The chart below illustrates the historical performance of the benchmark US index, the S&P 500, around the triggers of the so-called Sahm Rule, a US recession indicator which is triggered when the unemployment rate’s three-month moving average rises above its low over the previous 12 months. The “rule” is more a series of observations and correlations than a rule which is iron-clad.
Data released a couple of weeks ago showed the US unemployment rate rising to 4.3%, with nonfarm payrolls increasing by only 114,000 in July – both readings were significantly worse than expected. This breached the Sahm Rule and amplified recessionary fears, negatively impacting risky assets like the S&P 500.
For a couple years, some economists have forecast an imminent recession because of the Fed’s campaign to hike interest rates, which are intended to slow the economy to contain inflation. Historically, high interest rates make borrowing and spending so costly for businesses and individuals that the economy nosedives sooner or later.
This time around, some have found reasons to doubt the rule will hold true. The US is in an unusual economic situation, and other previously reliable recession indicators have set off false alarms e.g. the inverted yield curve has warned of a recession since mid-2022, but that has yet to materialise.
When asked about the Sahm rule, Fed Chair Jay Powell said that there is reason to believe the economy will act differently this time around. “Never assume it’s going to be just the same… Let’s remember that this pandemic era has been one in which so many you know, apparent rules have been flouted… The situation really is unusual or unique in that so much of this inflation came from the shutdown of the economy and the resulting supply problems in the face of, admittedly, very strong demand.“
Historically, the S&P 500 on average tends to bottom after such a trigger. The median performance indicates some downside risk over the following six months, but the interquartile and percentile ranges suggest a relatively positive performance over the subsequent year. So, while the market may face turbulence at first, recovery and growth are likely in the longer term.
With a slowing economy, the probabilities of a Fed rate cut increases. We are confident that the Fed will cut rates by 25bp at its next meeting in September. So how does the US market typically respond to Fed rate cuts? Relative to the index, Consumer stocks (cyclicals and non-cyclicals), Technology and Healthcare do well, but Energy Utilities and Finance sectors underperform.
Source: MacroBond
