Overview
This lecture explains why markets dipped last week, focusing on the mechanical process of institutional rebalancing and how spotting asset divergence can help predict future dips.
Market Dip Last Week: What Happened?
- Risk assets like stocks and Bitcoin saw sharp declines in the last three trading days of May.
- The market pullback was primarily due to institutional portfolio rebalancing at the end of the month.
- Stock indices dropped while bonds rallied because institutions adjusted their portfolio weightings.
Understanding Rebalancing
- Rebalancing is when large investors adjust holdings to maintain set stock/bond ratios (often 60/40).
- This process commonly occurs at month-end, especially after significant performance differences between stocks and bonds.
- Temporary price moves against broader trends often result during big rebalancing periods.
May's Divergence and Effects
- In May, US stock indices gained strongly (S&P 500 +7%), but bonds fell (TLT -6.7%).
- This divergence forced institutional investors to sell stocks and buy bonds to restore balance.
- S&P 500 fell by 1.7% and TLT rose by 1.7% over the last three days of May.
- Bitcoin weakened 5% during the same period due to risk-off flows.
- Bank of America estimated $42 billion in equity sell-offs and $42 billion in bond inflows during rebalancing.
- After rebalancing, stocks and Bitcoin rebounded, bonds slipped.
Looking Ahead: Future Rebalancing
- Quarter-end rebalancing (like June's end) can be even larger than month-end adjustments.
- Continued divergence between stocks and bonds may trigger more significant rebalancing at June's close.
- Monitoring relative stock and bond performance can help anticipate these market moves.
Key Terms & Definitions
- Rebalancing — Adjusting investment portfolios to maintain target asset weightings (such as 60% stocks/40% bonds).
- Risk Assets — Investments with higher volatility, including stocks and cryptocurrencies.
- Mechanical Flow of Funds — Non-discretionary money movements, often required by investment mandates.
- Divergence — When two asset classes (e.g., stocks and bonds) perform very differently over a period.
Action Items / Next Steps
- Track the relative performance of stocks and bonds throughout June to spot potential market dips from rebalancing.
- Prepare for possible increased market volatility at the quarter’s end.
- Participate in investor polls to help tailor future content.