Chief Investment Strategist
Summary: Equities are responding well to the latest move from the Fed and Germany's massive stimulus package. On a more technical level there are two catalysts that could extend the rally in equities. Rebalancing of pension portfolios could add $750bn in inflow into equities as the current equities and fixed-income mix has moved a lot in March. The other technical indicator is the S&P 500 distance to the 200-day moving average which hit -26% yesterday which is an extreme oversold situation. Historically the returns in the following month have been skewed to the upside.
Sentiment in global equities have improved significantly over the past 48 hours on the Fed’s open-ended quantitative easing programme and Germany’s large stimulus package as described in yesterday’s equity update. But besides policy moves two technical catalysts could send equities higher.
Rebalancing could add as much as $1trn into equities
There was about $30trn in pension funds in the OECD countries in 2019 assuming 8.8% return on funds from 2018. In many standard strategic asset allocations the mix between equities and fixed-income has shifted to much and potentially out of the allowed weight bands. If we assume a 2.5%-point rebalancing into equities, which is not unreasonable given the move in March, then rebalancing will add $750bn in capital that will allocated into equities over the near term. Add to this life insurance companies, retail investors, endowments and family offices and the amount quickly moves above $1trn in rebalancing.
S&P 500 is extremely oversold by historical standards
The S&P 500 was -26% lower than the 200-day moving average as of yesterday’s close which is around the 1.5% percentile of all distances observed since 1928. We did a bit of number crunching to see what the future returns have looked like whenever the S&P 500 was 26% below its 200MA or The distribution of 21-day future returns is positively skewed with a median around zero but with massive variance. The biggest drop from such a distance to the 200MA is another 25% which would take the S&P 500 to 1,678 by April. In the other extreme we find the maximum gain which has been 68% which would take the S&P 500 to 3,758 by April. The numbers fit very well with the high VIX Index that we are still observing thus moves are to be expected over the coming weeks. Given the nervousness in the market and the positively skewed distribution buying call options on the S&P 500 could be one way to express this and limit the losses to the premium paid.
One important thing to note of course is that the trigger of the recent declines is a global pandemic on the scale that the world has not seen since 1918. This means that modern financial markets are in unprecedented territory and prior dynamics may not repeat itself. So investors should obviously take that into consideration.
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