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 (Recession Probability) has risen again this month, the third consecutive increase. The job market continues to languish and consumer confidence is dropping fast - largely a reflection of the concerns over Europe's financial woes.
Between the stock market dropping and the items above RPA has been moving up. But RPA was fooled last year from similar issues and after rising above 50 in September (our warning signal) the market then turned on a dime, and rallied the last 3 months of 2011.
For the time being the economy still remains in the better half of historical conditions. So while I always advocate for more conservative, balanced investing approaches - there is no need at this time to get even more conservative. May was awful, but June has been mostly good thus far. Should the markets sustain this I would suspect RPA to improve shortly. If it doesn't, however, then RPA will give us a nice warning sign to further take risk off the table and start getting more defensive in the coming months.