Rebalancing

Macro Man is back, belatedly, after a glorious few days of eating, drinking, football, and even a little cycling.  He returns to what can be described as the business end of the year, with a lot of important event risks to navigate before books are taken down for the holidays.

Before considering payrolls, the Italian referendum, ECB, and Fed, however, we must also be cognizant of how far markets have come recently.  US fixed income markets are on course for their worst month since January of 2009, and the fourth worst since at least 1988.  While there has been a lot of shuffling of winners and losers under the surface, on an index basis US equities have done quite well as hopes of Trumpflation have gripped markets.

Put it all together, and you have the sixteenth biggest monthly SPX outperformance of Treasuries (on a total return basis) since 1988.

Now, this might naturally lend itself to concerns that we'll see some month-end rebalancing from the pension guys who suddenly find themselves overweight equities and underweight bonds.   Today's price action thus far fits that narrative to a T.   However, does this sort of behaviour really drive bond price action?   Macro Man decided to investigate.

As there are three trading days left in the month (including today), Macro Man parsed US 10 year yields by their movement over the last three trading days of every month since 1988.  He then sorted this data by the amount of aggregate equity outperformance over the course of the month, and focused on those months where stocks either over- or under-performed bonds by at least 5%.   Ifg there is something to the rebalancing gig, we should expect to see Treasury yields dip when stocks have outperformed and rise when they have underperformed.

As it turns out, the size of the sample window and the size of the long bond bull market mean than on average, bond yields have dipped no matter how you slice them.   However, the evidence seems to suggest that the last 3 trading days of the month are characterized more by momentum than mean reversion.  As the table below illustrates, when stocks have outperformed, bond yields tend to fall by less than average over the last few days of the month.   Similarly, when stocks have been crushed, yields tend to fall by more than average.

 
It may be the case that the fixed income sell off has exhausted itself, if only temporarily.   If so, however, the historical record suggests that it will not be month-end rebalancing that drives whatever correction we may see.