The popular cliché-reading between the lines-holds true in the recent Banks Stress Tests conducted in the USA by the Federal Reserve. The ardent investors must have read the facts and drawn few conclusions out of it. But yours truly has tried to absorb the facts with equal measure and tried to list out few observations that had attracted less media coverage.

Meaning of Bank Stress Test: The Fed collects disclosure from banks on the details of their assets and liabilities then modeling what is the likely impact on the holdings in the extreme scenario of falling house and stock prices and drastic rise in the unemployment. It does this to ensure that banks have sufficient capital, and to attempt to avoid the problems endured during the last recession.

The fact that is successfully getting over the stress gate is important in so much as it allows the company to return more capital to shareholders though dividends or buy backs, but it is based on an extremely negative scenario, and it is possible that the sort of balance sheet that does relatively poorly in declining asset prices also does well during the rise. Hence, rushing to the winners of the stress test might be exactly the wrong course of action, at least if this economic environment persists with US equities up during the concerned period.

If you, my readers have looked at the results, then one may notice that some banks had only just passed and hence drawing a line between the passing and failure might be overstating the reality. The Fed will also need to pay attention to the banks just passed to deviate the banks away from the line of conclusion.

The stress test data is useful for anyone who invests in the financial sector, but drawing a clear line between success and failure is misleading. Even though Bank of America and Morgan Stanley passed the impact test, investors of this scenario might actually be worst than all of the banks that failed the stress test according to the Fed’s projections. In addition, holders of similar large cap financial names should not be surprised if the stress test extends to those entities in future. The scenario of the stress test is almost the opposite of the rising prices in 2012, at least in the equity markets therefore, the concerned authorities should not be surprised if that same exposure that causes a bank to fail the test could be the very factor that leads to strong earning performance in 2012.