Several of the explanatory variables are market-based. These variables respond very quickly to changing market conditions and are never revised. This makes the Trader Edge recession model much more responsive than other recession models. The current *and* historical data in this report reflect the current model configuration with all 21 variables.

The Trader Edge diffusion index equals the percentage of independent variables indicating a recession. With the latest changes, there are now a total of 21 explanatory variables, each with a unique look-back period and recession threshold. The resulting diffusion index and changes in the diffusion index are used to calculate the probit, logit, and neural network model forecasts.

The graph of the diffusion index from 1/1/2006 to 6/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past two years. The number of variables indicating a recession is currently one out of 21 (4.8%), which was unchanged from last month.

Please note that past estimates and index values will change whenever the historical data is revised. All current and past forecasts and index calculations are based on the latest revised data from the current data set.

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels. While the *median* recession slack index is used in the recession models, I am now including the *mean* recession slack index in the graph as well.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The *median* recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold. The *mean* recession slack index is depicted in blue and is also plotted against the right axis.

The dark-red, horizontal line at 0.50 standard deviations denotes a possible warning threshold for the recession slack index. Many of the past recessions began when the recession slack index crossed below 0.50. Similarly, many of the past recessions ended when the recession slack index crossed back above 0.0.

In mid-2014, the revised median recession slack index peaked at 1.35, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low of 0.32 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.42, but declined in the fall before rebounding at year-end.

In May of 2018, the recession slack index increased from a revised value of 1.08 to 1.17, while the mean or average recession slack index increased from a revised value of 1.14 to 1.18. Both the mean and median recession slack indices are still significantly above the early warning threshold (0.50).

To gain further insight into the slack index, I recently went back and calculated a derivative value: the percentage of variables with increasing slack each month. The possible values range from zero percent to 100 percent. Due to the monthly volatility, I provide the three-month moving average of the percentage of variables with increasing slack in Figure 3, but I personally monitor the monthly percentages as well.

Slack is a standardized value, so it is directly comparable across all variables. More slack indicates a larger cushion relative to a recessionary environment. As a result, we would like to see as many variables as possible with *increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack increased from 34.9% last month to 41.3% in May. However, both of these values are unusually low. The 3-month moving average of the percentage of variables with *increasing* slack has remained below 50% for the past four months. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The ability to track small variations and trend changes over time illustrates the advantage of monitoring the continuous recession slack index. The new slack variable will provide additional insight into the near-term direction of the economy and should be used in conjunction with the median recession slack index.

While it is useful to track the actual recession slack index values and percentage of variables with increasing slack, the diffusion percentages and slack index values are also used to generate the more intuitive probit and logit probability forecasts.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 6/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.1% in May. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The peak-trough model forecasts are different from the recession model. The peak-trough models estimate the probability of the S&P 500 being between the peak and trough associated with an NBER recession. The S&P 500 typically peaks before recessions begin and bottoms out before recessions end. As a result, it is far more difficult for the peak-trough model to fit this data and the model forecasts have larger errors than the recession model.

The Trader Edge aggregate peak-trough model equals the weighted-average of nine different models: the probit and logit models based on the diffusion index, the probit and logit models based on the recession slack index, and five neural network models.

The aggregate peak-trough model estimates from 1/1/2006 to 6/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 6/01/2018 was 5.3%, which decreased by 1.7% from last month's revised value of 7.0%. The aggregate peak-trough probability remains low.

January and February 2016 marked a potential tipping point in U.S. recession risk, but those conditions proved to be temporary. Conditions have improved significantly since early 2016. The decrease in recession risk has been supported by both market and non-market variables.

U.S. recession risk remains very low. There is very limited evidence of near-term economic weakness in the explanatory variables, although the abnormally low percentage of variables with increasing slack is worth monitoring.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets -- as we saw in early February. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Finally, Hulbert's recent MarketWatch article cited research that used the household equity allocation percentage as a tool for forecasting long-term (10-year) future equity returns. The resulting correlation was so strong (-0.90) that I was compelled to duplicate the research and verify the results myself. I did so and the correlation is correct. It is highly unusual to ever see correlations that high in actual market data. Furthermore, a strong argument can be made for a causal link due to the direct effects of both market valuation and behavioral finance on the household equity allocation percentage.

