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 over 30%. 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) dropped to has risen for the second consecutive month and also had its largest jump (a bad thing) in over a year. On the surface this sounds like really bad news for the economy, but keep in mind some of this is due to temporary economic disruptions resulting from Hurricane Sandy. While the economy is far from strong, I don't think it's quite as weak as the 55.18 number registered for this month.
How the "Fiscal Cliff" is handled will ultimately dictate (in my opinion) where RPA goes from here. If it's handled gracefully I suspect RPA will go back below 50 and financial markets will gain strength heading into 2013. If it's botched, then the warning RPA is giving us will be timely as the possibility of a real recession sometime in 2013 becomes a very real possibility.
Since RPA is a math based, mechanical, non-emotional measurement of economic strength - the model is telling us now is a good time to be more conservative than normal.
For those not familiar with how my firm uses this measure, when it moves above 50 we reduce our "growth" investments by 50%. So if a portfolio is normally 60% income oriented and 40% growth oriented this would change it to 80% income and 20% growth. It's a fairly subtel change in the grand scheme of things, but removes the emotion from the investing process and keeps our already balanced investing philosophy a bit more guarded in times the economy is statistically fragile.
By no means is this post meant to be a recommendation for others to do I as do. If you are managing your own money it is your own responsibility to do your own research and come to your own conclusions.
On a totally unrelated note...
After taking about a week off from email, blogging, writing, and most work-related activities - it's good to be back! The only downside to these short respites is my fingers feel a bit fatter than normal. I suspect after a few more hours of typing the coordination will come back :).
I hope all my clients and blog readers are enjoying the Holiday season and my most sincere wishes for a Happy New Year to all of you.