Overview

Orion Risk Intelligence (“ORI”) utilizes various economic scenarios to back-test portfolios to assess upside potential and downside risk. Mutual’s Compliance Team utilizes a specific subset of these scenarios to help assess client portfolio risk. Below is a guide to the various scenarios being utilized and how those scenarios may affect the upside and downside shown in your clients’ portfolio(s). For more information about Mutual’s Risk Monitor process, see Risk Monitor Policy Guidance.

What scenarios are being used at the firm level?

How do these scenarios impact client upside and downside scores?

The various scenarios will individually be defined below. The way that ORI assesses a client’s downside score is by running every client’s portfolio through each of the five scenarios. The worst downside score is the score listed for the client. It returns the worst-case scenario.

The upside score is obtained by blending the stress test results of the five scenarios on a pro-rata basis set at the firm level. The greatest weighting is given to the primary scenario – S&P 500 up 10%. The rest of the scenarios are equally weighted from the remainder. For more information on how ORI calculates this return, click here.

Obtaining Access to ORI

If you are not currently a ORI user and you want to learn more about the system itself and/or get access to the tool, please reach out to the Advisory Services team at advisoryservices@mutual.group or by phone at 805-764-6740 x811.

Defining the Scenarios

All of the below information (plus more) can be found in the ORI scenario library as well.

BASELINE: S&P 500 Up 10% (Primary Scenario)

This scenario is based on the following:

Question: What if the S&P 500 rises 10%, in line with its long-term average since 1950?

Assumptions/Observations:

·        Since 1950’s the S&P 500 has risen roughly 10% per year including dividends (7.7% without dividends)

·        A small rise in rates might accompany this kind of average performance

·        Inflation and commodities prices would likely be held in check

Primary Levers Impact

S&P VALUATION: 21 CAPE – Pandemic Lows (Secondary Scenario)

This scenario is based on the following:

Question: What if the S&P 500 experiences a recessionary correction, bringing the CAPE (cyclically-adjusted PE ratio) multiple down to 21 like at the March 2020 pandemic lows?

Assumptions/Observations:

·        The S&P 500 CAPE multiple dropped by one-third during the COVID crash

·        Dropping to a CAPE around 21 would require a market decline of over 40% from an S&P 500 around 4200

·        Valuations are extended today, but earnings growth provides a partial cushion for a potential recessionary correction

Primary Levers Impact

S&P VALUATION: 44 CAPE – All-time Highs (Secondary Scenario)

This scenario is based on the following:

Question: Can low interest rates and the pandemic recovery plans enable the S&P 500 to sustain levels of valuation far above long-term averages?

Assumptions/Observations:

·        The S&P 500 reached an all-time high CAPE of 44.19 in December 1999, at the peak of the dot-com bubble

·        Reaching those levels would imply an S&P 500 rise to 5000 from 4000 at the end of Q1 2021

·        The last time this level of valuation was reached, the ensuing crash halved the S&P 500 over the following 2.5 years

Primary Levers Impact

FED STRESS TEST: 2024 Severly Adverse (Secondary Scenario)

This scenario is based on the following:

Question: What if the economy falls into a recession with a severity like that modeled by the Federal Reserve's severely adverse scenario?

Assumptions/Observations:

·        Unemployment rises above 9% and GDP Growth drops significantly.

·        Equities drop by 55%, volatility increases dramatically, and 10Y UST decreases below 1%.

·        Home prices plummet. 

PAST INFLATION: Volcker’s War on Inflation – 80s (Secondary Scenario)

This scenario is based on the following:

Overview: This scenario covers the time frame from late 1979 through 1983, when inflation abated in the United States.

Assumptions/Observations:

·        Paul Volcker was appointed Chairman of the Fed by Carter in 1979 and Reagan in 1983. He was credited with fighting U.S inflation starting in the late 70's: inflation dropped from 13.5% in 1979 to 3.2% in 1983, setting the stage for stronger economic growth.

·        Timeframe: Jan 1980 - Dec 1983Primary Levers Impact