GM. This is Milk Road Macro, here to sharpen your vision so you don’t miss the next market dip.

Here’s what we got for you today:

• ✍️ Why did markets dip last week

• 🫵 What’s the largest holding in your portfolio?

• 🍪 China is striking back on tariffs

WHY DID MARKETS DIP LAST WEEK 🤔 

Maybe you noticed the sudden pullback in markets last week?

Risk assets saw a big hit during the last 3 trading days of the month.

But this wasn’t by accident, it was actually by design (and something you can spot coming ahead of time).

You see, there’s a hidden “mechanical money flow” that often impacts risk assets like stocks and Bitcoin.

It’s called “rebalancing” and often occurs at the end of a calendar month.

We saw stocks and Bitcoin falling last week, but then recovering again this week.

So what’s going on? What is rebalancing?

And how can you spot the next month-end rebalancing?

Let’s take a look…

What is rebalancing?

Large financial institutions will often “rebalance” their portfolios at the end of a calendar month.

These institutions include pension funds, insurance companies, endowment funds and sovereign wealth funds.

This is a mechanical flow of funds.

Institutions are usually mandated to hold specific weightings, or “target ratios”, of stocks and bonds (often 60/40).

So, if the weightings get out of line, a rebalancing must occur.

This can often temporarily force price action against the wider trend in both stocks and bonds.

What happened recently?

Throughout the month of May, we saw a significant divergence in performance between stocks and bonds.

US stock indices moved strongly higher (S&P 500 +7%).

While at the same time, bonds sold off (TLT -6.7%).

This would have impacted the target ratios of many institutions.

So they were forced to “rebalance” their portfolios at the end of the month - selling stocks and other risk assets, and buying bonds.

Generally, the larger the divergence, the larger the rebalancing (and this was a big one).

The Great Rebalancing

In the last three trading days in May (Wednesday, Thursday and Friday last week), a large part of the rebalancing took place.

We saw the S&P 500 down (-1.7%) as institutions sold off stocks.

And we saw TLT up (+1.7%) as those same institutions went ahead and bought bonds.

We also saw weakness in bitcoin (-5%) in the last three trading days of May amid the “risk-off” market flows.

Bank of America estimates the rebalancing contributed to around $42 billion in equity sell-offs.

And on the bond side, it estimates inflows of approximately $16 billion into Treasuries, $22 billion into corporate bonds, and $4 billion into agency and GSE-backed securities.

Relative performance then flipped again starting on the first trading day in June (Monday), after the rebalancing had been completed.

Stocks and bitcoin recovered, while bonds slipped back down again.

More rebalancing ahead at the end of June?

Rebalancing flows can often be larger around the end of a quarter.

Some institutions will only rebalance once a quarter.

And the end of June will represent the end of Q2 and the next potential rebalancing.

If stocks and bonds continue to diverge through the month of June (meaning, stocks perform well and bonds perform poorly), we may see an even larger rebalancing in the final trading days of June.

So keep an eye on the relative performance of stocks and bonds.

And don’t get caught off guard by temporary end-of-month/end-of-quarter “mechanical rebalancing flows”!

POLL OF THE WEEK 🫵 

Let’s try something new here.

Every Thursday we’ll hit you with a poll. Not because we love asking questions, but because the more we know about you as an investor, the better we can tailor our content to be the most helpful macro investing content out there.

Sound good?

Let’s give it a shot:

BITE-SIZED COOKIES FOR THE ROAD 🍪

“Kill the Bill”. Elon Musk ramped up his attacks towards Trump’s “Big Beautiful Bill”.

We’re seeing some warning signs for stagflation. US’s PMI index dropped in May while we saw a rise in the ISM Price Paid Index.

China is striking back on tariffs, with export restrictions on rare earth metals. China holds an almost unchallenged monopoly on rare earth metals and are making it clear that they will not hesitate to weaponize that dominance.

MILKY MEME 🤣

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