Looking Back at The Stress Tests With Rose Colored Glasses
Monday, July 26, 2010 at 10:57AM Over the last week or so, we have heard several references made to last year's bank stress test results as being a catalyst that propelled the overall market, and more specifically Financials, higher. When you look back at the period, however, that comment couldn't really be further from the truth. In the chart below, we highlight the performance of the US Financial sector and the S&P 500 following the release of the US bank stress test results in May 2009. As shown, from May 8th through early July, the S&P 500 declined about 5% and the Financials sank over 15%. it wasn't until mid-July 2009 that the market bounced and began its next leg higher. And what was the catalyst in July that got the market going? It was the start of earnings season. In that earnings season, companies delivered strong results reinforcing the improved economic data that had begun to trickle out.
The main takeaway from this chart is that while everyone debates whether or not the EU stress tests were stressful enough, it seems as though they have forgotten that the key ingredient for a rally is improved earnings. Whatever the criteria are for a hypothetical stress test doesn't really mater. If the economy rebounds and earnings recover, the market will rally, but if the economy turns lower and earnings deteriorate, the markets will decline. It's really that simple.
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