It’s important to maintain a proper perspective of risk and financial stress in the markets. There are other aspects, besides the SP 500, to take into consideration when planning trades and investments. Some of the key leading indicators that I have found to be beneficial are the yield curve, financial stress index and weekly unemployment claims.
The first chart above is the yield curve or spread between 2 year treasury yields and the 10 year treasury yield. An inversion of this yield curve has correctly signaled most of the bear markets and recessions in advance.
The curve has flattened quite a bit in 2014 and early 2015, as the short end of the curve has increased more due to increased expectations of a “lift off” in the Fed Funds Rate. However the yield curve is in no immediate danger of inverting. An inversion on this chart would mean a reading below 0.
The yield curve between the 30 year treasury bonds and 3 month T-Bills is quite healthy also. There was a problem with the data so I was unable to replicate this chart.
The St. Louis Financial Stress index takes into account a variety of different financial market indicators and has done a good job of quantifying risk in the near term. A reading over 1 has generally been the warning signal over the last 15 years or so. Even though this reading has increased throughout 2015, it still remains in negative territory.
Weekly jobless claims has also been a pretty good leading indicator of stress and recessions. A spike in jobless claims has been a fairly reliable indicator of a nearby recession. And this reading currently stands at a 10 year low.
The conclusion here is that these indicators signal a low probability of a recession in the near term. It’s obvious the economic recovery has left a lot to be desired. However, without a recession on the horizon, the odds are low that we get a nasty bear market.
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