Caution before the end of the quarter

Crisis trading

23.06.2020 – Special Report. Soon prices will slide – at least according to Goldman Sachs, JPMorgan and the hedge fund GMO. Although there are constant warnings from one side or the other in the eternal battle between bull and bear, the most recent speeches seem particularly well-founded. Particularly in view of the date 30 June. We analyse the background.

Rebalancing of funds at end of quarter

Goldman Sachs had just warned that pension funds in the USA would have to sell shares worth 76 billion in the course of a “Quarter End Rebalancing”. This would be the third largest sum of all time after March 2020 and December 2018, both of which, incidentally, were quite volatile times on the stock market.
The background to this is that funds have to constantly loosen up cash, especially in order to be able to stem payouts at the end of the quarter. But they also have to sell in order to meet their own investment standards – in other words, to maintain the required equity ratio in the overall investment. About a 60/40 of stocks and government bonds. And after the recent rise in the stock market since March and the associated increase in the valuation of shares in a fund, this can only mean a sale.

JPMorgan sees sale of 170 billion dollars

JP Morgan has now gone one better: According to the report, shares worth 170 billion dollars are available for sale by the end of the quarter on 30 June. In his latest report entitled “Flows and Liquidity”, analyst Nikolas Panagirtzoglou said that a small correction was imminent. Incidentally, he had correctly predicted the return of 1.1 trillion dollars to the market since March 23.
In view of the ongoing stock market rally, JPM judged, “not only has the continuation of the equity market rally into June naturally eroded all of the previously estimated positive equity rebalancing flow, but it has likely created a need for negative rebalancing flow, i.e. equity selling, of around $170bn into the current month/quarter end. Panagirtzoglou took a closer look at five market players for his analysis: Investment funds, US pension funds, the Norwegian sovereign wealth fund of Norges Bank, the Swiss National Bank and the Japanese government pension fund GPIF.

Doomsday scenario from hedge funds

Regardless of a possible rebalancing of funds, one of the best-known Wall Street bulls has just taken the bear’s side: The British star investor Robert Jeremy Goltho Grantham, co-founder and co-chief investment strategist of Grantham, Mayo, & van Otterloo (GMO) in Boston. The hedge fund holds around 75 billion dollars of assets under management.
In a letter to his clients, Grantham wrote “we have never lived in a period where the future was so uncertain” and yet “the market is 10% below its previous high in January when, superficially at least, everything seemed fine in economics and finance. And if not “fine,” well, good enough. The future paths include many that could change corporate profitability, growth, and many aspects of capitalism, society, and the global political scene. In short, the future has never been so uncertain. In these unusual times everything could change – the profit situation of corporations, politics and society. So it is not fitting that the market is only about 10 percent below its all-time highs.

Stock market and real economy decoupled

The investment veteran admitted that he had lost faith in the upside case. Never before had the real economy and the financial market been so far apart. Specifically: “the current P/E on the U.S. market is in the top 10% of its history… the U.S. economy in contrast is in its worst 10%, perhaps even the worst 1%… This is apparently one of the most impressive mismatches in history. Ergo: While the stock market is in the top 10% of its history, the real economy is in the worst 1% of its history.
Grantham further told the FT: “The Covid-19 pandemic “should have generated enhanced respect for risk and it hasn’t. It has caused quite the reverse.” So no respect for risk in the stock market. As a result, GMO cut its net exposure to the global stock market from 55 to 25 percent. According to the “Financial Times” the share of American stocks slid from a net 3 to 4 percent to a short position of 5 percent.

This time everything is different

The current events are completely different from anything that has happened before, Grantham continued. Even before the Corona crisis, the USA and the world had already had problems due to the climate, population growth and a falling gross domestic product. In addition, the USA had the highest level of debt ever in the world. And then the virus struck.
The economy is now contracting much more strongly than it did during the Great Depression – the slide in US gross domestic product now lasted only four weeks, whereas it had taken four years during the Great Depression. And unlike 1989 Japan, 2000 Tech (U.S.) and 2008 (USA and Europe), Corona is now a truly global issue. Hope for a vaccine remains, but there is no effective protection against viruses. At the same time, the wave of major insolvencies has only just begun, as Hertz shows. Although the unparalleled intervention of the central banks has obscured the economic realities, this will not last long. With regard to the unrest in the USA, Graham added, “there are more things going wrong than normal”.

Possible crash of 50 percent

And then he had a house number elicited for a possible crash: “if you look back in two to three years and this market turns around and drops 50%, the history books will say ‘That looked like one of the great warnings of all time. It was pretty obvious it was destined to end badly.” So the market could lose a good 50% in the next two to three years.
GMO had been right in several previous crises: In 1987, for example, the fund exited the Japanese stock market at a 45-fold valuation – only to see the price-earnings ratio rise to 65. But before a 30-year downtrend set in. In 1998, GMO bid farewell to the tech bubble at 21x, which blew up to 35x – only to plunge 50 percent. And in 2007 the fund withdrew from the housing bubble. So we are dealing with very clever analysts.
Our conclusion: It is clear that the market is currently being driven mainly by the air money of the Federal Reserve and other central banks. However, it is unclear whether the recovery of the real economy in the US and around the world has already begun in a serious manner or not. The date of June 30 remains – you should keep a serious eye on fund rebalancing.
The Bernstein Bank wishes successful trades and investments!


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