KCFSI as a Stock Market Return Predictor

Posted in Economic Indicators


A subscriber suggested the Kansas City Financial Stress Index (KCFSI) as a potential U.S. stock market return predictor. This index “is a monthly measure of stress in the U.S. financial system based on 11 financial market variables. A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.” The paper “Financial Stress: What Is It, How Can It Be Measured, and Why Does It Matter?” describes the 11 financial inputs for KCFSI and its methodology, which involves principal component analysis and normalization. Is it useful for U.S. stock market investors? To investigate, we relate S&P 500 Index returns to values of KCFSI. Since KCFSI releases occur about eight days after ends of measured months, we use stock market data for the close on the eighth of each month (or the next trading day if the eighth is not a trading day). Using monthly data for KCFSI and the S&P 500 Index during February 1990 through March 2015 (302 months), we find that: (more…)

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