Recession Probability (RPA) Update - January 2014
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
Despite a rather volatile month of January, the economy is not currently the problem - at least in relative terms. RPA has risen slightly, but remains in the top 1/3 of all economic conditions per our measurements (31.3). 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 has gotten slightly worse, and new construction has slowed a bit, but investor confidence is still quite high providing a near equal offset. Perhaps after digesting a rather rough start to the new year consumer confidence will dip - we'll simply have to wait and see if that comes to fruition.
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 the past 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.