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No stress in markets, but some risks are building up, says government watchdog

Financial markets are far from stressed—stocks are near record levels, credit and liquidity are abundant and volatility is historically low. But some vulnerabilities in the system are building up and warrant investigation and reflection, according to the Treasury Department’s Office of Financial Research.

The OFR on Wednesday unveiled two new tools designed to do that. The new gauges suggest that stock market valuations, risk appetite and credit risk are flashing warning signs. But stress levels, meanwhile, are near the lowest levels since 2007.

The S&P 500 SPX, -0.47%  is trading within a percentage point of its record close at 2,555, while the cyclically-adjusted price-to-earnings ratio is at 31, well above its long-term average of 16. In other words, stocks are expensive. Implied volatility, as measured by the CBOE Volatility Index VIX, -0.27%  is at about 12, near a historical low.


The OFR, created in 2010 in the aftermath of the financial crisis by the Dodd-Frank Act has essentially split a gauge known as the financial stability monitor into two new tools: the financial system vulnerabilities monitor and the financial stress index.

The vulnerabilities monitor is designed to track various indicators for potential vulnerabilities and prompt further investigation when they flash warnings.

It condenses 58 indicators into six distinct categories: macroeconomics, markets, credit, solvency and leverage, funding and liquidity, and contagion. The resulting color-coded heat map is an easy visualization of risks building up in the system.

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