The “Sahm” Rule

The Scottish essayist and historian Thomas Carlyle once used the term "Dismal Science" to describe the study of economics.

Carlyle was said to have been inspired by the dire predictions of economist T.R. Malthus, but he could have easily just been talking about its efficacy.

We also think that the word "science" should be used lightly when discussing economics.

For those who have yet to follow economics closely and listen to the talking heads of the media and government, they make it sound like they know what they are talking about.

The issue is that economics is not a science like physics or chemistry. It is a “soft” science.

Any discipline that is trying to predict complex human behavior is imperfect. It is more about figuring out relationships and probabilities versus certainties.

This brings us to an economic "rule" you may have heard recently – the "Sahm” rule.

Economist Claudia Sahm created this "rule", which the Federal Reserve uses as an indicator of a potential recession.

It states that a +0.5% INCREASE in the three-month average unemployment rate above its twelve-month low indicates the start of a recession.

Basically, it says that a sharp and rapid increase in the unemployment rate relative to the average of the last year indicates that we have entered a recession.

How well does it work?

Historically, the measure has worked very well, with one false positive dating back more than seventy years.

Does that mean it is indicating that a recession has just begun?

We are not so convinced.

The reality is that the COVID period and corresponding reset have interfered with many measures of economic activity.

After the Federal Reserve Open Market Committee (FOMC) meeting last week, Powell was asked about the rule, and he said he believed it indicated “a normalizing labor market.” He did not think the movement in employment was indicative of rapidly deteriorating economic conditions.

Critics will point out that this was the same view he initially held on high inflation, and it didn't work out very well.

The folks at Bespoke Investment Group published an interesting analysis of the situation last weekend.

They looked at several other economic indicators and compared their current levels to those of previous times when the Sahm Rule was triggered.

Here is a table they published…

These charts indicate that the current situation does NOT look much like previous situations.

Job losses tend to have already started by the time the rule is triggered, but this time, it is more coincidental.

Jobless claims also tend to have been rising more consistently, the yield on 10-year government bonds has tended to be trending UP and not down, and real consumer spending also tends to be FALLING versus rising.

There are a couple of other considerations about the recent economic data.

Bespoke also points out that there is no slowdown whatsoever in the most recent economic data. Here is that table…

Without an extreme exogenous shock (like COVID), it would be unprecedented for us to have gone from the 2.8% GDP growth reported just a few days ago to economic decline.

Another point to consider is that the Bureau of Labor Statistics (BLS) argued that Hurricane Beryl did NOT impact the most recent unemployment number, but there were some irregularities.

Omair Sharif, founder of Inflation Insights, noted that in the data, the number of people not at work due to severe weather rose 11 TIMES MORE than the average July across the last forty-five years. Workers who switched from full-time to part-time work also spiked to more than 1.089 million in the month.

Maybe the hurricane didn’t have an impact, but these are some highly irregular results.

Time will tell whether the Sahm rule is right or wrong this time, but we think the situation supports the idea that THIS time, it is a false signal.

Remember – in economics, the rules only work Sahm-times! (Sorry – we couldn’t help ourselves…)