And no, we did not anticipate that President Trump would activate the Plunge Protection Team over the weekend: the good news in question was that as Wells Fargo calculated U.S. defined-benefit pensions fund would need to implement a “giant rebalancing out of bonds and into stocks” – in fact the biggest in history – with the bank estimating roughly $64 billion in equity purchases in the last trading days of the quarter and year, prompting the banks to ask if traders are about to make pension rebalancing “great” again.
Judging by today’s market action, the answer is a resounding yes, even though as Wells warned investors and traders looking for a desperately needed respite from market gyrations “may have to deal with yet one more seismic bout of volatility before Dec 31 finally pops up on their calendar dials.”
For those who missed our Friday post on the topic, Wells explained where this massive rebalancing comes from: the huge, end-of-quarter buy order was precipitated by the jarring divergence between equity and bond performances both in Q4 and the month of December. The stocks in the bank’s pro forma pension asset blend had suffered a 14% loss this quarter, including about an 8.5% drop in December. Contrast this with a roughly +1.6% quarterly total return for the domestic aggregate bond index. The gap between equity and bond performance in pension portfolios would have been even larger had IG credit OAS not widened nearly 40 bps in Q4.
As a result of this need for massive quarter-end rebalancing, corporate pensions would need to boost their equity portfolios by as much as $64 billion into year-end. Getting a bit more granular, Wells analyst Boris Rjavinski wrote that domestic stocks – both large cap and small cap – may need disproportionately large boosts of $35 billion and $21 billion, respectively, compared to “only” $9 billion for global developed equities (see table below). This is driven by large performance gaps within equity markets: U.S. stocks have trailed global and EM equities in Q4 and December after outperforming the ROW for quarters on end.
Meanwhile, in part explaining today’s bond market weakness,pensions would be looking at a historically large outflow of about $57 billion.
Some pensions rebalance every month and some only at quarter-end. Since bonds trounced equities both on a quarterly and monthly basis, the flows from the two groups of rebalancers will go the same way. This should amplify the market impact.
Finally, we also touched upon what assets pensions would buy (and sell): according to Wells, most of the initial outflows from fixed income would be affected via liquid Treasury futures contracts. Consequently, the TY and U.S. sectors should underperform potentially for most of the brief trading window this week.
Finally, while not directly related to today’s massive pension-driven buying spree, Wells laments that defined-benefit company pensions just cannot seem to catch a break, and notes that just a few short months ago, corporate pensions’ average funding ratio seemed poised to top 90% and stood at 88% in July, up from 85% at the end of 2017.
Alas, the good fortune proved fleeting, and the updated Well Fargo estimate pegs average solvency at 83%. The drop for 2018 is no surprise with equities posting hefty declines while long-term Treasury yields are up only 30-35 bps. As a result, pension trustees face an unenviable task of going back to the drawing board, while company Treasurers may be looking at writing another sizeable check to shore up their pensions.
We concluded our Friday post as follows:
For now, however, buckle up for what may be the single largest quarter-end pension rebalancing in history.
A few days later, with pensions seemingly deciding to take Christmas Eve off, Wednesday’s torrid price action – and that over the next two days with quarter and year-end imminent – is the result of this “single largest quarter-end pension rebalancing in history”, which is manifesting itself in the biggest percentage gain in the Dow since late March.
Or, as Trump would tweet, “pensions are BTFD today. Are you?”