Market Pulse: A few words about risk
In the investment world every asset class but one involves some risks, real or perceived. They are all measured against a risk-free return in Treasury issues. When for any reason the risks rise, the yield differential (called risk premium) widens. Moves can be sudden and extreme. We saw that in 2008-09 for stocks and bonds, we saw it again in March.
During the financial crisis in 2008-09 the risk premium soared, caused by a man-made event (leveraged mortgage-backed securities gone bad and Lehman’s bankruptcy). The risk investors perceived was that the financial system might very well collapse.
Yes, a few banks needed help, but the risks people perceived for the financial system were not real at all because the Fed and Treasury stood ready to do whatever was needed. Soon the recession ended (first quarter 2009) and the stock and bond markets began a 10-year bull run.
Now we have COVID-19, which triggered what started as an economic event but soon became a financial one as travel-related businesses and others shut down. As a result of the last crisis, banks are now overcapitalized and in very good shape. No one should worry about them.
Until March 18, investors demanded a greater premium so they knocked some bank preferred prices down. That was not a reflection of the real risks to banking, which was extremely low, and the even lower risk that dividends would not be paid.
Issuers of preferred stocks do not have the wiggle room they have with common dividends. The latter can be raised, cut or eliminated. Preferred dividends must be paid 100% or not at all. No cuts. Even in 2009, the bank preferreds continued to pay.
The selling in fixed-income vehicles and preferred stocks ended on March 23 with the Fed and Treasury providing trillions and trillions to small- and medium-sized businesses, even those much larger (Boeing, airlines, etc.). The Fed bought bonds of all types, even bond ETFs. The Fed and Treasury have brought out the big guns. And they have more weapons.
Now to stocks. The risk premium is more subjective than with other assets because one must estimate S&P operating profits a year out to determine the earnings yield.
Given the variables there is no way to put a fine point on the risk premium in the S&P 500. But we can say is that in March the perceived risk was far greater than the outcome that was likely to occur, evidence the huge rally. Sometimes perception is reality. But not this time.
David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
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