50% Recession Possibility Calls For A ‘Higher-Than-Usual’ Allocation To Non-Stock ETFs

Other than permanently bearish writers and investors, few address the possibility of the U.S. falling into a recession. Many conclude that the Federal Reserve’s ultra-low rate policy completely altered the landscape such that the idea of a business cycle no longer exists. Others merely ignore warning signs until, unfortunately for them, the opportunity to reduce investment risk has passed them by.

Until recently, I have only discussed the possibility of a recession in the context of a Fed policy mistake. (Thank you, Captain Obvious.) Indeed, I have addressed the pervasive concern that the central bank might raise rates too quickly and/or too frequently, hampering U.S. economic growth that has relied upon stimulus for six-plus years.

However, a social media participant reminded me of an article that I wrote back in December 2007. In my feature, I shared my personal predictive model for determining the probability of economic contraction. In December 2007, my model placed the recession likelihood at 70%. It moved up to 80% in January of 2008 in an article published by Investors’ Business Daily. Unfortunately for folks who relied on less robust indicators (or none at all), the National Bureau of Economic Research (NBER) did not identify that a recession had begun in October of 2007 until October of 2008 – one year later. By that time, the U.S. stock market had already been crippled by the 2008 stock bear.

There are five forecasting tools that I have traditionally favored for identifying the probability of a cyclical downturn. For simplicity sake, I weight the components equally to come up with a “probability picture.”

Here, then, is my predictive model as it stands in March of 2015:

1. The Institute For Supply Management’s Report on Business. One of the most popular measures of business expansion or contraction is the Purchasing Managers’ Index (PMI). In the broadest sense, a percentage over 50 is indicative of manufacturer health; February PMI came in at 52.9. However, since the Fed backed off of its quantitative easing (QE) in October, the trend has been toward slower and slower growth. PMI percentages came in at 57.9 in October, 57.6 in November, 55.1 in December, 53.5 in January and now 52.9 in February, the slowest growth in 13 months.

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ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser ...

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