The Traphagen Recession Index (TRI) is a proprietary economic index developed by Traphagen as a tool to help predict US GDP growth rates and possible recessions. The TRI incorporates several different factors that have had a history of predicting recessionary periods months ahead of the official recession start. Some of the factors we actively monitor and are incorporated into the index include US corporate profit margins, Treasury yield spreads/trends, non-farm payroll trends, two different Leading Economic Indicators (LEI).
The TRI can range from 0 to 100 (although for the vast majority of the time should be in the 10 to 70 range). The index levels should be interpreted as ‘the percentage of a recession within the next 12 months’. Therefore, if the current index level is ‘35’, that means there is approximately a 35% chance of a US recession over the next year. The ‘average’ chance of a recession over any 1 year period is about 15%.
Traphagen developed the index for two main reasons. First, we wanted a reliable, diversified, and useful tool that would assist us in predicting recessions and economic growth rates over the intermediate term. This index is one of many tools we use to help position our client portfolios. Secondly, we wanted to give our clients an easy and accessible way to view our opinion on the US economy over time.
CURRENT TRI INDEX
The TRI has fallen off its all-time highs, now indicating about a 54% chance of a recession within the next 12 months. The spread between the 10 year vs. the 2 year continues to remain flat. It is important to note both the spread between the 10 year vs. 2 year along with the shape of the curve in its entirety. Since last year, the yield curve has gotten more compressed and flatter – historically a signal of a slowing U.S. economy.
The consumer remains a critical factor in determining the chance of a recession. In August, the Leading Indicators Index – a metric used to predict the movement of the global economy – showed mixed signals when it came to the consumer, specifically, the labor markets. Embedded within our Nonfarm Payroll and the AIER leading economic indicator metrics, unemployment insurance moved from a neutral to a favorable outlook, suggesting that labor market remains relatively healthy. Unemployment is also holding strong, nearing a multi decade low along with a rising participation rate.
Consumer sentiment also plays a big role. It is important to note how the economy is perceived can effect consumer decision making. The University of Michigan Survey showed that overall consumer sentiment sharply fell from July to August. Some of the factors that contributed to this result were the ongoing threat of Chinese tariffs, cutting interest rates, and other policy risks. A drop in consumer sentiment could imply that the consumer may want to reduce their spending habits in an effort to save for an impending downturn in the economy.
Since the TRI passed the 50% mark, Traphagen has taken defensive measures within client portfolios by selling 100% out of emerging market stocks and reallocating between short term bonds, low volatility U.S. stocks, and a U.S. stock sector rotation strategy (depending on risk of the client portfolio)
As always, we continue to monitor the chances for a slowdown and will take additional action if we feel necessary.
|10 Year vs. 2 Year Treasury Note Spread|
|% CHANCE OF REC. BASED ON ABOVE METRIC||65%|
|US Treasury Curve Shape & Recent Trend|
|% CHANCE OF REC. BASED ON ABOVE METRIC||90%|
|Conference Board ‘Leading Economic Indicator’|
|% CHANCE OF REC. BASED ON ABOVE METRIC||25%|
|AIER Leading Economic Indicator|
|% CHANCE OF REC. BASED ON ABOVE METRIC||15%|
|Stock Market Action/Breadth|
|% CHANCE OF REC. BASED ON ABOVE METRIC||35%|
|SP500 Profit Margin & Trend|
|% CHANCE OF REC. BASED ON ABOVE METRIC||45%|
|Nonfarm Payroll (YoY%)|
|% CHANCE OF REC. BASED ON ABOVE METRIC||65%|
Q: What is the Traphagen Recession Index (TRI)?
A: Traphagen has incorporated 6-7 different factors that have had a great history of predicting past recessionS while at the same time limiting the amount of ‘false positives’ (or predicting recessions that never happened). We then weight all these factors differently and aggregate all signals into the overall TRI reading.
Q: When did Traphagen develop this index?
A: Traphagen began research on the index and many different factors in late 2015 and developed the first iteration of the TRI in January of 2016. Overall we expect the TRI to remain largely unchanged through time, but if certain factors lose their predictive ability or others seem more important we can add and/or subtract pieces of the index.
Q: How does the TRI affect Traphagen’s portfolios?
A: If the TRI is very low (lower than 15) or very high (over 60 or so) we would likely take some action. If the chance of a recession is below average, and therefore very low, we would likely position the portfolio in a more aggressive manor with more stock holdings. When the TRI is high (above 50-60) we would put more defenses in the portfolio and reduce stocks and likely increase alternative/bond holdings.
Q: How often is the index updated?
A: Traphagen updates all factors and calculates the new TRI index level once per month.
Q: I am a writer, author, reporter, or other interested party, can I use or quote your index level in my work?
A: You may, all we ask is that you cite the index with the source and Traphagen.