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 its 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 is just barely up (but very volatile), but when RPA has signaled less than 50 (the "green light" so to speak), the S&P 500 has risen over 50% (and not too volatile at all). I began publishing the model in November of 2007.
Here’s the full history of RPA from inception:
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What RPA is Saying This Month
A lot could change after August numbers are reported in September, especially considering many investors are starting to get a bit skittish with the recent market volatility, but the current RPA reading actually dropped quite a bit this month. This is a good thing. As of today, RPA stands at 23.84 - the lowest recession risk since 2006.
This is largely due to the July readings for higher consumer confidence, increased new construction starts, and reduced initial unemployment claims. I suspect consumer confidence will drop a bit for next month, and we already know that new construction starts will be lower in August (relative to July). As such, I don't get too excited by the very low recession risk number.
RPA has signaled a green light now for over a year (meaning it was below 50 - which is the better half of all economic conditions).
As I've mentioned before, this doesn't mean the stock market couldn't have a correction. Stocks were too high and the current decline certainly go move lower. A pullback from overbought conditions is perfectly normal and happens all the time. It's just that from an economic perspective, a pullback would be just that, and not necessarily the sign of a full blown recession.
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. Times are pretty good at the moment, but good times don't last forever - so be sure to keep on eye on this economic indicator next month.