A mid-year review of 2018 recession risk

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities*
• Trend Model signal: Risk-on*
• Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


What is the risk of recession?
Over at A Dash of Insight, Jeff Miller criticized WSJ reporter Greg Ip for writing what Miller consider to be a doomster-like article about rising recession market risk. He went on to accuse Ip of cherry picking data to make his point about a heightened risk environment, and concluded:

The entire article reads like a laundry list of points that would make sense to investors with limited knowledge of economics. That is why I am disappointed. My hope is that top journalists would help explain reality rather than feed fears stoked by so many others. This article will frighten investors. Is that what the author intends?

The issue of recession risk is important to investors because every recession has been accompanied by an equity bear market. So let me put in my two cents worth in my own assessment of recession risk for the American economy.

Some time ago, I created a Recession Watch page on my website. The recession risk criteria on the page was based on the framework specified by New Deal democrat. NDD used the work of Geoffrey Moore, the founder of ECRI, to create seven long leading indicators designed to spot recessions a year in advance (click on links for the latest FRED charts):

• Corporate bond yields (Corporate bond yields have always made their most recent low over 1 year before the onset of the next recession)
• Housing starts (Housing starts peaked at least one year before the next recession)
• Real private residential fixed investment (Aside from the 1981 "double-dip," and 1948, it has always peaked at least one year before the next recession)
• Money supply (In addition to the 1981 "double dip," on only 2 other occasions have these failed to turn negative at least 1 year before a recession)
• Corporate profits and Proprietors` income, which can be a more timely proxy for corporate profits (Corporate profits have peaked at least one year before the next recession 8 of the last 11 times, one of the misses being the 1981 "double-dip.")
• Yield curve, which may not be relevant in the current interest rate environment (The yield curve inverted more than one year before the next recession about half the time)
• Real retail sales (It has peaked 1 year or more before the next recession about half of the time)

A review of the seven indicators revealed both good news and bad news. Here are the details of each indicator, along with a discussion of the internals behind each indicator,

The full post can be found at our new site here.