% potential fillip JPMorgan sees for the S&P from fixed weight allocators, the bank also predicts a sizable tailwind for the Russell, the MSCI EAFE and emerging market equities (1.2%, 1.1% and 2.4%, respectively).
That comes with the “all else equal” caveat, but assuming Trump can abstain from further trade escalations for a couple of days, “all else” might in fact turn out to be “equal.”
Meanwhile (and this is something of a non sequitur), BofA reminds you that “Fed pricing is everything, and everything is about Fed pricing”. The reflexive relationship between monetary policy and markets is hardly news, but it bears repeating under the circumstances.
“In theory, a central bank’s objective is to balance inflation and the labor market [but] in practice, there are many moving parts”, BofA writes, adding that “regressing Fed expectations against equity market returns and economic data surprises reveals that during Fed turning points and significant market stress (e.g. early 2000, ’06-‘08, ’15-16), both economic data and risky asset moves have an impact on Fed pricing.”
(BofA)
The bank continues, noting that seen in this light, Fed pricing is really just “another measure of market fear similar to implied volatility.”
As far as whether BofA would fade expectations for rate cuts, the bank says that “while we are not pessimists and do not believe a Fed cut is currently warranted”, the reflexive relationship (amplified by the extent to which market stress is transmitted to the real economy through tighter financial conditions and the reversal of the vaunted “wealth effect”), leaves the bank’s rates strategists “not eager to fade the current market pricing either.”
We are in a market where fundamentals appear to be “trumping” technicals. Fundamentals suggest that economies are slowing worldwide. It also appears we have a reactive not a proactive Federal Reserve. They will ease only when their hand is forced by a slowing economy with the risk of deflation and/or a market crack leading to deflation risk. The political backdrop does not help, with uncertainty rising.
Hmmmm….. either the NY Fed is still stuck in the Hamptons’ traffic on the LIE or Michael Wilson’s timely perspicacity might actually be signaling the inchoate stages of the trumpCrash are now gestating in the deep sprockets of actual price discovery!