Based on the most recent data, the regression model indicates that the expected annual price return of the S&P 500 index for the next 10 years is slightly less than zero, with an expected drawdown in that period of 36% (from current levels). In other words, the expected price return of the SPX is 0% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 64% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected *annual* price return of the S&P 500 index for the *next 10 years* is significantly negative (-4.33%), with an expected drawdown in that 10-year period of over 50% (from current levels).

Overvalued securities can *always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Unlike human prognosticators, the Trader Edge recession model is completely objective and has no ego. It is not burdened by the emotional need to defend past erroneous forecasts and will always consistently apply the insights gained from new data.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>Several of the explanatory variables are market-based. These variables respond very quickly to changing market conditions and are never revised. This makes the Trader Edge recession model much more responsive than other recession models. The current *and* historical data in this report reflect the current model configuration with all 21 variables.

The Trader Edge diffusion index equals the percentage of independent variables indicating a recession. With the latest changes, there are now a total of 21 explanatory variables, each with a unique look-back period and recession threshold. The resulting diffusion index and changes in the diffusion index are used to calculate the probit, logit, and neural network model forecasts.

The graph of the diffusion index from 1/1/2006 to 5/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past two years. The number of variables indicating a recession is currently one out of 21 (4.8%), which increased from zero last month.

Please note that past estimates and index values will change whenever the historical data is revised. All current and past forecasts and index calculations are based on the latest revised data from the current data set.

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels. While the *median* recession slack index is used in the recession models, I am now including the *mean* recession slack index in the graph as well.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The *median* recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold. The *mean* recession slack index is depicted in blue and is also plotted against the right axis.

The dark-red, horizontal line at 0.50 standard deviations denotes a possible warning threshold for the recession slack index. Many of the past recessions began when the recession slack index crossed below 0.50. Similarly, many of the past recessions ended when the recession slack index crossed back above 0.0.

In mid-2014, the revised median recession slack index peaked at 1.27, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low of 0.32 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.41, but declined in the fall before rebounding at year-end.

In April of 2018, the recession slack index decreased from a revised value of 1.13 to 1.07, while the mean or average recession slack index increased from a revised value of 1.13 to 1.14. Both the mean and median recession slack indices are still significantly above the early warning threshold (0.50).

To gain further insight into the slack index, I recently went back and calculated a derivative value: the percentage of variables with increasing slack each month. The possible values range from zero percent to 100 percent. Due to the monthly volatility, I provide the three-month moving average of the percentage of variables with increasing slack in Figure 3, but I personally monitor the monthly percentages as well.

Slack is a standardized value, so it is directly comparable across all variables. More slack indicates a larger cushion relative to a recessionary environment. As a result, we would like to see as many variables as possible with *increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack dropped from 38.1% to 34.9% in April. Both of these values are unusually low. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The ability to track small variations and trend changes over time illustrates the advantage of monitoring the continuous recession slack index. The new slack variable will provide additional insight into the near-term direction of the economy and should be used in conjunction with the median recession slack index.

While it is useful to track the actual recession slack index values and percentage of variables with increasing slack, the diffusion percentages and slack index values are also used to generate the more intuitive probit and logit probability forecasts.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 5/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate increased from 0.0% to 0.1% in April. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The peak-trough model forecasts are different from the recession model. The peak-trough models estimate the probability of the S&P 500 being between the peak and trough associated with an NBER recession. The S&P 500 typically peaks before recessions begin and bottoms out before recessions end. As a result, it is far more difficult for the peak-trough model to fit this data and the model forecasts have larger errors than the recession model.

The Trader Edge aggregate peak-trough model equals the weighted-average of nine different models: the probit and logit models based on the diffusion index, the probit and logit models based on the recession slack index, and five neural network models.

The aggregate peak-trough model estimates from 1/1/2006 to 5/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 5/01/2018 was 7.0%, which was up by 3.4% from last month's revised value of 3.6%. While still very low, this was the largest monthly increase in the last 18 months.

