Our industry is notorious for the random indicators. Any time we see market volatility, there is always a random indicator which will become the buzzword. The indicator we could see make some headlines is the "Sahm Rule" indicator. As media primarily focuses on negative news to catch clicks/eyeballs, it's no surprise that this is a negative indicator.
The Sahm Rule is a recession indicator that signals the start of a recession when the three-month moving average of the national unemployment rate (in the US) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months. It's based on "real-time" data and is useful in evaluating the business cycle. As you can see on the chart below, the indicator has been triggered.
It's interesting to learn where did this indicator come from. It started with Claudia Rae Sahm (thus the Sahm Rule) who is an American economist, currently serving as Chief Economist for New Century Advisors. She is also the founder of Sahm Consulting. Claudia was formerly director of macroeconomic policy at the Washington Center for Equitable Growth, and a Section Chief at the Board of Governors of the Federal Reserve System, where she worked in various capacities from 2007 to 2019. Sahm specializes in macroeconomics and household finance. She is best known for the development of the Sahm Rule, a Federal Reserve Economic Data (FRED) indicator for identifying recessions in real-time.
Claudia provided a great summar of the Sahm rule in her blog called “The Sahm rule: I created a monster.” Even though it was penned back in 2022, she understood the risk of the rule being misinterpreted, especially in the off-kilter post-pandemic environment of economic extremes and overcorrections.
She cautions, “Repeat after me: the Sahm rule is an empirical regularity. It’s not a proposition; it’s not a law of nature.” In fact, she highlights another traditional informal recession signal that did not work in the current economic environment, two consecutive quarters of GDP decline, which we had in the first half of 2022. Since then we can throw in some other traditional recession signals that did not work as many expected, including the Conference Board’s Leading Economic Index, yield curve inversion, and M2 mania.
It's important to note that these types of indicators don't always work. In this case, this rule when back tested would have provided a false positive in 1950. However, it has generally been correct. Another important point is that investors who follow this rule to make investment decisions could suffer serious losses such as in 2020 when the rule was triggered during the market downturn. Investors who sold in March 2020 would have missed one of the greatest market returns of our lifetime in the proceeding months.
As always, we are here to support your financial goals. If you require any assistance or have any questions, please do not hesitate to reach out to Cliff, Mario, Mark, or our TSG team.
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