More Evidence That Financial Stress Is Back To Pre-Crisis Levels

Includes: DIA, SPY
by: Mark J. Perry

Further evidence that financial stress has returned to pre-crisis levels is provided today by the St. Louis Federal Reserve's update of its Financial Stress Index ((STLFSI)). The St. Louis Fed Financial Stress Index is calculated based on 18 weekly financial variables that include seven interest rates, six yield spreads, and five other financial variables. Each of the 18 component variables captures some aspect of financial risk, and an overall index measure of financial risk in the US economy is constructed from those variables using a procedure called "principal components analysis."

For the week ending last Friday, the STLFSI declined to -0.627 (lower values indicate less financial stress), which is the lowest financial stress reading since July 2007 (see red line in chart). As can be seen in the chart above, the STLFSI started increasing during the last half of 2007, and increased steadily toward the end of 2008 as the financial crisis and economic recession worsened. For the last four years, the stress index has gradually declined as financial conditions and stress have returned to their pre-crisis conditions.

Another statistical measure of the overall financial conditions is the Bloomberg U.S. Financial Conditions Index, which provides a daily measure of the relative strength of the U.S. money, bond, and equity markets. It is also considered a useful gauge of bank lending conditions and the overall availability of credit. The U.S. Financial Conditions Index has been trending upward for the last year (higher values indicate improving financial conditions) and has reached levels over the last week above index values of 1.20, which we haven’t seen since early 2007.

Bottom Line: Based on recent data from every available measure of financial risk, volatility, and overall financial conditions (the St. Louis Fed Financial Stress Index, the Kansas City Fed Financial Stress Index, the Chicago Fed National Financial Conditions Index, the CBOE Volatility Index, and the Bloomberg U.S. Financial Conditions Index) an overwhelming consensus is emerging that the U.S. financial markets have made a complete recovery from the Great Recession and financial crisis. The return of financial stress to pre-crisis, pre-recession 2007 levels according to all five measures identified above is one reason that the Dow is trading at an all-time high and the S&P 500 is within several points of its 2007 high.

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