Equity Markets Could Be Vulnerable Into Year's End, Say Analysts

Rebalancing flows could keep equities vulnerable into the end of the year, according to JPMorgan analysts. To determine how much activity to expect in equities heading into the end of the year, they looked at four multi-asset investors have either fixed allocation targets or that tend to exhibit strong mean reversion in their asset allocation: balanced mutual funds, pension funds, the Norwegian oil fund, and the Japanese government pension plan. 

Watch For Equity Rebalancing

JPMorgan analyst Nikolaos Panigirtzoglou and team said in a recent report that balanced mutual funds, a $7 trillion universe, must sell about $160 billion in equities around the globe by the end of December. That would bring the funds back to their 60/40 allocation.

If the equity market continues to rally into December, the JPMorgan team expects another $150 billion in equity selling into the end of December by pension funds, which usually rebalance on a quarterly basis. U.S. pension funds manage $7.5 trillion in assets and tend to rebalance over one or two quarters. 

Adding fuel to the fire of concerns about the bull run in equities, Credit Suisse analysts said in a separate report that the U.S. equity market is now overbought as 85% of S&P 500 stocks are above their 200-day average. They said that doesn't necessarily mean the market can't extend its gains, but it suggests that any strength probably won't last very long. 

Value Rotation

It's been a difficult few years for value, but in recent months, a new rotation into value has been occurring. Credit Suisse analysts said in their own report that the S&P 500 Value index has seen a bullish triangle continuation pattern emerge over the last five months. They expect a more decisive move higher with resistance at the neckline to the first quarter top at 1,245. 

JPMorgan analysts noted that the rotation into value slowed last week, especially in U.S. stocks. The relative performance of the long versus short basis was basically flat after a 9% outperformance in the week that ended Nov. 13. However, the rotation has continued in Europe, although at a much slower pace with an 11% outperformance of the long versus short value baskets during the week. 

The JPMorgan team said the slowdown in the value rotation isn't surprising due to the "violence" of the initial shift, especially in the days after Pfizer's COVID-19 vaccine announcement. They also said the momentum reversal has slowed as well, but less than the value rotation. Investors have continued to shift toward companies that previously underperformed in both the long and short value baskets.