Seemingly every day, US investors are hit with a deluge of sometimes conflicting economic data.
Take last week for example: the US economic index fell 1.2% in March, the sharpest drop in three years. The indicator has now fallen for 12 consecutive months.
Then a day later on Friday, investors got readings from the S&P Global Flash US Manufacturing Gauge and the S&P Global Flash US Services Business Activity Index, both of which showed improvement in April.
See: Why the stock market is so frustrating right now
As economists, portfolio managers, and stock market strategists attempt to analyze a non-stop sea of data for clues as to where the US economy is headed, some leading indicators such as the Sahm Rule and Blanchflower-Bryson Rule are turning to them for clues They determine when the Federal Reserve’s aggressive rate hikes — the central bank raised its benchmark interest rate by about 5 percentage points over the past year — will have their desired effect.
Each of these rules takes a different approach to anticipating, so to speak, when the next shoe might fall.
Jake Jolly, BNY Mellon’s head of investment analysis, said he closely follows the Sahm Rule and other early recession indicators for clues as to when the widely anticipated recession might begin.
Of course, by the time the National Bureau of Economic Research, the official recession arbiter, declares that a recession has hit, it will already be too late for investors to act.
“We believe there is an increased likelihood of a recession in the second half of the year and into 2024, but admittedly exact timing is very difficult,” Jolly said during an email exchange with MarketWatch. “We’re looking for turning points in key economic data.”
The Sahm Rule
The Sahm Rule has become a widely used indicator among market experts and economists alike. It was developed by Claudia Sahm, a former Federal Reserve economist and founder of Sahm Consulting, as a tool to help policymakers respond to a flagging labor market, perhaps by automatically sending out stimulus checks to help affected workers .
The rule is relatively simple and firmly anchored in historical patterns, according to Sahm. It is triggered when unemployment rises 50 basis points from its 12-month low. To meet the rule now, unemployment would need to rise to 3.9%, up 50 basis points from the 3.4% rate recorded in January, the lowest in the last 12 months.
While the rule has applied regularly in the past, Sahm told MarketWatch during a phone interview that she wouldn’t be surprised if it “breaks” this time due to the economic distortions caused by the COVID-19 pandemic.
“It’s an empirical regularity, it’s based on historical contexts, which doesn’t mean that it always has to apply. This is not a law of nature. If the Sahm rule broke, it would be this time,” Sahm said.
At a time when the US job market seems to be defying gravity, investors are desperate for clues as to when the turning point might occur.
For months, investors have received an incessant march of reports of layoffs at large corporations. Still, the US economy added 236,000 jobs in March, with the unemployment rate hovering at a comfortable 3.5%.
Data released in recent weeks has shown a fall in job vacancies and a rise in weekly jobless claims, but signs of significant weakness are yet to come.
“The Sahm rule is interesting because the focus is so much on the labor market. Consumer confidence has been low for a while making it seem less predictable for this particular environment,” said Callie Cox, a US investment analyst at eToro, in emailed comments.
The Blanchflower-Bryson Rule
Another indicator of an early recession was created by economists David Blanchflower and Alex Bryson. It draws on consumer confidence survey data from the Conference Board and the University of Michigan to try to predict when the job market will collapse.
According to a paper published by Blanchflower and Bryson, it was a reliable predictor of past recessions and offered even earlier insight than the Sahm rule.
The premise behind the meter is simple: it assumes that ordinary people have a reliable understanding of what’s happening in their own communities.
“It turns out people know what’s coming because they have a sense of what’s happening in their communities. If they think bad times are coming, they will,” said Blanchflower, a former member of the Bank of England’s monetary policy committee.
The alarm bells are already ringing. Conference Board numbers have been trending down since the summer of 2022, although the outlook has brightened in recent months. A preliminary reading from the University of Michigan read 63.5 in April versus 62.0 in March.
For years, stocks have rallied inexorably, driven in part by the Fed’s rock-bottom interest rates, analysts said. Last year’s plunge into a bear market came as the Fed aggressively hiked rates. Now, with the prospect of an economic slowdown on the horizon, markets are becoming increasingly sensitive to economic data as investors look for clues as to how severe a slowdown will be.
In a recent note, Tom Essaye, founder of Sevens Report Research, offered some thoughts on why a sharp downturn in the economy would likely take a toll on the stock market, even if the Fed cuts interest rates in response.
“A hard landing is the worst case scenario for markets given the recent rally. Because on a hard landing, it doesn’t matter if the Fed cuts rates (which is the mainstay of this market right now). The rate cuts come too late.
“Also, with a hard landing, there’s virtually no chance that S&P 500 earnings expectations will stay where they are,” he added.
Next week, investors will get an update on the pace of inflation when Friday’s latest personal spending index, the Fed’s preferred indicator of inflation, is released.
Meanwhile, US stocks ended Friday’s session with modest gains, but the main indices didn’t gain enough to stave off a weekly decline for the second time in three weeks.
The S&P 500
SPX
declined 0.1% to 4,133.52, according to FactSet data for the weekend. The Nasdaq Composite
COMP
posted a weekly decline of 0.4% while the Dow Jones Industrial Average
DJIA
0.2% lost.
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