A $900 Billion Rebalancing Flow?

As discussed here late last week, there’s a strong argument to be made that beleaguered equities are in for a bit of respite headed into month- and quarter-end thanks to what should be a pretty epic rebalancing flow.

This has, of course, been an absolutely egregious month for stocks, with SPX -23% (and -30% on the quarter). The disparity with bonds is quite something to behold.

“Drilling down into this portfolio rebalancing” dynamic and looking at a simple performance-spread of SPX versus TY over this current quarter-to-date, we see an astounding -35.5% (SPX underperformance) through Friday”, Nomura’s Charlie McElligott writes, in a Monday note. Here’s a visual:

That ranks in just the 0.7%ile since 1982.

“Broadening the trigger rank to build a larger sample set, we looked at 3%ile or worse ‘Quarter-End Performance Spreads Extremes’ between SPX and TY since 1982 and the output showed a very solid ‘Equities Higher’ reversal on the back-test”, McElligott went on to say.

Here are some historically large instances of equity underperformance for context:

Meanwhile, JPMorgan’s Nikolaos Panigirtzoglou suggests in his latest that the flow into equities could be quite large indeed.

“On our estimates, balanced or 60:40 mutual funds, a $1.5 trillion universe in the US and $4.5 trillion universe globally, need to buy around $300 billion of equities to fully rebalance to 60% equity allocation”, he says, adding that US defined benefit plans, a $7.5 trillion universe, “would need to buy $400 billion to fully rebalance and revert to pre-virus equity allocations”.

And don’t forget about Norway (which sits atop the whale of whales when it comes to SWFs) and GPIF, which Panigirtzoglou notes “would need to buy around $150 billion equities to fully revert to their target equity allocations of 70% and 50%, respectively”.

So, in total, that’s somewhere between $800 billion and $900 billion in potential flows into equities, and while Panigirtzoglou acknowledges that “the timing of these rebalancing flows is uncertain”, he also points out that “even if one-third of pending rebalancing flows is done over the next few weeks [it] should help to reduce vol and to lift equity prices higher”.

Those “old” enough to remember 2018 might recall that the worst December since the Great Depression for US stocks probably would have been even more painful were it not for a historic rebalancing flow.

Part of the reason why that flow catapulted stocks to the extent it did was due to poor liquidity. This time, that dynamic could be even more dramatic. After all, liquidity is severely impaired.

(JPMorgan)