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Ok so..... We know we're in for a wild ride as economic data will most likely be bad in the coming weeks/months. That's a given.....bad news is a known known. And of course, everyone knows how to read a calendar, and the end of March and end of Q1 is fast approaching.
Because it's the end of Q1, portfolio managers, mutual funds, pension funds, hedge funds, investors, etc will be rebalancing their book. This is probably already happening, and will likely be completed before Tuesday of next week....
With the massive move lower in the S&P and Nasdaq, I would expect some buying in equities to rebalance the book to a set % of equity exposure..... And with the recent move higher in Treasuries, I would expect some selling in order to rebalance to a lower % of bond exposure...... This buying of the losers and selling of the winners is merely a mechanical move that is a known event by most market participants.... What is UNknown is how much rebalancing has already been done because of the massive move lower in S&P over the last number of weeks (and the fund managers preset triggers for rebalancing being hit early).... And then also, how much is the Fed ponying up RIGHT NOW to keep Treasuries, Mbs, and Corp debt bid? To me, the bond market seems to be broken because of the relentless bid, but I guess that's to be expected with one market participant (the Fed) buying everything under the sun. Anyway..... The doomers are gonna be out again telling you that the reason for the rally in equities over the next few days is merely due to rebalancing... and once Q1 is over, there's nothing to look forward to except dark stormy clouds on the horizon. I agree that rebalancing is a PART of the move higher, but I don't know how much is due to rebalancing.... and I don't know if there's a report or SEC filings or some website that calculates that data? If anyone knows, please post a link...
So imagine a portfolio manager who is running a $100 billion fund, and the investment objective is to be 60% weighted to equity (let's say S&P 500) and 40% weighted to bonds (let's say Barclay's US Aggregate Bond Index-AGG). So that's $60 Billion in S&P 500 and $40 Billion in the bond index proxy AGG. But S&P has been getting pummeled. So let's say the S&P exposure is now only $40 Billion (having a 30% off sale!) and AGG is about back to where it was on Jan 1 (after some WILD moves!), so still $40 Billion exposure in AGG.
The fund manager needs to be 60% S&P and 40% AGG... and the fund value has declined from $100 Billion to only $80 Billion. So now she's gotta SELL some Agg and BUY into S&P to get back to 60/40. Selling the bonds doesn't really matter because the Fed will be sitting there on the bid to soak up the selling pressure.... But the buying binge on S&P could really push this thing higher... especially if the rebalancing is just getting started..... and if short sellers' stops start getting hit, that could lead to even more buying.
This isn't limited to just equity and bonds either...... I imagine the same thing is happening in the ag complex too.... Managed funds in commodityland could be buying to get back to a certain weighting of corn, soya, wheat, oil, etc... and selling other assets to get back to a "normal" weighting in the overall portfolio. Likewise, bond-only funds might be Buying high yield (because that part of the bond universe has been crushed), and Selling investment grade bonds just to get back to a normalized weighting...... same thing with equity-only funds - Buy the beaten up names, and Sell the ones that haven't gotten hammered as much...
This could be a short term smash & grab rally that suckers-in all of us muppets, or it could be the beginning of the end of the panic selloff. I'm betting on the latter. The evidence I'm using to support my bullish thesis is the end of Q4 in 2018.... Equities had a 19ish% meltdown during Q4 of 2018.... and the buying towards the end of the Quarter/end of year was relentless! (maybe rebalancing was the spark that lit the fuse back then??)
As always, we'll have to wait and see what happens this time around......
Any thoughts or additional insight? Any portfolio managers-turned-farmers on here that can shed some light on rebalancing? Any wall street sharks reading this and want to chime in? Anyone? Bueller? lol...
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End of Month, End of Quarter rebalancing shenanigans...
