The stock market could surge 7% next week as quarter-end rebalancing drives buying spree for equities, JPMorgan says

• The stock market could surge 7% next week as quarter-end rebalancing leads to a buying spree in equities, according to JPMorgan.
• The bank expects rebalancing trades to favor equities after a year-to-date decline of nearly 20%.
• "Next week's rebalance is important since equity markets were down significantly over the past month, quarter and six-month time periods," JPMorgan said.

Investors should expect a sharp 7% rally unfold in the US stock market next week as quarter-end rebalancing trades among investment portfolios leads to a buying spree in equities, JPMorgan said in a Friday note.

The bank highlighted that while rebalancing trades are usually not the main driver of the stock market, they can have an outsized impact when stocks see big moves in the same direction. In today's case, nearly all stocks are down big, with the S&P 500 down nearly 20% year-to-date.

The rebalancing trades can also have an outsized impact on the stock market when liquidity is low, which is the case today, according to JPMorgan. "Taking into account the current market liquidity, as measured by futures market depth, which is about 5 times lower the historical average," JPMorgan's Marko Kolanovic said.

"Next week's rebalance is important since equity markets were down significantly over the past month, quarter and six-month time periods, and it is happening in a period of low liquidity. On top of that, the market is in an oversold condition, cash balances are at record levels, and recent market shorting activity reached levels not seen since 2008," Kolanovic said.

Any up move in the stock market next week would be reinforced by quant trading funds and option gamma hedging flows that reinforce momentum, according to the bank.

This scenario has already played out in 2022. JPMorgan highlighted that near the end of the first quarter when the stock market was down 10%, it experienced a 7% rally in the last week of March. And during the end of May when the market was down 10%, it experienced a rally of 7% heading into month end as rebalancing trades were executed.

The current rebalancing setup is similar heading into the end of the second-quarter, given how big the recent decline in stocks has been.

"Rebalances across all three lookback windows would reinforce and, based on historical regression, would imply a 7% move up in equities next week," Kolanovic said.