No doubt most of us read and heard about the U.S. government’s stress testing of the largest 19 American banking firms. Regulators assumed the economy would continue to weaken in 2008 and 2009 and sought to determine if the banks had sufficient resources to withstand this weaker scenario. They concluded that 10 of the 19 banks needed more capital.
Have you had your investment portfolio stress tested?
While stock markets rebounded strongly from their early March 2009 lows, the near term future direction remains uncertain. How much would our investments lose if we had another “Black Monday” (October, 1987 when stocks dropped 20% in a day), or another “flight to quality”, or, God forbid, another 911? The good news is that Regency Wealth, through its Bloomberg subscription, runs these stress tests, or scenario analysis, regularly as part of our risk management process. Reviewing these results on a security specific and overall portfolio basis helps us gauge the risks vs. rewards from our asset allocations. Considering the downside relative to an investor’s overall financial picture helps us put things in perspective. It also helps us to refine and affirm our risk tolerance.
The graph above is an example of what stress test results may look like. By incorporating various scenarios into the testing, it allows us to estimate future performance under multiple market conditions. In this example, scenario one would mean this portfolio would lose approximately 9.5% in one week if positions were left unchanged. Behind each of these scenarios are specific estimates of how individual positions would behave under that scenario. Knowing this allows us to prioritize what to buy or sell in order to help protect capital.
Let us know if you would like to discuss these results with us as part of your portfolio update. If you know of someone who could benefit from having their portfolio stress tested, we would be happy to chat with them. Utilizing these tools will assist all of us in having less (financial) stress.
Are we there yet?
Although the Spring Northeastern weather was cool and wet, financial markets were investor friendly in the quarter ended June 30th as tentative signs of “green shoots” emerged amidst continued economic weakness. Investor confidence increased even as unemployment rose and two of the “Big 3” auto makers parked themselves in bankruptcy court. Several constructive developments occurred in 2Q09 including modest improvements in trade activity, replenishment of bank capital, and easing of real estate market values. Global trade rebounded in April and May before moderating in June, as measured by the Baltic Dry Index (tracks the cost of shipping “dry” goods globally). Time will tell if the improvement is temporary and only reflects idled capacity or increased demand from China. As noted earlier, US bank stress tests were completed followed by some of the stronger banks repaying the government’s TARP investments. Preferred stocks in these banks rebounded strongly yet still boast 7-10% yields. Residential real estate prices dropped further through the first quarter but at a slower pace in February and March. The S&P/Case-Shiller Home Price Indices’ Composite-20 CSXR (measuring the 20 largest metropolitan markets) dropped 2.2% in each of those two months, an improvement from -2.5% in December and -2.8% in January.
But the best news was the rebound of stocks from the lows of early March 2009. As measured by the S&P 500 index, stocks rose 15% in 2Q2009, and a relief-inducing +35% since March 6th. Are we there yet? Is the worst over? Have I missed the bounce? Is this a bear market rally (where stocks rise for a bit but resume a prolonged sell off)? Isn’t the economy still weakening and unemployment rising? Gas prices are also up. I hear taxes will be increasing. CD yields are down and money market yields are very low. What should I do? These are only some of the many questions you may be asking yourself (or us). As always, definitive answers are elusive. The worst seems to be over but economic recovery may well be subdued. We continue to advise maintaining a diversified portfolio and, while hoping for the best, being prepared for the worst (stress test).