by Jason Norris
Director
Equity Research and Portfolio Management
Over the last week, investors and market watchers were introduced to a relatively unknown economic indicator, the Sahm Rule. As highlighted by Google search data, interest in the indicator spiked last week.
The Sahm Rule was developed by economist Claudia Sahm when she was at the Federal Reserve. The indicator looks at trends in the unemployment rate, specifically the unemployment rate rising at an accelerated rate to indicate an impending recession. What piqued interest for consumers recently is the feeling of an imminent recession, as shown in the August 1 employment report which flipped the indicator. This concerned investors since historically, the Sahm Rule has been pretty reliable. This resulted in a selloff in equities, a rally in bonds and investors betting that the Fed will cut by 0.50% in September.
While the data shows that the indicator does occur right before recessions, we should remind ourselves that “correlation doesn’t imply causation”. Ms. Sahm wrote a piece for Bloomberg earlier this week stating, “my recession rule was meant to be broken.”
Unemployment is a key determinant of a forthcoming recession and one indicator we like to look at is weekly continuing unemployment claims. While the weekly claims get a lot of headlines, continuing claims is key since they show that workers are having a tougher time finding work after being laid off. The hard truth is that people are going to lose their jobs. However, if they are able to find work in a short period of time, then the jobs market still remains healthy. Both data points are timely, reported weekly, and since the data is actual applications for unemployment benefits, fairly reliable.
As shown by the chart below, continuing claims have been increasing, but they are still at relatively low levels.
Carry On
A lot of investors were introduced to another investment strategy this week, and that was the “carry trade”. This strategy has been around for a long time, but the risks of it came to fruition early this week with the global selloff in equities on Monday. So, what is a “carry trade” and why did it lead to the sell off?
This trade involved multiple currencies and investments. First, investors would borrow money in Japan. This was attractive since interest rates are still very low and the Japanese Yen had been weakening. They would then take those funds and invest them in U.S. bonds. Over the last year, investors would pick up 3-4% in yield from this trade, and any benefit from the weakening Yen. However, last week, the Bank of Japan raised rates, and the Yen started to strengthen. Coupled with U.S. rates falling last week due to the jobs report, investors “panicked” and sold their investments to pay back their loan in Japan. As it turned out, investors weren’t just buying U.S. treasuries, they were investing in equities, a lot of which were the Magnificent 7 stocks. Thus, a forced liquidation occurred.
This phenomenon is a short-term occurrence and seems to have been washed out by now. But, it is a reminder that markets are volatile and consist of a group of individuals that at times can cloud their own judgement with common emotions such as fear and greed. For long-term investors, the focus has to be on the economy and corporate profit growth.
Takeaways For the Week:
Even after the selloff and volatility the last week, the S&P 500 is still up over 12% this year
By Friday, investors have reduced their Fed rate cut expectations to 0.25% in September