Sahm-things Are Never Certain

The latest bear market indicator has hit financial markets. The Sahm Rule, created by former Federal Reserve economist, Claudia Sahm, triggered for the first time since 2020 on 2 August 2024 when the latest jobs report showed U.S. unemployment rate increasing to 4.3%.

The rule’s premise is relatively simple, it says that once unemployment rate rises by a certain amount, the labour market goes into a downward trajectory as job losses and declining demand feed into a negative feedback loop, plunging the broader economy into a recession.

On a recent Bloomberg Surveillance radio show, she is said to be “without question, the most influential economist in America right now”, and for good reason. Her indicator has a perfect record of identifying recessions since 1970.

Rules are meant to be broken

Claudia Sahm wrote in a recent op-ed that her “rule was meant to be broken” and her belief that the economy is not in a downturn. She is quoted as saying:

“If the Sahm Rule was going to fail, it’s going to be this time.”

Digging into the underlying data, we find that the supply side of the unemployment equation is what triggered the potential false positive. In July, the economy added 114,000 jobs but the labour force increased by 420,000. As such, the unemployment rate increased due to the increase in supply of workers who have not found jobs; layoffs were not the cause.

Equity markets give us information about recessions as they typically decline and bottom months before the start of a recession. That is why it is highly unusual to see global stocks rise +13.10% (end July 2024) before the triggering of the Sahm Rule.

Market behavior and economic data do not point to a recession at this point in time despite weakening labour markets. However, this can change quickly in successive months which is why it is important for investors to have an institutional level risk management system in place to respond to changes in the market.

Our data driven approach allows us to not be side-tracked by narratives, headlines and the varying tide of human emotions. We stay focused on capturing returns wherever they show up and protecting capital in times of systemic market stress.

We have written about another indicator with a perfect track record of predicting recessions but similarly, has failed to do so far. Read about it here. This highlights our weight of the evidence approach where we do not rely on any single indicator to make investment decisions even if they have a perfect track record of predicting markets.


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