This omen of disaster just showed up for the first time since 2020…

The Sahm Rule is one of the most reliable early indicators of a recession. It’s named after former Federal Reserve economist Claudia Sahm.

This recession signal triggers when the three-month moving average of the unemployment rate rises 0.5 percentage points or more from its lowest point within the past year.

Historically, this has been a near-perfect sign that a recession is either underway or imminent. It shows when the labor market is weakening.

And recently, it made an unexpected entrance…

In the most recent jobs report, the unemployment rate ticked up to 4.3% in July. That pushed the three-month moving average to 4.13%… up more than 0.53 percentage points from the lows in the three months ending July 2023.

At first glance, this might seem scary. After all, the Sahm Rule has caught every recession in the past 50 years. But before we rush to conclusions, we need to understand what’s driving the numbers this time around.

That’s because if you unpack the state of the jobs market, this signal doesn’t spell as much doom and gloom as you might think.

Let’s dive into the details…

The labor market today is very different from what it was in the past.

One of the biggest changes is that the workforce-participation rate is higher now. We simply have more people in their prime working years who are employed or actively looking for work.

That’s a good thing on its own. But it also throws off traditional indicators like the Sahm Rule. The jump in unemployment mostly wasn’t due to widespread layoffs or a sharp economic downturn… Instead, it’s partly because more people are entering the job market.

When demand for workers is low, that’s a problem… one that tends to snowball out of control into a recession. But when unemployment rises due to a high supply of workers, that’s a different story entirely.

Second, many of the sectors that typically lead a recession – like manufacturing or construction – are still resilient parts of the jobs market right now…

While some areas of the economy have been softer than others, we haven’t seen the kind of broad-based job losses that would usually come with a true recession.

Instead, we’ve seen what some might call a “rolling recession.” A rolling recession damages only a few industries at a time… Then, those pockets of the economy tend to recover as the next part of the economy starts to falter.

For example, think of the technology slowdown in 2022 before the AI craze hit. Many tech companies – except for the largest, like the Magnificent Seven – are still hurting two years later. But the worst of the pain stayed in tech. Other sectors, such as retail and manufacturing, kept moving along just fine.

These rolling recessions have hit a few industries over the past several years… like housing, cars, and semiconductors. But they’ve swept through these areas one by one, not hitting at the same time.

This shows that despite some occasional slowdowns, the overall economy is strong.

Now, it’s important not to ignore the Sahm Rule entirely. For one thing, it’s simple enough to cut through the noise of more complex indicators. And again, it correctly predicted every recession of the past 50 years.

But today’s labor market has changed. And this time around, this warning signal might not flag the same problems as it has in the past. Even Claudia Sahm herself is unconvinced that her indicator spells doom for the U.S. today.

We can also see this by looking at the economy outside the jobs market…

While the economy may be growing less quickly than it was, it is undoubtedly still growing. Americans don’t have a recession to worry about, at least not yet.

Consumer spending – one of the major drivers of our economy – is still going strong. Retail sales in July were $615 billion. That’s the highest they’ve ever been.

All the while, the Fed is signaling that it will begin to lower the federal-funds rate at its September meeting. Cutting interest rates would ease the pressure on both consumers and businesses. It could even lead to the fabled “soft landing.”

This warning sign is just one piece of the puzzle today… So I’m not ready to say the bull market is dead.

The Sahm Rule may have a powerful track record. But this time, it likely isn’t telling us that a slowdown is right around the corner.

As always, it’s important to look deeper for the full story… And that story shows our economy is still strong today.

Good investing,

Andrew McGuirk

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Source: Daily Wealth