By MoneyMorning.com.au

We hope you didn’t fall for it…

Yesterday, we warned you to ignore the bear stampede.

We’re talking about the stampede of market gurus — the ones who’d have you believe this week’s US Federal Reserve statement could send markets into a tailspin.

We say let these gurus run. Their arguments are bogus.

That’s certainly the message that the bouncing Australian stock market is sending.

But just as hope springs eternal in the stock market, so too does fear. And the market is never too far from another imagined crisis.

As we’ve shown you, bears seem to have a new reason each week for why the stock market will crash.

So when one bearish theory is disproven and its forecast fails, the bears just try another one.

And another, and another…until the white noise drowns out all common sense.

We’d find the latest phoney crash theory hilarious, if it didn’t pose such danger to your wealth…

In financial circles, the term ‘stress test’ has become buzzwords over the past few weeks.

A group of officials chose that name for their ‘what-if’ report on the European banking sector.

This month, the European Central Bank (ECB) — which sets euro interest rate policy — and the European Banking Authority (EBA) both ran stress tests on around 150 lenders across the Eurozone.

If your eyelids are getting heavy, stay with us. The forces that determine the fortunes of Europe’s banks are also a major driver of the Australian share market. So European bank stability is important.

But we’d forgive you for asking ‘why should I care?’

Well, for the most part — you shouldn’t care.

The bears out there seem to think banks ‘failing’ these arbitrary tests could spook the market into a downward spiral.

But we were on the stock trading floor in London in 2011, when regulators carried out their last round of stress tests.

They didn’t matter then, and they don’t matter now.

Let us explain…

A chilling portent of doom?

The first clue to why you shouldn’t care about the outcome of the stress tests comes on the EBA’s website.

Here’s how the EBA describes its objective on its website:

‘The main task of the EBA is to contribute to the creation of the European Single Rulebook in banking whose objective is to provide a single set of harmonised prudential rules for financial institutions throughout the EU. The authority also plays an important role in promoting convergence of supervisory practices and is mandated to assess risks and vulnerabilities in the EU banking sector.’

Still with us? No?

Well, this is part of the problem.

The EBA could have explained itself in fewer than ten short words. It aims to make sure the crisis doesn’t happen again.

But give a bunch of unelected bureaucrats an inch, and they’ll take a mile.

In the real world, when groups merge or join forces, they can typically achieve more together by combining their cost bases. Our old investment banking colleagues would call that ‘synergy’.

But pulling the nations of Europe together has had the opposite effect. The European Union has layered new red tape over old…building armies of public servants desperate to justify their existence, lest their funding dry up.

Supranational groups like the ECB and EBA run stress tests so Europeans see them ‘doing something’.

These stress tests are little more than thought experiments that bear little resemblance to reality.

That means any investor who takes the outcomes of these tests as a chilling portent of doom must be living on another planet.

Avoid this dangerous move

Not only are these ‘tests’ based on a fictitious reality, they’re also backward-looking in the extreme.

The EBA ran its stress tests based on the banks’ positions at the end of 2013.

Since then, banks have made ten months of profits.

What’s more, the European and global economies have continued to expand over this period.

Self-anointed geopolitical experts can bleat about the risks from Middle Eastern conflict as much as they like. It won’t change the fact that we’re further than ever from the last banking crisis…and the next hasn’t even come close to turning up.

I put all of this to our Resources Analyst Jason Stevenson when he asked me if I thought these tests could push the market down.

Jason has been hard at work picking four potentially high-performance energy stocks. These companies are set to benefit from the forces pushing and pulling the price of crude oil. His ideas could magnify your portfolio’s gains.

Jason sagely pointed out that this round of stress tests didn’t even consider any scenarios involving deflation.

For a test supposedly designed to plan for the worst case, that seems like a bit of an oversight.

Imagine if economic growth and inflation both fell off a cliff.

It’s a remote possibility.

In that stagnant, deflationary scenario, if a poor but important bank looked to be in trouble — as defined by its Tier One capital ratio falling below a safe level — organisations like the ECB and EBA would still come to the rescue.

The authorities have made that clear time and again.

So if you think bank bailouts were a one-off feature, you’d be wrong.

The backstop of central bank intervention is now a permanent feature of the financial markets.

That’s bad news for taxpayers, because it socialises risk.

But it’s good news for shareholders, because stock market profits are still private (for now).

If you sold your stocks because of ‘concerns’ stemming from the ECB and EBA’s stress tests, you’re missing the point.

The most dangerous move you could make would be avoiding the markets. The authorities have loaded the dice so stockholders will continue to get richer.

You don’t have to agree with their policies…but you might as well get on the winning team.

Cheers,

Tim Dohrmann+
Editor, Money Morning

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The post Why You Shouldn’t Take Stock Market ‘Stress Tests’ Seriously appeared first on Stock Market News, Finance and Investments | Money Morning Australia.

By MoneyMorning.com.au