January and February 2016 marked a potential tipping point in U.S. recession risk, but those conditions proved to be temporary. Conditions have improved significantly since early 2016. The decrease in recession risk has been supported by both market and non-market variables.

U.S. recession risk remains very low. There is very limited evidence of near-term economic weakness in the explanatory variables, although the abnormally low percentage of variables with increasing slack is worth monitoring.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets -- as we saw in early February. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Finally, Hulbert's recent MarketWatch article cited research that used the household equity allocation percentage as a tool for forecasting long-term (10-year) future equity returns. The resulting correlation was so strong (-0.90) that I was compelled to duplicate the research and verify the results myself. I did so and the correlation is correct. It is highly unusual to ever see correlations that high in actual market data. Furthermore, a strong argument can be made for a causal link due to the direct effects of both market valuation and behavioral finance on the household equity allocation percentage.

Based on the most recent data, the regression model indicates that the expected annual price return of the S&P 500 index for the next 10 years is approximately zero, with an expected drawdown in that period of 36% (from current levels). In other words, the expected price return of the SPX is 0% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 64% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected *annual* price return of the S&P 500 index for the *next 10 years* is significantly negative (-4.62%), with an expected drawdown in that 10-year period of over 50% (from current levels).

Overvalued securities can *always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Unlike human prognosticators, the Trader Edge recession model is completely objective and has no ego. It is not burdened by the emotional need to defend past erroneous forecasts and will always consistently apply the insights gained from new data.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>Several of the explanatory variables are market-based. These variables respond very quickly to changing market conditions and are never revised. This makes the Trader Edge recession model much more responsive than other recession models. The current *and* historical data in this report reflect the current model configuration with all 21 variables.

The Trader Edge diffusion index equals the percentage of independent variables indicating a recession. With the latest changes, there are now a total of 21 explanatory variables, each with a unique look-back period and recession threshold. The resulting diffusion index and changes in the diffusion index are used to calculate the probit, logit, and neural network model forecasts.

The graph of the diffusion index from 1/1/2006 to 4/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past two years. The number of variables indicating a recession is currently zero out of 21 (0.00%), which remained unchanged from last month.

Please note that past estimates and index values will change whenever the historical data is revised. All current and past forecasts and index calculations are based on the latest revised data from the current data set.

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels. While the *median* recession slack index is used in the recession models, I am now including the *mean* recession slack index in the graph as well.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The *median* recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold. The *mean* recession slack index is depicted in blue and is also plotted against the right axis.

The dark-red, horizontal line at 0.50 standard deviations denotes a possible warning threshold for the recession slack index. Many of the past recessions began when the recession slack index crossed below 0.50. Similarly, many of the past recessions ended when the recession slack index crossed back above 0.0.

In mid-2014, the revised median recession slack index peaked at 1.27, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low of 0.32 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.41, but declined in the fall before rebounding at year-end.

In March of 2018, the recession slack index increased from 1.17 to 1.27, which is misleading, because the mean or average recession slack index declined from 1.21 to 1.15 in March. Both the mean and median recession slack indices are still significantly above the early warning threshold (0.50).

To gain further insight into the slack index, I recently went back and calculated a derivative value: the percentage of variables with increasing slack each month. The possible values range from zero percent to 100 percent. Due to the monthly volatility, I provide the three-month moving average of the percentage of variables with increasing slack in Figure 3, but I personally monitor the monthly percentages as well.

Slack is a standardized value, so it is directly comparable across all variables. More slack indicates a larger cushion relative to a recessionary environment. As a result, we would like to see as many variables as possible with *increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack dropped from 33.3% to 28.6% in March. Only 28.6% of the variables experienced *increasing* slack in March, which is abnormally low, especially after a similarly poor performance in February. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The ability to track small variations and trend changes over time illustrates the advantage of monitoring the continuous recession slack index. The new slack variable will provide additional insight into the near-term direction of the economy and should be used in conjunction with the median recession slack index.

