Quantitative modeling insights: repeat performance

Our modeling inputs appear stuck in neutral for 2017, offering no reason to change our outlook on equities or recession risk.

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Neutral equity outlook

Our model for U.S. equities versus U.S. fixed income remains neutral, similar to what we reported in our annual outlook report in December and the subsequent quarterly update in March.

EAA² U.S. equity vs U.S. fixed income aggregate signal

Source: Russell Investments, as of June 15, 2017. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Within our cycle, value and sentiment investment framework we make the following overarching assessments based on our quantitative models.

  • Business cycle: Our proprietary Business Cycle Index (BCI) model uses a range of economic and financial variables to estimate the strength of the U.S. economy and forecast the probability of an upcoming recession. We conclude:
    1. A near-term U.S. recession is unlikely.
    2. We’re also unlikely to see accelerating economic growth in this aging cycle. Our probit model, which incorporates the BCI’s “mediocre but non-recessionary” view, gives a neutral preference to U.S. equity versus U.S. fixed income.
  • Valuation: Our Fed model stayed positive and increased slightly because the 10-year U.S. Treasury yield dropped while the earnings yield held constant. ›› Sentiment: Equities have continued to hit historic highs in the first half of 2017, but the pace of the rally has slowed. Our momentum signal as of June 15, 2017, is stable and positive, but our long-term mean reversion signal is stable and negative for equity versus fixed income.

BCI model: historical forecasted recession probabilities

Similar to last quarter’s report, the BCI model shows near-zero risk of a recession in the near term, while probabilities for the next 12 months fluctuate between 20% and 25%.

BCI historical forecasted recession probabilities

Russell Investments as of June 15, 2017.

BCI-based heat map: ups and downs, but still neutral

The heatmap below shows payrolls and consumption have moderated in the past year, compared to 2015, while more favorable credit spreads help to offset those trends. The yield curve remains flat, which could foreshadow slower economic growth.

Impact on BCI, relative to recent history

Heat map colors of green/yellow/red denote the economic variable’s positive (green)/neutral (yellow)/negative (red) impact on business cycle strength relative to recent history.

Source: Russell Investments as of June 15, 2017.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

2Enhanced Asset Allocation (EAA) is a capability that builds on Strategic Asset Allocation (SAA) by incorporating views from Russell Investments’ proprietary asset class valuation models. EAA is based on the concept that sizable market movements away from long-term average valuations create opportunities for incremental returns. The EAA Equity-Fixed Income Aggregate Signal is based on the S&P 500 Index and Bloomberg Barclays U.S. Aggregate Bond Index.

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