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 only up about 15% (but very volatile); however, when RPA has signaled less than 50 (the "green light" so to speak), the S&P 500 has risen over 75% (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
After the Government shutdown suspended data releases in November the RPA calculations were impossible for a month. All is back to normal with economic data now, and not much has changed. After retro fitting the November data we're able to see that the strength of the US economy was unchanged over the past two months (29.8). This is better than average, and clearly in the "green light" zone for investors. Sure, there's always some reasons to be concerned - there's just not a whole lot in the very short term.
The job market continues to slowly improve and economic growth has picked up slightly. On the negative side, real estate in general is starting to slow down quite a bit.
Looking forward, the US still needs to eventually face the repercussions of years of record deficit spending. When the piper comes to get paid, it's very possible it could get ugly. For now, however, it looks like that day is quite a bit down the road (certainly more than 6 months).
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 a few more months (or longer). 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.