While it is useful to track the actual recession slack index values and percentage of variables with increasing slack, the diffusion percentages and slack index values are also used to generate the more intuitive probit and logit probability forecasts.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 4/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.0% in March. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The peak-trough model forecasts are different from the recession model. The peak-trough models estimate the probability of the S&P 500 being between the peak and trough associated with an NBER recession. The S&P 500 typically peaks before recessions begin and bottoms out before recessions end. As a result, it is far more difficult for the peak-trough model to fit this data and the model forecasts have larger errors than the recession model.

The Trader Edge aggregate peak-trough model equals the weighted-average of nine different models: the probit and logit models based on the diffusion index, the probit and logit models based on the recession slack index, and five neural network models.

The aggregate peak-trough model estimates from 1/1/2006 to 4/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 4/01/2018 was 3.3%, which was down 0.5% from last month's revised value of 3.8%.

January and February 2016 marked a potential tipping point in U.S. recession risk, but those conditions proved to be temporary. Conditions have improved significantly since early 2016. The decrease in recession risk has been supported by both market and non-market variables.

U.S. recession risk remains very low. There is very limited evidence of near-term economic weakness in the explanatory variables, although the abnormally low percentage of variables with increasing slack is worth monitoring.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets -- as we saw in early February. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Finally, Hulbert's recent MarketWatch article cited research that used the household equity allocation percentage as a tool for forecasting long-term (10-year) future equity returns. The resulting correlation was so strong (-0.90) that I was compelled to duplicate the research and verify the results myself. I did so and the correlation is correct. It is highly unusual to ever see correlations that high in actual market data. Furthermore, a strong argument can be made for a causal link due to the direct effects of both market valuation and behavioral finance on the household equity allocation percentage.

Based on the most recent data, the regression model indicates that the expected annual price return of the S&P 500 index for the next 10 years is approximately zero, with an expected drawdown in that period of 35% (from current levels). In other words, the expected price return of the SPX is 0% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 65% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected *annual* price return of the S&P 500 index for the *next 10 years* is significantly negative (-3.94%), with an expected drawdown in that 10-year period of over 50% (from current levels).

Overvalued securities can *always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Unlike human prognosticators, the Trader Edge recession model is completely objective and has no ego. It is not burdened by the emotional need to defend past erroneous forecasts and will always consistently apply the insights gained from new data.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 3/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past two years. The number of variables indicating a recession is currently zero out of 21 (0.00%), which remained unchanged from last month.

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The median recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold.

In mid-2014, the revised median recession slack index peaked at 1.28, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.34 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.41, but declined in the fall before rebounding at year-end.

In January of 2018, the recession slack index jumped from 1.16 to 1.37. Unfortunately, the improvement proved to be temporary. In February, the median recession slack index gave up all of its January gains and dropped back to 1.16. While the median recession slack index is still significantly above the early warning threshold (0.50), the one-month decline of 0.21 standard deviations is notable.

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack dropped from 50.8% to 44.4% in February. Only 33.3% of the variables experienced *increasing* slack in February, which is abnormally low. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 3/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.0% in February. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 3/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 3/01/2018 was 3.8%, which was up 0.5% from last month's revised value of 3.3%.

U.S. recession risk remains very low. There is very limited evidence of near-term economic weakness in the explanatory variables, although the magnitude of the one-month decline in the slack index was surprising.

*MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Based on the most recent data, the regression model indicates that the expected annual price return of the S&P 500 index for the next 10 years is now negative, with an expected drawdown in that period of over 36% (from current levels). In other words, the expected price return of the SPX is less than 0% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 64% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected *annual* price return of the S&P 500 index for the *next 10 years* is significantly negative (-4.76%), with an expected drawdown in that 10-year period of over 50% (from current levels).

*always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 2/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past two years. The number of variables indicating a recession is currently zero out of 21 (0.00%), which remained unchanged from last month.

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The median recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold.

In mid-2014, the revised median recession slack index peaked at 1.28, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.34 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.41, but declined in the fall before rebounding at year-end.

