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Financial Stress and Market Tops

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    September 10, 2014

    Last month I argued that there was “Still No Sign of a Bear Market” with four charts displaying the following:

    1. Strong upward trend in leading economic data
    2. Low probability of recession
    3. Low levels of financial stress
    4. High corporate profits margins


    Since there has been no change in outlook to the above, I’ll refrain from posting each of those charts with the exception of the TED spread, which was used to illustrate the very low levels of financial stress in our current market environment. As you can see from the chart below, stress in the financial system rose significantly (red regions) during the two prior peaks as underlying market conditions began to deteriorate.

    ted spread
    Source: Bloomberg

    Given that spreads are currently very narrow, indicating low levels of financial stress, the obvious implication is that we are not seeing the same conditions that appear near a market peak, major crash, or the onset of a bear market (side note: the TED spread also spiked leading up to the 1987 crash as you can see here).

    However, given that the TED spread measures the difference between 3 month T-bills and LIBOR, one astute reader commented that we can no longer rely on it as an accurate signal of financial stress found near market tops since both inputs—LIBOR and T-bills—are likely distorted.

    Let’s assume this is true and also offer that it is never wise to rely on one measure alone. To get around this, I am now including three different financial stress indexes each compiling a large array of financial, market, and economic data, which also support the view that financial stress conditions are currently quite low.

    The data below is compiled by the Kansas City, Chicago, and St. Louis Federal Reserves. Readings below 0 (the x-axis) indicate below average levels of financial stress.

    financial stress
    Source: FRED

    Unlike the TED spread, which only measures the interbank lending market, these indicators provide a more comprehensive view of financial stress levels by tracking (in the case of the Chicago Fed index) up to 100 different data series in numerous categories: money markets, debt and equity markets, and the banking system (see A Comparative Analysis of US Financial Stress Indicators for more information).

    Given the broad-based nature of the financial stress indexes above and the other three items mentioned at the beginning, the near-term outlook for a market peak or bear market still remains low. Monitoring these measures for any major trend changes will be important going forward.

    Images: Flickr (licence)

    About the Author – Cris Sheridan

    Puplava Financial Services, Inc. Research Assistant
    Puplava Securities, Inc. Registered Representative
    Financial Sense Senior Editor.
    Cris joined PFS Group in 2002. He holds a B.S. in Mathematics from California State University San Marcos. His professional designations include FINRA Series 7 & Series 63;  and he is also currently pursuing the designation of Chartered Financial Analyst.


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