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Stocks: Stress Indices Tell Us When to Worry


With the Composite Indicator of Systemic Stress at an all-time low, does that mean we can kick back and relax?

One of the quotes that has been making the rounds lately is, "The only thing to worry about is that there isn't anything to worry about." That lack of concern is clearly evident among measures that are monitored by the Federal Reserve. Several of the individual branches of the Fed compute stress indices, like the following:
  • Cleveland Financial Stress Index
  • Chicago Fed Financial Conditions Index
  • St Louis Fed Financial Stress Index
  • Kansas City Fed Financial Stress Index
They monitor similar phenomena, so there is quite a bit of redundancy. The indices focus on stock prices, volatility, interest rates, credit
spreads, asset correlations, liquidity demands, systemic leverage, and more.

They're all essentially bounded from +2 (extremely high stress) to -2 (extremely low stress), with 0 being the baseline.

Typically, when the average gets near +1, we're at "the world's gonna end" kind of sentiment. When it gets to +3, that's pretty much the apocalypse, but inevitably, stocks bounce back.

When the average gets near -1, we're at "the country's firing on all cylinders, full speed ahead!" Whatever is beyond that is where we are now; the Composite Indicator of Systemic Stress (CISS) just hit a new all-time record low.

A few days ago, the Composite hit a level of -1.21, which has never been matched. It has approached -1.0 four other times: February/March 1977, August 1993, April/October 2006, and January/February 2007.

Of the 68 days the index has neared that level, the one-year return in the S&P 500 (INDEXSP:INX) was positive 29% of the time with a median return of -6.4%.

To be fair, the Composite was low, below -0.5 but not beyond -0.95, during much of the mid-1990s, and stocks rallied massively. But usually, the time to worry is when there is nothing to worry about.

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No positions in stocks mentioned.

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