Prepare for the Unexpected

When building and maintaining investment portfolios, many investment professionals often take into consideration many different future, potential economic and stock market scenarios based upon their own research and forecasts. In fact, my research team at Hennion & Walsh developed five such potential scenarios, based upon our research, for 2009. We then assigned probabilities to each scenario, based on our research and opinions, and found relevant periods of historical data for each scenario. This data was then utilized to build our new asset allocation models which then led to the necessary adjustments for each affected client portfolio.

However, as is often the case for most money management strategies, every potential scenario that could have an impact on the economy, the stock market or both is not known and cannot possibly be accounted for accordingly. A case in point is the recent Swine Flu scare. Who would have been able to predict that this type of pandemic would start in April within a somewhat isolated area of Mexico and spread throughout the rest of the world so quickly? Who would have predicted the effect that such a scenario would have on certain sectors of the economy (Ex. Health Care and Airlines) and the stock market, which both appear to be muted at this point? The answer to both of these questions is likely no one.

This should remind us of how important it is to build an appropriate amount of diversification into our portfolios in order to minimize the potential impact of a negative surprise. Additionally, it should remind us of the need to employ active management strategies, where applicable, to react accordingly to such surprises. Finally, it should also help to reiterate the importance of re-visiting investment portfolios frequently and making adjustments to asset allocation strategies as necessary. In other words, prepare, or attempt to prepare to the best of our abilities, for the unexpected.