Tactical Investment System For S&P 500 - Financial Stress Index (Part 4)

1 month ago

We’ve entered the September and October period, which is typically the worst seasonal agelong for stocks and this twelvemonth has been nary different. Market volatility has risen, plus prices person fallen and the media are doing a bully occupation of stirring the cookware and ensuring that there’s a steadfast dose of fearfulness successful the market.

The OFR Financial Stress Index, which is provided by the Office of Financial Research is an overlooked measurement for accent successful the fiscal markets. The scale is comprised of 33 fiscal marketplace variables and arsenic we showed successful Part 1 and Part 2 of the series, it has predictive powerfulness for the S&P 500. When the FSI scale is affirmative it means that accent levels are supra mean and worthy taking enactment of, and erstwhile it is antagonistic accent levels are little worrisome.

The scale is comprised of a composite of the pursuing marketplace variables:

Credit – Credit spreads, some HR and IG Corporate
Equity valuation – Stock valuations, the banal scale terms levels
Funding – Bank lending standards, recognition conditions index
Safe Assets – Valuations for assets similar Yen, CHF, and Gold that are considered harmless stores
Volatility – VIX Index, Move Index, implied and realised volatility

What we are going to bash successful this nonfiction is revisit the probe that showed the astir optimal levels to travel for the indexes and past update connected wherever we are and what levels you should ticker retired for moving forward, to amended clip plus allocation decisions.

This clip we’re going to bash this regionally, truthful you get a consciousness of wherever cardinal satellite banal markets are successful presumption of fiscal stress.

Overview of the Financial Stress Index and S&P 500 (US Stocks)

The OFR Financial Stress Index has a determination filter that allows america to absorption connected the information for US stocks first. Let’s instrumentality a look astatine the bigger representation and past drill down:

The FSI has done a bully occupation of covering the recessions implicit the past 22 years and being aligned to forecasting them with a grade of accuracy.

Right present you tin spot that we are conscionable hovering adjacent the 0 mark. Historically – based connected our erstwhile Python-driven investigation – we recovered that a speechmaking of 0.5 marked a turning constituent for the US FSI scale and the S&P 500. The reddish enactment indicates a merchantability awesome erstwhile accent is elevated capable to warrant reducing your equity exposure. We recovered that a strategy that followed bargain and merchantability rules astatine this level bushed the S&P 500 since 2000.

Here is simply a amended presumption of the illustration implicit the past 6 months:

Today’s speechmaking is -0.526. A speechmaking of 0.5 oregon supra for the US FSI would bespeak a merchantability signal. This means that the accent successful the fiscal strategy astatine that level, oregon above, is much intimately associated with antagonistic equity returns.

Put different way, this level indicates that volatility successful the equity markets, recognition markets, slope lending standards, and formation of investors' funds to harmless assets person reached a tipping constituent that suggests antagonistic aboriginal returns for stocks. We’re not rather astatine this level but we could beryllium approaching it soon – truthful caution is warranted.

Overall appraisal for US stocks is simply a cautious buy until specified a constituent that this indicator hits 0.5 for the US FSI index.

Overview of the Financial Stress Index and HSI Index (Asia Pac Stocks)

The OFR Financial Stress Index has a determination filter for Emerging Markets that is worthy investigating. Let’s look astatine the bigger representation and past drill down:

The FSI besides has market-beating instrumentality imaginable erstwhile it is applied to the Hang Seng Index. I person yet to people an nonfiction showing my workings here, but pursuing the aforesaid logic that I utilized for the US FSI, I came to an absorbing conclusion. The Hang Seng Index should beryllium bought erstwhile the Emerging Markets FSI scale is beneath -0.009 (very astir 0 mark) and sold erstwhile it is supra that level.

Here is simply a amended presumption of the illustration implicit the past 6 months:

It’s precise important to enactment that the achromatic enactment is not the measure: the orangish line, represents the Emerging Markets information and it presently shows a affirmative speechmaking supra 0.

Today’s speechmaking is 0.323. A speechmaking of -0.009 oregon supra for the Emerging Markets FSI would bespeak a merchantability signal. Just arsenic above, this means that the accent successful the fiscal strategy astatine that level, oregon above, is much intimately associated with antagonistic equity returns, which we are seeing successful the Hang Seng Index.

The wide appraisal for the Hang Seng Index is simply a cautious sell until a clip erstwhile the Emerging Markets FSI scale drops beneath -0.009.

Overall Assessment

Having built dozens of rules-based systems successful the past, I person noticed 1 captious origin for success. You person to judge successful your systems and travel them, alternatively than trying to front-run the results.

What the US FSI scale tells maine is that close present crossed a scope of measures, which look to correlate good with the S&P 500 index, the marketplace is not yet showing signs of accent that would warrant panicking astir your equity positions. These measures bash look to beryllium accelerating, though, truthful it’s worthy keeping an oculus connected the scale during the period of October to spot if we adjacent successful towards 0.5, which would bespeak a merchantability signal.

The other is the lawsuit with the Hang Seng Index. The Emerging Markets FSI has been a merchantability for a agelong time. The scale has consistently work supra -0.009 and determination is precise existent accent successful the Chinese banking, credit, and volatility markets. Investors should beryllium cautious by going excessively heavy over-weight stocks successful the emerging markets until we spot signs of accent astatine oregon beneath -0.009 connected the FSI index.

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