It has been 41 months since the recession watch model triggered an alert. The last one took the model from 40% probability of a recession within the next 6 months, to 55% probability. Today the model is telling us that the risk of recession sometime in the next 6 months is 15%. What exactly does this mean, and what, if anything, should you do about it?
The short answer is that recession risk is very low. The way this model is constructed, readings between 20% and 45% are normal. Readings below 20% are very good. It’s only when the signal gets into the “red zone” at 50% or higher that you should consider taking defensive action.
When the indicator reaches 80% or higher, caution is advised for equities. I recommend cutting equity exposure in half at that point. When it declines to 15% or less, I recommend a full allocation to risk assets like equities. And when it reaches 95%, I recommend a zero allocation to equities.
With the reading today at 15%, no action is called for. For very active investors, some trimming back on equities would be fine, but not required. Some selling for tax harvesting would be encouraged as well.
If no change is required, then why publish this note at all? Because each of us interprets these kinds of signals in a slightly different way. At what point would I be likely to recommend a more defensive posture? At 50% I start to get concerned. Anything less than that is more noise than signal.
Erik Conley