The recession slack index is currently 1.37, which is up materially from last month's revised value of 1.16. The current slack index value of 1.37 is one of the highest values seen since the last recession. The median recession slack index is significantly above the early warning threshold (0.50).

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack remained constant at 52.4% in January. There is no evidence of economic weakness in the median recession slack index data. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 2/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.0% in January. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 2/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 2/01/2018 was 3.3%, which was down 0.3% from last month's revised value of 3.6%.

U.S. recession risk remains very low. There is very limited evidence of near-term economic weakness in the explanatory variables.

*MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Based on the most recent data, the regression model indicates that the expected price return of the S&P 500 index for the next 10 years is now negative, with an expected drawdown in that period of over 35% (from current levels). In other words, the expected price return of the SPX is less than 0% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 65% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected *annual* price return of the S&P 500 index for the *next 10 years* is significantly negative (-4.43%), with an expected drawdown in that period of over 50% (from current levels).

*always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 1/1/2018 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The Trader Edge recession slack index equals the median standardized deviation of the current value of the explanatory variables from their respective recession thresholds. The resulting value signifies the amount of slack or cushion relative to the recession threshold, expressed in terms of the number of standard deviations. Higher slack values signify larger cushions above recessionary threshold levels.

The gray shaded regions in Figure 2 below represent U.S. recessions as defined (after the fact) by the NBER. The median recession slack index is depicted in purple and is plotted against the right axis, which is expressed as the number of standard deviations above the recession threshold.

In mid-2014, the revised median recession slack index peaked at 1.31, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.34 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.41, but has since pulled back modestly.

The recession slack index is currently 1.07, which is down materially from last month's revised value of 1.24. The median recession slack index is still significantly above the early warning threshold (0.50).

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack decreased from 60.3% last month to 52.4% at the end of December. This decrease was driven by a surprisingly low percentage of variables with increasing slack in December of only 38.1%. The above percentage decline is consistent with the drop in the median slack index value in December. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 1/01/2018 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.0% in December. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 1/01/2018 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 1/01/2018 was 4.1%, which was down 0.3% from last month's revised value of 4.4%.

U.S. recession risk remains very low, even considering the decline in the slack indexes this month. There is very limited evidence of near-term economic weakness in the explanatory variables.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Based on the most recent data, the regression model indicates that the expected price return of the S&P 500 index for the next 10 years is less than 1% per year, with an expected drawdown in that period of 34% (from current levels). In other words, the expected price return of the SPX is less than 1% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 66% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The Buffett Indicator regression model currently indicates that the expected annual price return of the S&P 500 index for the *next 10 years* is actually negative (-4.16%), with an expected drawdown in that period of over 50% (from current levels).

*always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Brian Johnson

Copyright 2018 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 12/1/2017 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past 18 months. The number of variables indicating a recession is currently zero out of 21 (0.00%), which decreased from a revised value of one last month.

In mid-2014, the revised median recession slack index peaked at 1.31, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.35 in February 2016, before rebounding over the next few months. In early 2017, the median recession index peaked at 1.40, but has since pulled back modestly.

The recession slack index is currently 1.24, which is up for the second month in a row from a recent low of 0.98. The median recession slack index is significantly above the early warning threshold (0.50).

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The 3-month moving average of the percentage of variables with *increasing* slack increased from 36.5% in both July and August to 60.3% at the end of November 2017. The recent rebound has alleviated any near-term concerns of economic weakness. New evidence of economic weakness (or strength) often shows up first in this timely metric.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 12/01/2017 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate decreased from 0.1% to 0.0% in November. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 12/01/2017 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 12/01/2017 was 4.3%, which was down 0.9% from last month's revised value of 5.2%.

U.S. recession risk remains very low. In addition, the median recession slack index *and* the percentage of variables with increasing slack have both rebounded in recent months. As a result, there is very limited evidence of near-term economic weakness in the explanatory variables.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Based on the data, my analysis indicates that the expected price return of the S&P 500 index for the next 10 years is less than 1% per year, with an expected drawdown in that period of 34% (from current levels). In other words, the expected price return of the SPX is less than 1% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 66% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

I completed a similar historical regression analysis using the "Buffett Indicator", which is the ratio of equity market capitalization to GDP. The correlation is not quite as strong, but is still very significant (-0.74). The resulting historical analysis of the Buffett Indicator suggests that the expected annual price return of the S&P 500 index for the *next 10 years* is actually negative (-4.65%), with an expected drawdown in that period of over 50% (from current levels).

