Traders are perplexed by today's market action: not only did the S&P stage a dramatic intraday reversal from session highs, and all three indices are now red on the day, but so far the BTFD ETF flows are missing. What gives?
We may have an explanation courtesy of Credit Suisse, which writes in a trading note that U.S. pension funds that rebalance monthly - which is most of them - will have to sell more than $12 billion of stocks in the coming days to return to prior asset allocation levels given recent rally in the stock market - the S&P is up 6% YTD while bonds are down just shy of 1%.
As a result, CS calculates that funds are expected to sell a sizable $12BN in equities and buy roughly $24BN in fixed income. The amount of selling, CS writes "would be the biggest in at least a year for a month that does not coincide with quarter-end."
The details from Credit Suisse:
- Equities have had a strong start to the year with the S&P 500 up 6.5% MTD. As a result, our model currently estimates selling in U.S. equities to total just over $12bn from funds that rebalance on a monthly basis – a relatively large amount relative to recent history for a month that does not coincide with quarter-end.
- In addition, U.S. pension funds are also expected to be net sellers of international equities due to their similarly strong performance (MSCI EAFE up 6.8% and MSCI EM up 8.7%). We estimate over $9bn of selling in Developed Market equities and $3bn in selling of Emerging Market equities.
- Given the relative underperformance versus equities, we expect the significant rotation of assets into fixed income to continue. Our model estimates slightly under $24bn of buying in fixed income securities in total.
CS does caution that projections may shift materially based on the relative performance of asset classes and that "In practice, pension fund rebalancing may not specifically fall on a specific day (e.g. month-end) and the actual timing of trades can vary based on several different factors including market sentiment, implementation costs, and regularly scheduled cash flows."
Bloomberg confirms as much writing that today is the trigger day for month-end rebalancing, and warns that today's action may be a signal to expect pension rebalancing over the next week.
What about over the longer-term?
This weekend, JPMorgan's Flows and Liquidity note revealed that "the average long-term sovereign yield level at which pension funds would start de-risking was 2.8% and the yield at which they would expect to be fully hedged was 3.7%. The 30y UST yield at 2.9% currently has already crossed the 2.8% level mentioned in this survey."
Furthermore, JPM calculations suggest that this year’s 5% rise in equity prices alone could create up to $125bn of pending rebalancing flow by US defined pension plans.
We look for G4 pension funds and insurance companies overall to buy a lot more bonds than the $460bn bought last year, and for their bond buying to return to at least the 2016 pace of $640bn. In fact, we see upside risks to this projection assuming equity markets remain strong.
To JPM the news is bullish for the long-end of bond curves: "This pension fund rebalancing flow should support the long end of DM bond curves causing further flattening this year."
As to what forced pension selling of stocks will mean for equities, we may find out in the next few days...