US stocks hit a ceiling and are now facing resistance, while the bond market is taking over the role of absorbing the losses
The divergence between stocks and bonds in the third quarter triggered a large-scale institutional rebalancing. Pension funds are expected to sell $33 billion worth of stocks and buy bonds. In the fourth quarter, asset prices will face a revaluation.
The divergence between stocks and bonds disrupts the allocation balance.
Over the past quarter, the US stock market continued to approach its historical peak, while the bond market experienced a severe sell-off. The 10-year US Treasury yield once exceeded 5.3%, reaching its highest level since 2002. This divergence has severely disrupted the traditional stock-bond portfolio. The stock position has been passively over-allocated, while the bond position is significantly insufficient. According to the rules, managed institutions must sell stocks and buy bonds at the end of the quarter to restore the established ratio.
Goldman Sachs estimates that US pension funds may sell $33 billion in stocks and shift funds to the bond market. This scale is at the 98th percentile in the quarterly end adjustments since 2000, a historically rare level. JPMorgan Chase strategists believe that this rebalancing magnitude may be the most significant one in history. The volatility is higher, and the degree of deviation from the target allocation is also more severe.
Bonds are attracting capital inflows back.
It should be emphasized that such operations are mechanical portfolio adjustments and do not represent a fundamental change in the institutions' long-term views on the stock market. Long-term funds such as pensions and target-date funds must follow their investment policies; otherwise, they may bear the risk of fiduciary responsibility. The impact of rebalancing may gradually become apparent in early December. How many fund managers will act immediately and how many will choose to wait and see will directly affect the short-term trends of stocks and bonds.
The bond market has experienced a painful decline, but high yields have begun to attract capital inflows back. Recent fund flows in mutual funds and ETFs show that investors are becoming larger buyers in the bond market. BlackRock ended its six-year underweight position in US Treasuries and turned to a tactical bullish stance on short-term US Treasuries. The reason is that high yields have provided a considerable buffer for returns, sufficient to hedge against stock market volatility risks.
Technical factors amplify fluctuations.
Investing funds into loss-making assets is always a psychological hurdle. Michael Gates, the chief investment manager of Blackstone's Target Allocation ETF, said that he is supervising some rebalancing operations to control stock positions to manage risks.
The current market structure also intensifies the impact of rebalancing. Rising volatility has suppressed potential buying. The position adjustments of trend-following funds such as CTA may bring additional selling pressure. The Goldman Sachs CTA model shows that in a sideways market scenario, these institutions may sell Russell 2000 index futures.
Rebalancing may provide short-term support, but the deep-seated problems in the bond market have not disappeared. The expansion of the US fiscal deficit, the increase in corporate bond supply due to AI infrastructure financing, and the energy prices pushed up by geopolitical conflicts are all exerting pressure. UBS has raised its end-of-year target for the 10-year US Treasury yield to 5.2%. Yields may fluctuate at high levels in the coming months, with limited room for further significant increases.
The rebalancing capital flow may temporarily depress the stock market and support the bond market, but this is a technical factor and does not represent a fundamental shift. Whether the stock market can absorb the selling pressure depends on corporate earnings and interest rate trends. The game of asset allocation in the fourth quarter has just begun.