Key facts
- The third quarter saw a significant bond selloff, contrasting with stocks near record highs.
- Analysts expect substantial portfolio rebalancing to realign stock and bond allocations.
- Goldman Sachs estimated US pension funds would sell $33 billion in stocks to buy bonds.
- This rebalancing estimate ranks in the 98th percentile for absolute dollar terms since January 2000.
- The full impact of rebalancing is anticipated in the early days of the fourth quarter.
Investors typically conduct routine portfolio rebalancing at the end of each quarter, but the quarter ending Wednesday is expected to have seen unusually large adjustments due to a steep selloff in bonds. This bond market slump occurred while stocks remained near record highs, forcing portfolios to deviate from their target allocations.
Analysts anticipate that this significant drift away from target allocations will necessitate substantial portfolio changes. Jordan Jackson, global markets strategist at JP Morgan, noted that higher volatility and the magnitude of the allocation drift make this quarter's rebalancing particularly significant historically.
The extent of these rebalancing activities, and whether managers choose to act immediately or delay, could influence trading patterns in both stocks and bonds around the quarter's end. This could potentially lead to increased demand for fixed income and pressure on equities.
Goldman Sachs projected in a report that US pension funds alone were expected to sell approximately $33 billion in stocks in the days surrounding the quarter's close to realign their portfolios, redirecting these proceeds into bonds. This estimate places the third quarter's projected rebalancing activity in the 98th percentile of all such estimates since January 2000, indicating that only 2% of quarters have seen higher projected rebalancing volumes.
While tracking these flows in real-time is challenging, Jackson has observed indicators in mutual fund and ETF flows suggesting increased investor appetite for bonds in recent weeks. The quarterly portfolio review is a key risk management practice for many investment managers. They may adjust positions more frequently during periods of high market volatility, or defer rebalancing if allocations have not breached specific trigger levels.
Michael O'Rourke, chief markets strategist at JonesTrading, suggested that investors should be more aggressive in rebalancing due to the attractive opportunities in Treasury bonds, which have not been seen in decades, while stocks appear relatively expensive. However, he expressed concern that many might find the process more difficult than usual.
Rebalancing into an underperforming asset class like bonds presents a psychological challenge for investors. The bond market steadily deteriorated throughout the quarter, leading to the largest increase in the 10-year Treasury yield since the second quarter of 2009, while US stocks largely held near their peaks.
Michael Gates, lead portfolio manager for BlackRock’s Target Allocation ETF model portfolio suite, confirmed that his team is overseeing some rebalancing, shifting model portfolios to favor stock and bond categories perceived as lower risk with greater upside potential for the remainder of the year. He stated that they are managing risk by preventing their models from becoming too heavily weighted in stocks at this stage.
For financial advisers working with individual investors, overcoming client aversion to investing in underperforming assets is a significant hurdle. Mike Casey of AE Advisors highlighted that clients often prefer to let winning investments continue to grow.