Recession Probability (RPA) Update - February 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 17% (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
Financial markets have been rather up and down so far in 2014, but the economy is started to consistently only moving in the negative direction. Overall, the numbers still are above average, but February marked the 3 consecutive month of economic worsening.
To be fair, RPA still has Recession Probability marked at only 34.27. What this means is based on my research we have a 34.27% chance of being in a recession in 6 months. So, odds are more likely the US will be okay, it's just those odds are getting slightly worse each month.
Much of this could just be the toll of a very harsh winter for much of the US. Record low temperatures and snowfall have hurt consumer spending, new construction starts, and even consumer sentiment. We'll have to wait and see if a spring thaw reinvigorates the economy.
As I've mentioned (many times) before, the stock market is still due for 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.