There’s a reason why markets gyrate up and down, and a major one is when institutional money starts rebalancing its holdings. When big money takes some profits off the table to move to underperforming stocks or other assets, the market can trade weakly, or even sell off. With the market strength of the past few months, end-quarter rebalancing could create a few bargains in the coming weeks.
JPMorgan Chase estimates that pension and sovereign wealth funds will shed about $200 billion in stocks . That’s enough of a shift to cause some stocks to plunge, with the most significant risk from recent top performers.
Top funds are required to maintain specific ratios in some assets. Without rebalancing, riskier assets that fare better over the long haul (stocks) can come to dominate a portfolio that ideally should be better mixed.
Rebalancing is ultimately a two-way street. When stocks have been poor performers, investors may want to reallocate some of their cash or fixed-income into stocks instead, which appears to have been part of the big move higher for equities at the end of March .
While studies show that rebalancing is good for maintaining asset allocation, some think that ultimately the policy does little more than generate some fees for brokers or, at best, only add a small return every year. That’s because rebalancing requires taking profits on investments that have done well and dropping them into poor performers.
The extra performance from rebalancing also depends on when you start and stop investing in the market.
While rebalancing is a respectable theory with only a few detractors, the fact of the matter is, when big money moves, even retail investors can get burned. For all the options trading on the market, if there are more stock sellers than buyers, share prices are likely to go down.
The good news? With $200 billion being shifted around, the overall market isn’t in for a crash just because big money needs to up their stake in bonds.
In other words, this won’t cause a market crash in and of itself. But it should lead to some bargains, much like how the big tech names just suffered a mini-crash this month.
Meanwhile, since the market crash back in March, funds have been holding onto record levels of cash. That’s because retail traders quickly piled into stocks first, and funds have been much more cautious about investing back into the stock market.
This “cash on the sidelines” argument for stocks to head higher was also touted in the early stages of the recovery from the Great Recession. And, while it took years, the market did move higher. So don’t sweat any selloff based on rebalancing. Just take advantage of any bargain that does pop up.