Year-end fund rebalancing may explain why stocks aren’t rallying despite a $900 billion U.S. fiscal deal

Year-end fund rebalancing may explain why stocks aren’t rallying despite a $900 billion U.S. fiscal deal

Stock markets may have a tough time extending their gains before the end of 2020 as investors take their chips off the table.

That’s the theory touted by Steven Ricchiuto, chief U.S. economist for Mizuho, who said the puzzling inability of equities to extend their gains this week even though Congress passed a $900 billion fiscal relief bill may be somewhat explained by investors taking a victory lap in a great year for Wall Street.

See: Coronavirus aid deal easily sails through Congress, as both sides eye future fight

“Investors that had a good year have already positioned themselves for the year-end, and are probably as close to neutral as they wish in their exposure heading into the turn,” said Ricchiuto, in a Tuesday note.

That left more bearish traders as the driving force of a market left to its own devices by those counting their gains.

And amid the uncertainty around the trajectory of the COVID-19 pandemic, with new lockdowns across Europe and a new strain of the virus discovered in the U.K., investors may be tempted to wait for more clarity on the health front, said Ricchiuto.

Year end rebalancing by funds also needs to be taken into account as money managers cut down their inflated equity holdings and shore up their bond holdings to realign the weightings of their portfolios.

Though a basket of high-grade corporate bonds, mortgage-backed securities and government debt had returned over 7% year-to-date, as tracked by the iShares Core U.S. Aggregate Bond exchange-traded fund
equities have racked even more impressive gains.

The S&P 500

has returned over 14% during the same stretch year to date.

Indeed, analysts at BNP Paribas estimated around $63 to $85 billion of funds would be siphoned from stocks and redirected into bonds before the end of the year.

By their estimation, the divergence between stock and bond performance and the consequent rebalancing necessary to ensure a more even keel to investor portfolios could lead to a modest 1.5% decline in U.S. stocks in the final week of trading.

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