*always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Brian Johnson

Copyright 2017 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 11/1/2017 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past year. The number of variables indicating a recession is currently one out of 21 (4.75%), which increased from a revised value of zero last month.

In mid-2014, the revised median recession slack index peaked at 1.31, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.35 in February 2016, before rebounding over the next few months.

The recession slack index is currently 1.14, which is up sharply from the last month's reading of 0.90. The recession slack index had declined for three consecutive months before rebounding last month. The median recession slack index value of 1.14 is once again significantly above the early warning threshold (0.50).

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The moving average percentages of variables with *increasing* slack declined significantly from April 2017 (55.6%) to August (36.5%). Fortunately, the three-month moving average rebounded in September to 44.4% and again in October to 54%. New evidence of economic weakness (or strength) often shows up first in this timely metric. The recent rebound has alleviated any near-term concerns of economic weakness.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 11/01/2017 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate increased from 0.0% to 0.1% in October. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 11/01/2017 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 11/01/2017 was 5.2%, which was down 0.5% from last month's revised value of 5.7%.

U.S. recession risk remains very low. In addition, the median recession slack index *and* the percentage of variables with increasing slack have both rebounded in recent months. As a result, despite the small increase in the diffusion index in October, there is very limited evidence of near-term economic weakness in the explanatory variables.

As I have repeatedly emphasized, recessions are not the only source of pullbacks in the equity markets. The U.S. equity market continues to be overvalued and global event risk continues to be elevated. This recent *MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Based on the data, my analysis indicates that the expected price return of the S&P 500 index for the next 10 years is less than 1% per year, with an expected drawdown in that period of 34% (from current levels). In other words, the expected price return of the SPX is less than 1% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 66% of its current value sometime in the next 10 years. The risk/return trade off for holding periods as short as three years look equally unattractive, albeit with lower correlations.

*always* become more overvalued - especially in the near-term. That said, history offers compelling evidence that bullish equity positions today will face significant headwinds over the coming years.

Brian Johnson

Copyright 2017 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 10/1/2017 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past year. The number of variables indicating a recession is currently one out of 21 (4.75%), which was unchanged from last month.

In mid-2014, the revised median recession slack index peaked at 1.31, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.35 in February 2016, before rebounding over the next few months.

The recession slack index is currently 0.97, which is down sharply from the recent peak of 1.30 at the end of May 2017. The recession slack index has now been below 1.0 for two consecutive months and is at its lowest level since August 2016. The slack index is still materially above the early warning threshold, but the recent rapid decline is not encouraging.

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The most recent three-month moving average percentages of variables with increasing slack were very low in both July (38.1%) and August (38.1%). Fortunately, the three-month moving average rebounded in September to 44.4%. New evidence of economic weakness (or strength) often shows up first in this timely metric, which warrants continued scrutiny at the current elevated market levels. The market is especially vulnerable to pullbacks when trading at or near its highs, as it is now.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 10/01/2017 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate remained constant at 0.1% in September. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 10/01/2017 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 10/01/2017 was 6.3%, which was up 1.1% from last month's revised value of 5.2%.

U.S. recession risk remains very low. However, the median recession slack index has weakened recently and the three month moving average of percentages of variables with increasing slack has been below 50% for five consecutive months. The levels in July and August (38.1%) have not been seen since early 2016.

*MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Finally, Hulbert's recent MarketWatch article cited research that used the household equity allocation percentage as a tool for forecasting long-term (10-year) future equity returns. The resulting correlation was so strong (-0.90) that I was compelled to duplicate the research and verify the results myself. I did so and the correlation is correct. It is highly unusual to ever see correlations that high in actual market data. Furthermore, a strong argument can be made for a causal link due to the direct effects of market valuation and behavioral finance on the household equity allocation percentage.

