Recession Probability (RPA) - September 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 25% (but very volatile); however, when RPA has signaled less than 50 (the "green light" so to speak), the S&P 500 has risen over 80% (and much less volatile). I began publishing the model live in November of 2007.
Here’s the full history of RPA from inception:
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What RPA is Saying This Month
Record Breaking!! (and shocking)
I've been reporting the true statistical rank of the US Economy now for nearly 7 years. The past 3 months have each set new records for the best ever "live" numbers reported. The August numbers came in at 17.88. This means on a scale of 1 to 100 (1 being the best) the US Economy would rank just better than 18.
This is great in some ways, but bewildering in others. There are still a lot of people that can't seen to believe the market rally over the past few years is the real deal. I myself, have been a doubter more than once. But the numbers don't lie - the economy is actually pretty strong right now, which has pretty well justified the big rally in stocks / real estate and other growth oriented investments.
The drivers for the economy as of late have been: Improving consumer confidence, increasing home values, and continuous improvement in labor markets.
Alas, 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 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.