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A Wave Of Selling Is About To Hit The Market – Here’s What You Need To Know Now

We could be in for a wild ride ahead with the selling amounting to as much as $76 billion.

So far in Q2 2020—which closes out this coming week—the S&P 500 has gained nearly 25%. 

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While it has been a choppy ride recently as surging coronavirus cases have roiled stocks, markets could see a fresh wave of selling next week as pensions, other funds, and investors unload some of their big gains and switch to bonds.

JPMorgan said that if stocks lose ground next week as a result of the end-of-quarter selling, investors should take it as a buying opportunity. Though there’s also a chance the volatility of the end of the quarter may have already been playing out in the equity derivatives market.

“The end of the quarter is going to be pretty interesting, given how much the market has moved during this quarter,” said KKM Financial managing director Dan Deming. “There could be volatility here. We already witnessed it and there’s potential for more, as we move toward the end of Q2.”

At month end, bond strategists watch for moves in fixed income markets as pension sand other funds recalibrate their portfolios. But the end of a quarter is an even bigger event, and given this quarter’s bi move higher in stocks, there’s speculation that there may be a sizable move by pension funds into bonds.

“We estimate that U.S. corporate pensions will move about $35 billion into fixed income,” said Michael Schumacher, director of rates strategy at Wells Fargo, adding that this is the largest flow in the six years since he has tracked portfolio rebalancing.

“The reasons are pretty obvious,” Schumacher continued. “You had this massive rally in stocks and bonds haven’t been keeping pace.”

But the move could be even larger.

JPMorgan analysts see a $65 billion rebalancing flow from U.S. defined benefit pension funds, while Goldman Sachs is estimating a $76 billion wave of selling by pensions.

“While we acknowledge the risk of a small correction in equity markets over the coming two weeks as a result of this negative equity rebalancing flow,” the JPMorgan analysts wrote, “we continue to believe that we are in a strong bull market in equities and any dip would represent a buying opportunity.”

But while JPMorgan sees this wave of selling as chance to buy, Mohamed El-Erian said he’s waiting to put cash to work as the stock market faces continued uncertainty with the coronavirus pandemic.

“I have money on the sidelines, and I missed the last rally of the last three weeks. I’m not putting it to work here,” El-Erian, chief economic advisor at Allianz, said this week. 

El-Erian is waiting until he sees areas “under the umbrella.”

“There’s two types of umbrellas out there,” El-Erian continued. “If you are comfortable with moral hazard, the umbrella support by the Fed, which involves high-quality bonds and certain high-yield bonds. If you’re comfortable with a market-based umbrella, it is companies with very strong balance sheets and positive cash-flow generation. There’s quite a few of them… out there, and I suspect they will continue to do well, albeit in a very volatile fashion.”

The economist believes the volatility will continue until the market has an “anchor” to hang on to. Early on in the pandemic, the anchor was the policy responses from the Federal Reserve and Congress, and then the anchor transitioned to economies beginning to reopen as the coronavirus curve appeared to be flattening. But after that, retail investors pushed the market higher with Goldman saying much of mom-and-pop investors’ outperformance occurring in the middle of May as the spread of the coronavirus seemed to be slowing and less-bad economic data encouraged bargain hunting.

“But retain flows no longer have the same influence,” El-Erian said. “You can see from what’s happened to the rotation trade. … So the big question is, what is the next anchor for markets? And it’s not clear to me where that’s going to come from.”

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