Based on the data, my analysis indicates that the expected price return of the S&P 500 index for the next 10 years is less than 1% per year, with an expected drawdown in that period of 34% (from current levels). In other words, the expected price return of the SPX is less than 1% per year over the next 10 years, *and* it is likely that an investor would have the opportunity to purchase the SPX at 66% of its current value sometime in the next 10 years - not a very compelling argument for owning stocks today.

Brian Johnson

Copyright 2017 Trading Insights, LLC. All rights reserved.

]]>*and* historical data in this report reflect the current model configuration with all 21 variables.

The graph of the diffusion index from 1/1/2006 to 9/1/2017 is presented in Figure 1 below (in red - left axis). The gray shaded regions in Figure 1 below represent U.S. recessions as defined (after the fact) by the National Bureau of Economic Research (NBER). The value of the S&P 500 index is also included (in blue - right axis).

The U.S. economy flirted with entering a recession in early 2016, which was reflected in the deteriorating economic, fundamental, and especially market-based data. The diffusion index, slack index, and recession probability forecasts all captured the weakening conditions. However, the weakness proved to be temporary and the conditions and recession model forecasts have improved significantly in the past year. The number of variables indicating a recession is currently one out of 21 (4.75%), which decreased by one (4.75%) last month.

In mid-2014, the revised median recession slack index peaked at 1.29, far above the warning level of 0.50. The recession slack index declined significantly in 2015 and reached a low 0.34 in February 2016, before rebounding over the next few months.

The recession slack index is currently 0.95, which is down sharply from last month's revised value of 1.15. The median recession slack index has now declined for three consecutive months and is at its lowest level since August 2016. The slack index is still materially above the early warning threshold, but the recent rapid decline is troubling.

*increasing* slack. Given the diverse nature of the explanatory variables, it is unusual to see more than 60% of the variables with increasing slack or fewer than 40% of the variables with increasing slack. These extreme values are significant and predictive of the near-term direction of economic growth and *often the equity market*.

The most recent moving average percentages of variables with increasing slack were only 36.5% this month *and* last month, which were the lowest readings since February 2016. The very low percentages of explanatory variables with increasing slack is very troubling and could represent an early warning of further weakness in the market and/or the U.S. economy.

The breadth of weakness across variables in two consecutive months is notable and suggests an increasing risk of an equity market pullback in the near future. It is rare to see the moving average of increasing slack values fall below 40% and most instances are followed by significant short-term market declines. The market is especially vulnerable when trading at or near its highs, as it is now.

The Trader Edge aggregate recession model is the average of four models: the probit and logit models based on the diffusion index and the probit and logit models based on the recession slack index. The aggregate recession model estimates from 1/1/2006 to 9/01/2017 are depicted in Figure 4 below (red line - left vertical axis). The gray shaded regions represent NBER recessions and the blue line reflects the value of the S&P 500 index (right vertical axis). I suggest using a warning threshold of between 20-30% for the aggregate recession model (green horizontal line).

The aggregate recession model probability estimate declined from 0.2% in July to 0.1% in August. According to the model, the probability that the U.S. is *currently* in a recession continues to be extremely remote.

The aggregate peak-trough model estimates from 1/1/2006 to 9/01/2017 are depicted in Figure 5 below, which uses the same format as Figure 4, except that the shaded regions represent the periods between the peaks and troughs associated with NBER recessions.

The aggregate peak-trough model probability estimate for 9/01/2017 was 5.4%, which was down 1.9% from last month's revised value of 7.3%.

U.S. recession risk remains very low. However, the recent sharp decline in the median recession slack index and the very low percentages of variables with increasing slack in the past two months is particularly problematic. The recent levels have not been seen since early 2016.

*MarketWatch* article suggests that "*There are only two other times in history when stocks were more expensive than today*." On a related topic, Mark Hulbert's latest *MarketWatch* article demonstrated that the *Russell 2000's current P/E ratio is actually 78.7*, not the more commonly reported value of 25.6.

Brian Johnson

Copyright 2017 Trading Insights, LLC. All rights reserved.

]]>