Whether it was brought on by strong Q3 earnings, a return to post-electoral certainty, or the promise of deregulation heralded by the Trump administration, stocks have experienced quite a surge in value over the past two months. It’s worth remembering, though, that there’s no more powerful force in the universe than central tendency. Every market rally must come to an end. The question burning in the minds of investors is when.
One way to estimate market events is to look at the big, institutional investors. They tend to signal market events in two ways. First, they swing enough weight to actively influence prices; if an institution is buying up millions of dollars worth of stock, the price of that stock is going to increase in response. Second, institutional investors hire the best and brightest analysts. They tend to have a leg up on trends in data.
That’s why it was interesting to see the moves bond giant Pacific Asset Management Corporation (Pimco) has made over the past weeks. Pimco is one of the biggest institutional investors. They focus on fixed income funds, which includes quite a bit of exposure to the bond market.
Pimco has been dramatically increasing its cash reserves, and funding the increase by selling off riskier assets, like high-yield corporate debt. The firm is also buying long-term securities, which tend to be safer investments. These moves signal to some investors that they might want to do the same.
The dumping of high-risk debt is a surprising move, given the renaissance of junk bonds in recent months. Pimco fears that, if the trade environment turns hostile, high-risk debt will be the first to feel the squeeze. If corporate profits start to fall, the default risk on that debt goes up dramatically.
Of course, there’s also reason to be skepitcal. Pimco specializes in fixed income securities, which means they have to deliver a stable return to their investors. As such, they tend to be more risk averse than other investment groups.
Whether or not Pimco is right, it still might be a good idea to mirror their moves. Big, institutional investors like Pimco can swing the market. Enough other investors might be watching Pimco’s moves to create a self-fulfilling prophecy. At the very least, it’s worth monitoring the moves of big players in the bond market for signals of a market reset.