The so-called "Sahm rule" has been in the headlines a lot lately. Many express their opinions, concerns, and even fear about it, saying that the risks of recession are huge, that it is necessary to reduce interest rates rapidly, that lending should be stimulated, etc.
So, what is the "Sahm rule"? Why is everyone paying attention to it right now?
According to Investopedia:
The "Sahm Rule" is a recession indicator created and named after Claudia Sahm, a macroeconomist who worked at the Federal Reserve and the White House Council of Economic Advisers. According to the Sahm Rule, the early stages of a recession is signaled when the three-month moving average of the U.S. unemployment rate is half a percentage point or more above the lowest three-month moving average unemployment rate over the previous 12 months.
The Sahm Rule has been widely recognized for its accuracy, simplicity, and ability to reflect the onset of a recession quickly.
So, why is it relevant right now?
In July, this indicator was 0.53%, in August: 0.57%. According to the "Sahm rule" - a recession is expected very soon, or even more - we are already in a recession.
How accurate this "Sahm rule" actually is?
Actually: very accurate!
Almost whenever the "Sahm rule" is above 0.5%, it is followed by a recession or there is already a recession! Look at this graph that shows the value of the "Sahm rule" over a longer period: from 1959 to the present day. As always, the periods of recession are shown as gray vertical stripes.
Historically, the "Sahm rule" signals the early stages (onset) of a recession and generated only two false positive recession alerts since the year 1959 (there have been 11 recessions since 1950); in both instances — in 1959 and 1969 — it was just a little untimely, with the recession warning appearing a few months before a slide in the U.S. economy began. In the case of the false positive warning related to the year 1959, it was followed by an actual recession six months later. The Sahm rule typically signals a recession before GDP data makes it clear.
As you can see, this is a very accurate indicator for forecasting a recession.
The only question is timing. When exactly will the recession occur and how long will it last?
Now, if we distance ourselves from all other indicators and blindly look only at this one - then an interesting trend appears. If we mark the period on the S&P500 chart when the "Sahm rule" shows a value of 0.5% or more, until the "Sahm rule" reaches the maximum value of that period, we see that this period is good for making investments in the stock markets. In principle, a pretty good timing indicator. This is what it looks like visually: S&P500 Monthly graph from 1958.
In principle, this period almost always marks the "bottom" of the market. Or it is almost always a good period to consider long-term deals. This is the time to look for buying opportunities. Almost every time, during this period, when the "Sahm rule" shows a value of 0.5% or more, the market experiences a correction. This correction is a great place and time to consider buying trades.
So, now the "Sahm rule" is 0.53%. And the price of the S&P 500 has seen a small correction of 10%. (S&P500 Daily graph).
Is the correction of the predicted recession already behind us? Was this 10% correction the last chance to buy cheap and the market is already "pricing" better times? To try to understand this, let's take a look at the size of the average S&P500 correction during the recession period.
Here's a graph from the "Market Declines: A History of Recoveries":
Now, look at the graph with all periods of Market Crashes since 1950:
As you can see, the average drop during the recession is ~30%. And yes, of course, each case is individual. And yes – I don't think that this time there will be a "classic" recession.
However, that doesn't change the essence of the matter. In the long term, the stock market is bullish. And we can use this moment as a great Timing tool.
We are waiting for a correction, we follow "Sahm rule" indicators and make long-term purchases.
Stay tuned!
Agris
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