Q1 2012 Deja Vu: Pension Fund Rebalancing Suggests Window Un-Dressing Could Hurt Stocks
As we previously expected, 2013 has started in a strikingly similar vein to 2012 and 2011 and we are nearing that deja-vu turning point once again. However, the extreme relative outperformance of stocks to bonds in Q1 suggests very sizable quarter-end pension-fund rebalancing flows - and perhaps today's ramp was perfectly presented to enable that into the next two days. UBS expects US defined benefit funds to do sizable Q1 quarter-end rebalancing - anticipating $29-35 billion of equity outflows and perhaps as much as $15-19 billion of fixed income inflows. Equity outflows should be dominated by domestic stocks, with $22-27 billion of large cap and $10-12 billion of small cap sales. Furthermore, reading through the recent 10K statements of large corporate pension sponsors, they note consistent, and growing, interest in liability-driven strategies and even full-blown de-risking - supporting high grade long and intermediate government and corporate bonds. Not only are the flows pointing in a similar direction but the catalysts are lining up too.
Pension Related Q1 Rebalancing Estimates
Assessing pension asset allocation is as much art as science. Therefore, we provide ranges rather than a single number to account for the variability in the share of funds that rebalance their allocations regularly. Relative asset returns month-to-date and quarter-to-date are obviously the main driver of rebalancing activity; if equity and bond markets experience a strong bout of volatility between now and the quarter-end, the estimates below may look somewhat different.
Better US data and sentiment improvement in Europe help equities trounce bonds in Q1
Figure 1 explains why we expect significant outflows from equity: US stocks outperformed bonds by a very large margin. Curiously, Figure 2 shows that 2012 had started in a very similar manner with bond returns trailing stocks by about 10 percentage points going into Q1 quarter-end. Incidentally, the Q1 equities rally had very similar drivers in 2012 and 2013: better economic data in the US and improving sentiment in the eurozone.
Figure 2 shows that 2012 Q2 had brought a complete turnaround. By early June, stocks had given up all of its year-to-date gains while government bond yields plunged. The risk-off trade to start Q2 2012 was triggered by the funding troubles in Spain and exacerbated later on by the hung elections in Greece. Fast-forward to 2013, the eurozone is dealing with the crisis in Cyprus and waiting to see the resolution of inconclusive elections in Italy just as the Q2 is about to begin.
Figure 3 contains detailed returns for representative indices. Domestic equities clearly had the best performance in Q1, besting broad bond indices, which were slightly down, by a large margin. Given the 10-12% outperformance of US stocks over bonds, it is not surprising pensions could be expected to be large sellers of domestic equities.
The model pro-forma estimate is about $29-35 billion of potential outflows from equities versus up to $15-19 billion inflows into fixed income.
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