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

Recession Probability (RPA) Update - March 2013

Nothing like reporting old news!!!  For some reason this post didn't get published last month as it was supposed to.  Technology/User error I guess ;).  Either way, here was last months RPA update (along with some old news about the sequester). -----

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, since I started publishing RPA the S&P 500 has fallen over 5%, but when RPA has signaled less than 50 (the "green light" so to speak), the S&P 500 has risen over 38%.  I began publishing the model in November of 2007.

Here’s the full history of RPA from inception:

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For the second consecutive month RPA (Recession Probability) dropped in February, though not by much compared to the large drop in January.  On the surface this is good.  The only problem is the coming sequester that could shake the economy (and the financial markets) quite a bit.

For those not familiar with the sequester, here's a quick primer of what it is, and what it means to the economy:

The sequester is a series of budget cuts that kick in this Friday (March 1, 2013).  They were originally part of the "Debt Ceiling" issues of 2011 and were pushed off into the "Fiscal Cliff" issues at the end of 2012.  Unless another push off occurs, the sequester will initiate broad based spending cuts of $1.2 trillion spread over the next 10 years.

The spending cuts are to be equally spread across defense and non-defense spending.  However, different kinds of spending will be hit harder percentage wise.  In September 2012, the Office of Management and Budget estimated that if the cuts occurred as projected in January, discretionary defense spending would be cut by 9.4 percent in FY2013, mandatory defense spending would be cut by 10 percent, discretionary nondefense spending would be cut by 8.2 percent, mandatory nondefense spending would be cut by 7.6 percent, and Medicare and other mandatory health programs would be cut by 2 percent.

How exactly this impacts the economy going forward is unknown.  My guess, however, is it will hurt.  Over the past few years government spending (and debt accumulation) has far outpaced actual economic growth.  For example, since 2008 GDP (gross domestic product) has only increased $1.5 trillion, while the national debt has increased more than $6 trillion.  So in a nutshell, without the massive deficits and government spending, we'd still be in a massive recession.

In the end, I'm not a fan of either recessions, nor growing national debts.  But at this point, without one - it appears we'll have the other.  By Friday we'll know either, A) the budget cuts will be delayed again, B) the budget cuts will kick in and potentially hurt the economy quite a bit, or C) the budget cuts will be modified in some way to have a little bit of both A) and B).  Of course, I'll keep clients and blog readers posted as this all unfolds.

Back to RPA...

Last month we saw lower initial unemployment claims, an increase in construction permits, and rises in total wealth (due to the stock market rising substantially).  Despite those positives, consumer confidence dropped, keeping Recession Risk mildly high.

While RPA has been cautious for the past year, it has mostly signaled a green light (meaning it was below 50 - which is the better half of all economic conditions).

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 balanced as an investor.  Times could be better, but at least for the short term, there's no reason to be especially cautious.  This could all change if/when sequester kicks in - so be sure to keep on eye on this economic indicator next month.

I hope all my clients and blog readers are enjoying a great start to the New Year.

Cheers,

Jason Wenk

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