The St. Louis FED publish a “Markov switching” recession model with rigorous test statistics:
Monthly data are also provided, allowing testing with Fama-French benchmark data. Results from buying and selling at various recession probability levels are shown below.(selecting portfolio with highest annual momentum):
Selling when recession probability is greater than 80% is best for returns. The buy threshold has little effect, possibly because the market recovers before the recession risk subsides.
Sharpe is maximized by buying when recession risk is under 30% and selling when risk is greater than 60%. It makes intuitive sense that investing risk is lowest under those conditions.
Buy = rm <= Optimize(“buy threshold”,30,10,100,10);
Sell = rm >= Optimize(“sell threshold”,60,10,100,10);
PositionScore = IIf(ROC(C,12)>0,ROC(C,12),0);
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