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In early 2008, I was part of a dedicated new risk group at Wellington that was focused on looking at markets from a factor perspective, identifying what our investors needed to know, and encouraging the use of stress testing before it had really come into fashion. As it turned out, the market was just about to face a stress test for the ages, with the collapse of Bear Stearns and all that followed. While today’s market faces a different set of tests, I think much of what we learned in 2008 is once again very relevant.
Using our factor lens, the main point we conveyed to investors in early 2008 was that while markets were uniformly down from a region, growth, and value perspective, factor positioning mattered. Regardless of how a market shock starts, we noted, if the process continues beyond the original event, then one should expect high-beta and high-stock-specific factors to decline, shaky balance sheets to be exposed, and so on. Consequently, one of our key messages after the first quarter of 2008 was: Expect more volatility ahead and understand your factor positioning to get a better feel for how your portfolio might react. That message applies today.
By the end of 2008, we were debating the usefulness of stress testing during the events of that year. In short, stress testing had worked pretty well in estimating future performance, but we determined that, for the moment at least, it was too new and unproven to be embedded regularly in portfolio construction. Given that stress testing had been effective in helping to frame the risks, however, we started talking about the other side: Broadly speaking, the firm’s investors had shifted to more defensive positioning over the course of the year. So was the potential for missing out on a “relief rally” the “stress” risk we should be worrying about? That warning eventually proved correct, although there were a few more down months to endure.
Currently, it feels more like the end of the first quarter of 2008 than the end of 2008. With this in mind, my message to investors today is that now is the time to focus on stress testing portfolios (if they haven’t already). Importantly, it is not necessary to predict what will happen or call the way in which the market may go down. What’s more, I see no need to isolate a particular historical event that matches today’s with the same “before and after” macro, rates, and fundamental characteristics. There is no harm in simply throwing a wide range of historical, factor, and macro shocks at the portfolio to see what happens. Ultimately, the point of the exercise is to understand the key drivers in a test, what contributed to the largest outliers, and how that matches up with the investor’s current conviction.
I’d offer several other suggestions on mindset and approach:
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Financials amid rising dispersion
We explore why we believe dispersion across stocks, sectors, and geographies is supporting numerous secular themes in long/short investing in financials.
US regional banking sector update
We explore how banking regulation and legislation could impact US regional banks, including highlighting the potential for M&A activity and for dispersion to drive long/short opportunities.
State of the credit markets: Does cash rule everything around us?
Fixed Income Portfolio Manager Brij Khurana outlines the state of the credit market today, compares historical periods of quantitative easing, and warns credit investors of cash scarcity in the near future.
FX outlook: Is USD exceptionalism withering away with the Fed hiking cycle nearing an end?
Discover the status of the USD today, learn where the greenback may be headed going forward, and understand why.
Private credit in a new regime
We explore how a shifting macro backdrop, ongoing banking crisis, and evolving competitive dynamics may create opportunities across private credit markets.
Credit market outlook: Expect greater opportunities in back half of 2023
Against a backdrop of elevated recession risks and banking-sector stress, Fixed Income Portfolio Manager Rob Burn identifies relative-value sector opportunities in the credit market.
Inflation loosens its grip, but bank turmoil could put the squeeze on US growth
US Macro Strategist Juhi Dhawan weighs the benefits of disinflation for consumers and companies against the risks of a credit crunch brought on by the recent bank crisis.
Global high yield: Attractive entry points could soon emerge
Fixed Income Portfolio Manager Konstantin Leidman shares his outlook for high-yield fixed income for the rest of this year and beyond.
Did the Fed just make a policy error?
Did the Fed just make a policy error? All things considered, Fixed Income Portfolio Manager Jeremy Forster thinks the answer is yes. Learn why and what the implications could be.
How do bank failures impact fintech?
Global Industry Analyst Matt Ross analyzes the ways in which recent US bank failures could impact the fintech sector in public and private markets.
Three macro assumptions that could be just plain wrong
Fixed Income Portfolio Manager Brij Khurana offers his non-consensus take on three entrenched, but potentially flawed, beliefs in today's market environment.