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 economic 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 25% and when it is below 50 the S&P 500 has risen nearly 15%. I began publishing the model in November of 2007.
Here’s the full history of RPA from inception:
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RPA has risen again this month and is looking very similar to last year when RPA rose throughout the summer and into the fall. This year the main culprits are a weakening job market as well as lower consumer and business sentiment - largely a reflection of the concerns over Europe's financial woes.
Obviously the stock market has also weakened considerably over the past 6 weeks, but it isn't really due to weakness in the US economy which is why RPA remains under 50 and not issuing any warning signs.
The next couple months could very well be significant for the US economy and financial markets. "Sell in May then go away" is getting more and more chatter with 3 consecutive years now of legitimacy. This topic will be thoroughly tested and revealed on my blog this week as sort of a side post to the usual content on my blog.
In the end the economy isn't strong but it isn't weak either. It's just average. And with all the potential problems stemming from Europe, demographics supporting less interest in the stock market and more interest in income producing investments, and still fresh reminders of how quickly the stock market can drop (2008) - all culminate to make investors very nervous and selling to ramps up at any sign of weakness. Those are the reasons the stock market has pulled back so far.
This past week was lousy, but all in all the year is still decent and well balanced conservative investors haven't had to endure all that bumpy of a ride.