Fintech executive, writer, math geek, and investment systems developer. Founder and CEO of Altruist and Founder of FormulaFolios.

Recession Probability Update - October, 2011

Each month I calculate the strength of the US economy using a math based model I call RPA (Recession Probability Analytics). When the number rises above 50 it means the US economy is in the bottom 50% of all historical conditions relative to it history. While far from perfect, the model has had an uncanny ability to correlate (negatively) with stock market returns. In other words, when the model moves above 50 the S&P 500 has fallen over 30% and when it is below 50 the S&P 500 has risen over 15%.  I began publishing the model in November of 2007.

Here's the full history of RPA from inception:

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Please note that the September, 2011 value of the S&P 500 is as of today (9/20/2011) and that the model is a month end model.  This means that any action from the data in the model is not implemented until the end of the month.  In the case of this months reading it means we will not change any of our portfolios until the last trading day of September (9/30/2011).

The rise in RPA for September is the largest since December of 2008.  In the month following that rise the S&P 500 lost 8.6%.

Since the model is not always correct, I would strongly caution investors from assuming next month will produce a similar loss.  More than anything consider the reading a warning regarding the US economy.  The model is based on known facts, not opinions.  And the fact today is the US economy is weakening, regardless of what economists and politicians try to tell us.

For another visual of RPA relative to the S&P 500 I build this chart.  It shows the monthly reading of RPA overlayed against the S&P.  When the bars are red the reading is above 50 and when it's gray the reading is below 50.

RPA Chart


The reason RPA jumped so much in just one month can largely be attributed to poor labor market reports (jobs), and a huge decline in consumer confidence.  When people can't find good jobs and their confidence is shaken it generally correlates to reduced spending.  Since spending is such a major part of our economy the model is suggesting there is a good chance our real economy will contract within 6 months.

A shrinking economy is not good for investors.

As a reminder to clients, when this measure moves above 50 we reduce equities in client portfolios by 50%.  So if an allocation is normally 60% stocks / 40% bonds - it would become 30% stocks / 40% bonds / 30% cash.

It's a defensive maneuver designed to preserve portfolio value in the event the stock market declines.  It is by no means a guarantee against all losses, but it is a step in the more conservative direction.

Like all models this one can be frustrating.  There will be months the market goes up and the model is suggesting caution.  But as I've written and talked about in the past - it's avoiding the major declines that will lead to long term success as an investor - not the short term rallies.

The last time RPA went above 50 was December of 2007 and it stayed there until August of 2009.  Over that time period there were a few very nice up months in the market.  As a whole however, it lost roughly 38% of it's value.  Those are the types of declines we're trying to mitigate with a tool like RPA.

If you have questions about this and are a client feel free to contact our office via phone or email.  If you're not a client and have questions just use the contact form on this post.  If you're reading this via email you need to click on the title of the post to go to my website, which is where you'll find the form.

Lastly, if you know someone who might benefit from this reading (I would hope all investors would want to know this information) then please feel welcome to forward this email or share my blog with them.

On a more positive note - my wife had a wonderful Birthday yesterday!  Since my daughters birthday is the day prior (9/18) my wife often get's leftover style celebrations.  But my kids went the extra mile to make sure mom's day was great and we all had a bang up celebration.  Thanks to those of you who read my blog and are also friends of Jillian's that reached out and wished her a Happy Birthday.


Jason Wenk

Market Update - September 22, 2011

Market Update - September 19, 2011