I hope you are all well and enjoying a great holiday season!
One question/comment I consistently hear from clients relates to current events (government shutdowns, deficit spending, wars) and the worry that the market is heading toward a cliff. I spend a lot of time scanning the horizon looking for coming cliffs.
The market goes through periods of ups and downs and includes pullbacks (down 5%), corrections (down 10%), and bear markets (down 20+%). Such occurrences are normal, but few represent major cliffs like the financial crisis of 2008/2009. One way to look for cliffs is to monitor stress within the financial system.
The most common stress indicator is the VIX – the volatility index – sometimes called the fear gauge. And while the VIX can indicate a heightened level of stress in the markets, it is but one measure and one that does not necessarily predict a coming cliff.
The Federal Reserve developed a financial stress indicator that takes a much broader view of financial stress than simply equity volatility. The indicator measures stress related to the following areas of the financial system: credit, equity valuations, funding, safe assets, and volatility. The indicator further classifies each into geographic regions: the United States, other advanced economies, and emerging markets. This indicator is much more useful in trying to determine whether increasing stress in one area of the financial markets, volatility for example, is spreading into other areas.
In the lead up to the 2008/09 financial crisis, stress was increasing in all five components of the indicator as early as August 2007. Similarly, broad-based stress was evident in early 2000, ahead of the Dot-Com bust. Whereas in early 2020, ahead of the lock-downs brought on by the pandemic, stress levels were low in all areas of the financial system. And while that downturn was pronounced and sharp, the stress levels began to abate quickly.
To get a sense of what the indicator was showing at different times over the past five years, I created an interactive chart. To access this chart, download the PowerPoint Show by clicking this link:
https://www.whiteoakfinancialmanagement.com/wp-content/uploads/2023/12/Stress%20Interactive.ppsx
Open the file and click the button to begin, then click each of the numbered buttons for a short explanation.
If you have questions or would like to talk more about this indicator or anything else, please let me know.
Happy Holidays!!
