Investor Essentials Daily

Quiet ripples started just before the financial tempest

December 4, 2023

Claudia Sahm has correctly identified every recession since 1949.

To be more accurate, the “Sahm Rule” has.

Sahm worked as an economist for the Federal Reserve in the 2000s. She specialized in consumer spending.

And it didn’t take long for her to realize that unemployment is one of the most important recession indicators.

It comes down to the “consumer feedback loop.” As soon as unemployment rises even a little, it takes a toll on consumer demand.

Folks who get laid off spend less money, which hurts businesses. That leads to more layoffs and then those folks spend less money, and the cycle repeats.

Unemployment rises again, spending contracts more, and soon we’re in a recession.

There are a lot of different ways to look at employment statistics. Right now, most of them don’t paint a pretty picture.

Today, we’ll unpack the implications of these troubling trends and what they spell out for our economy in the language of the Sahm Rule.

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Continuing claims, or the number of people unemployed for at least five weeks, was up almost 12% year over year in October.

Hiring rates have fallen from post-pandemic highs. They’re now more in line with 2015 to 2017 levels.

And the employment rate for people between ages 25 and 54 – the heart of the workforce – is starting to roll over. It fell from 80.9% in August to 80.6% in October.

Unemployment is still fairly low, at only 3.9%.

But job prospects are getting harder to come by. Corporate hiring rates are at a post-pandemic low. As folks get laid off, it’s getting harder for them to find new jobs.

No matter what metric you look at, it all says Sahm’s dreaded “feedback loop” may be starting, and the Sahm Rule reveals why we should be worried.

The rule tracks the three-month rolling average unemployment rate. If that rolling average climbs 0.5 percentage points above its one-year low, it’s a sign that a downturn has started.

For example, this average was 3.5% in April 2023. If it surpasses 4% before April 2024, the Sahm Rule would say we’re in a recession.

We’re not there yet.

But the indicator is rising fast. The unemployment rate was 3.8%, 3.8% again, and 3.9% in the past three months.

Right now, it sits at about 3.83%. That’s 0.33 percentage points higher than the April low.

The trend is not the economy’s friend right now. Take a look.

In the past 70-plus years, the Sahm indicator only got this high without surpassing 0.5 percentage points once in 2003.

Every other time the indicator reached 0.33 percentage points, we went on to recession territory.

We’ll be keeping a close eye on these metrics.

As the consumer feedback loop gets underway, unemployment will continue rising.

We could surpass the Sahm Rule’s threshold within a few months.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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