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Is Market Volatility Translating to Economic Stress?

CAMS Weekly View from the Corner – Week ending 11/16/2018

November 19, 2018

The St. Louis Federal Reserve Bank is the 8th District Bank of the 12 District Bank Federal Reserve System.  The St. Louis branch publishes a Financial Stress Index that gives us a sense of how much stress is registering in our economic system through various market measures.

This Index is comprised of eighteen different market based measures in order to get a sense of how collective market participants are interpreting our current economic landscape.

Interestingly, with the historic Monetary Policy actions the Federal Reserve (FED) had taken dating back to the Great Recession of 2008/09, said relationships became “manufactured” if you will.

The FED itself was a massive buyer/participant in markets with their purchases of various investment instruments through their tremendous money printing policies.  This played a notable role in creating market based relationships which pointed to lower financial stress.

As of September 20, 2017, the FED informed us said policies had been fully concluded as the “un-printing” process was ushered in and thereby have been allowing their massive balance sheet to reduce in size.

The process of extreme money printing always leaves downstream issues.  One such issue is the residual (often referenced in these Weekly Views) historically high valuation levels of asset markets.

The FED’s market based purchasing programs resulted in asset prices growing consistently faster than actual underlying economic growth.  Over the post-Great Recession follow-on years this added up to historic valuation levels of markets overall.

The above underlines (yes, offered yet again consistent readers) that we are in a time that solid and consistent economic growth is an absolute must if asset markets are to hold up.

We are historically highly valued and the aforementioned reduction in the FED’s balance sheet (“un-printing”) began more than a year ago.  This leaves highly valued markets relying completely on economic growth – take growth away and markets will be looking at a notable downside scenario.


The above chart depicts the Financial Stress Index dating back to the Great Recession.  This Index is constructed in that zero is viewed as representing normal financial market conditions.  A value below zero represents below average financial stress conditions or higher than if above the zero line.

While we have seen an increase off the historic lows the current level remains generally subdued.  For reference we remain under the level attained as recently as early 2016 as the red line depicts.  Even though markets have been notably volatile since early October this Financial Stress Index continues to point to a constructive economic backdrop.

We will continue to share this measure according to its behavior.

We wish you all a Happy Thanksgiving!  The Weekly View will be back in two weeks to continue our on-going observations.

I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Portfolio Manager, CAMS Spectrum Portfolio

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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