As we first reported one week ago, a "red flag" emerged for the market, and big hurdle for Dow surpassing 20,000, as a result of year-end pension fund rebalancing, which as Credit Suisse calculated have to sell between $38 and $58 billion. According to CS analyst Victor Lin, the “estimated rotation out of domestic U.S. equities would be one of the largest on record” with relatively large outperformance versus other asset classes both on a monthly and quarterly basis.
And, as yesterday's price action showed, "prudently" said pension funds appear to have waited until the very last possible moment, i.e., the end of the year to dump billions in ultra thin tape, leaving C-grade traders in charge of execution.
Further, as RBC's cross asset head Charlie McElliggott notes in a note this morning, yesterday's selling was hardly the only "rebalancing day", with today and tomorrow still on the calendar.
So what time should traders expect these selling waves?
Here is RBC's answer:
Mean-reversion (both cross-asset and intra-asset) has officially commenced ahead of schedule, but still setting-up for a now modestly downgraded “January Effect”; that said, real money / asset-allocators have a longer-term basis to continue to shift portfolios to a more reflationary-footing which will see that equities dip bot and that UST rally sold (which is a now dangerous market consensus in and of itself!); the key to sustaining the move will HAVE to be the continued “percolation of animal spirits” in 1Q17 economic data with confidence metrics, inflation and PMIs.
The US Dollar has reversed the entirety of yesterday’s gains (and then-some) on four key ‘inputs’ over the past session and a half:
- Large month-end FX hedging from US equities clients, where major MTD gains in stocks force USD-selling on the hedging adjustment.
- Lower US rates (= stronger USTs) from the blistering indirect takedown (highest all-time at 71.4%) at yesterday’s strong 5Y auction, which stopped 1.2bps through WI and squeezed the mongo leveraged-fund short base
- Lower US rates (= stronger USTs) boosted by the mechanical pension asset-rebalancing into bonds from stocks (on acct of massive relative performance gap MTD / QTD), most-clearly evidenced by the programmatic ~ half-hour long selling-waves seen in SPX at 9:35am, 11:55am and 3:35pm. Expect this flow to continue through the new year, as market liquidity simply is not deep enough to ‘take it.’
In other words, anyone looking to BTFD may want to step away just before noon today - and especially tomorrow when nobody will be around - and just after the start of what is the traditional 3:30pm ramp, which if RBC is correct, will have an opposite effect on the market in the last 25 minutes of trading.