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
Although there is still quite a bit of uncertainty in financial markets with another debt ceiling debate in the US, the risk of recession coming in the near term is still quite low. It did go up a slight bit to 26.82.
The rise was largely due to a huge drop in new construction. All other indicators remain relatively strong.
This could change very quickly if the debt ceiling is not raise, which could cause a government shut down of sorts. I don't think this is a huge risk, but if it happens the shock to the economy could hit in the fourth quarter. I'll definitely be keeping a close eye on this and will report what's happening here on the blog.
As I've mentioned before, this doesn't mean the stock market couldn't have a correction. Stocks have gone up substantially this year (and the last 5 years). 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. Each pull back we've had over the last year has been modest, with most just 4% to 8%. I fully expect we'll get a real pullback eventually, which would be more like 10% to 15%. It may happen soon, or may not happen for another year. Either way, stay tuned to blog updates for warning signs.
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.