Home / Stocks / These two factors may be driving the stock market’s double-digit gains this week, says JP Morgan strategist

These two factors may be driving the stock market’s double-digit gains this week, says JP Morgan strategist

Investors have thanked the imminent passage of a $2 trillion fiscal stimulus bill for driving the U.S. stock-market’s double-digit percentage gains this week, but one strategist at JP Morgan says the rally’s underpinnings are less driven by economic and political fundamentals than market pundits would allow.

“The initial stage of the rally is driven by short-covering and rebalancing,” said Nikolaos Panigirtzoglou, a global market strategist at JP Morgan
JPM,
+6.96%
, in an interview.

The analyst said the stock-market’s recovery from the damage done by the coronavirus pandemic will be first driven by market participants who have to buy equities regardless of what they envision for the U.S. economy’s path.

Pension funds and so-called balanced mutual funds need to start re-jigging their portfolios in favor of stocks as the selloff in equities and rally in government bonds has driven down the value of their equity relative to their bond positions. Commodity trading advisors and long-short equity hedge funds have also had to cover their short bets on stocks.

“The investment community and several types of investors have got to very low level of equity positioning in recent weeks,” said Panigirtzoglou.

Pension funds like Japan’s Government Pension Investment Fund, the largest in the world, have more discretion when they rebalance their assets and can wait as long as six months, but could move earlier. Balanced mutual funds like so-called 60/40 funds, which divvy up 60% of their assets to stocks and 40% of their funds to bonds, tend to rebalance every month or two.

This rebalancing dynamic as investors sell their inflated bondholdings and shift the funds into equities could drive as much as $800 to $900 billion of inflows in the coming weeks and months, he said.

“It looks like some of this is happening as we speak,” said Panigirtzoglou.

The SP 500
SPX,
+6.24%
is up 12% and the Dow Jones Industrial Average
DJIA,
+6.37%
is set to gain 15.6% week-to-date, FactSet data show. Still, both equity benchmarks still down more than 20% this year.

The abysmal overall return in equities this year has helped to push down yields for government paper as investors took shelter in haven assets. The 10-year Treasury note rate
TMUBMUSD10Y,
0.805%
stood at around 0.80% on Thursday, around a 110 basis points lower than at the start of 2020.

Long-short equity hedge funds and risk-sensitive investors such as commodity trading advisors have also been buying stocks to cover their short positions.

Some needed to snap up equities as many had leveraged up their short bets to take advantage of the incessant selling in equities over the past few weeks. By Panigirtzoglou’s estimation, short positions betting on a decline in equities stood at around $450 billion, representing additional ammunition for stock-market gains.

When on March 17 the Cboe Volatility Index
VIX,
-4.61%
, or VIX, topped its previous high seen in 2008, many of so-called risk-parity funds were forced to start liquidating their positions as they are designed to curtail the size of their investments when volatility surges.

Beyond these technical drivers of market activity, longer-term investors are likely to pay more attention to a third widely cited factor that could unlock the second leg of a more sustained rally in equities.

If money managers see some stabilization in the infection rate of the coronavirus pandemic and the prospect of a global economic recovery, Panigirtzoglou estimated investors could plough $3.3 trillion of funds into equities by the end of 2020, including the $800 to $900 billion of rebalancing inflows.

U.S. stocks rose for a third straight day on Thursday, after posting back-to-back daily gains Wednesday for the first time since February 12. The Dow Jones Industrial Average
DJIA,
+6.37%
was up 817 points, or 3.9%, Thursday afternoon.

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