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Three indexes of the Federal Reserve…calculate and report statistical measures of financial stress in the U.S. economy on a regular basis…[and] all three have returned to their pre-recession levels last seen in May 2007. [What does that mean for stock market valuations? Let’s take a look.] Words: 460; Chart: 1
So writes Mark J. Perry in edited excerpts from his original article* as posted on seekingalpha.com entitled 1 Reason For Market Rally? Financial Stress Has Returned To Mid-2007 Levels By 3 Fed Measures.
This post is presented compliments of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and the Intelligence Report newsletter (It’s free – sign up here), and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.
Perry goes on to say in further edited excerpts:
They appear together in the chart below from January 2004 to March 2013.
(click to enlarge)
Here’s a summary of the March stress indexes:
1. The Kansas City Financial Stress Index (KCFSI)
- a monthly composite index of 11 variables reflecting stress in the U.S. financial system,
- fell in March to -0.63, which is the lowest index reading…since May 2007 (see blue line on chart),
- negative values…indicate that financial stress is below the long-run average, and
- the KCFSI has been below zero for 14 consecutive months starting in February of last year.
2. The St. Louis Fed Financial Stress Index (STLFSI)
- a statistical measure of financial market stress…based on 18 weekly data series (7 interest rates, 6 yield spreads, and 5 other financial variables),
- has been steadily trending downward…[since] October 2011 when the monthly average for the index was at 0.70 (red line on chart),
- the March STLFSI averaged -0.66, which is the lowest financial stress reading since July 2007.
3. The Chicago Fed National Financial Conditions Index (NFCI)
- a composite index based on 100 different financial indicators,
- a highly accurate leading indicator of financial stress at horizons of up to one year.
- increasing risk, tighter credit conditions, and declining leverage are consistent with tightening financial conditions and produce positive values for the NFCI, while negative values indicate the opposite conditions.
- has been negative since late 2009, and has been trending downward since mid-2011 (see brown line on chart)’
- the March NFCI average fell to -0.77, which indicates that the stress in U.S. financial markets is at the lowest level since May 2007 by this measure.
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Based on these three different Federal Reserve bank measures of financial stress that have all shown a high degree of historical accuracy in assessing the amount of stress in U.S. financial markets, we can conclude several things:
- financial stress has been gradually falling since the fall of 2008, when all three indexes reached their cyclical highs,
- after reaching slightly elevated stress levels in the fall of 2011, all three indexes indicate that financial stress in the U.S. have been declining over the last 18 months, and
- all three indexes have returned to their pre-recession levels last seen in May 2007 for the Kansas City and Chicago Fed stress indexes and July 2007 for the St. Louis index.
Conclusion
The return of financial stress to mid-2007 by three different measures indicates that financial conditions have now normalized and stabilized at historical averages.
Current financial stress levels are consistent with the conditions of an economy in recovery and are one reason that stock market indexes have been trading close to record highs in recent weeks. Lower financial stress equals higher stock market valuations.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://seekingalpha.com/article/1328411-1-reason-for-market-rally-financial-stress-has-returned-to-mid-2007-levels-by-3-fed-measures
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