The stock market could get knocked down soon as managers rebalance portfolios by moving money into bonds and out of stocks.
Much of that rebalancing could happen Friday, the last day of the first half of the year. Wealth managers and asset allocators, who invest in various asset classes for families and institutions, will want to show clients a healthy diversification of assets. Why not do that when bonds look attractive, and the recent stock market rally faces some risk? Stocks could be pressured by managers selling or simply not buying equities, while other investors also sell.
A second-quarter rise in bond yields has made fixed income more attractive, while a recent run-up in stocks makes them less appealing. This sets up a “likely sell stock/buy bond rebalance ahead at 6/30,” wrote Julian Emanuel, Evercore strategist.
Let’s start with how bonds are looking. Some short-term bond yields are near 5%, looking at the Treasury market. Even something as long as the two-year Treasury yield is at just over 4.7%. Expectations for average annual inflation for the next 10 years is at about 2.2%, according to St. Louis Fed data. Sure, inflation is above that this year, but markets understand that, with the Federal Reserve having lifted interest rates, economic demand, and inflation will decline, making those yields look enticing. As those short-term bonds mature, folks can reinvest proceeds into the higher-yielding areas of the bond market, whether that’s ultimately shorter-term debt or longer term.
The resulting allocation to bonds, should managers and advisors do so, could mean they’ll pull money out of the stock market. The stock market is riskier and more expensive today than it was months ago, with the
S&P 500
up more than 20% from early October, its bear-market low. It’s vulnerable to a slowing economy and lower expectations for corporate profits, as the full impact of higher rates hits the economy with a delay.
And anyway, people have recently bought a lot of stock, and they may not be inclined to buy more and lift prices.
One thing that could bolster stocks, however, is that big investors also have tons of cash on the sidelines. A Bank of America survey shows equity managers who handle portfolios worth trillions of dollars have allocated over 5% to cash. Historically, the cash allocation can dip under 4%, so fund managers have more cash than they can put to work in the stock market. That could counteract any negative stock market impact from people rebalancing into bonds.
Also individual investors have sent trillions of dollars into money-market funds recently, so they could draw on that cash to buy stocks. But it is true that this cash now yields a lot, so maybe it will continue to sit there—or migrate out of money-market funds and into bonds.
However you cut it, there’s a good chance that money will move into fixed income, not stocks, for some time.
Write to Jacob Sonenshine at [email protected]
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