The Holy Grail of Indicators

The Fed frets more about unemployment than any other economic indicator. And if the unemployment rate keeps getting weaker, they’ll cut rates right away.

Tuesday, July 9, 2024

London, England

By Tom Dyson

Late last year, I highlighted a recession indicator with a near-perfect track record of predicting recessions since 1950. (It produced a false positive 1959.) It’s called the Sahm rule, after economist Claudia Sahm. 

The rule says when the 3-month average of the unemployment rate rises 0.50% off the bottom, the US is in a recession, even if no one has declared it yet.

The Sahm Indicator has now risen five months in a row. The BLS released its latest reading last Friday. The unemployment rate is now 0.43% off the bottom... very close to the 0.50% it needs to trigger the Sahm Rule. So the Sahm Rule hasn’t flashed yet… but it’s getting very close. 

Here’s how the Economist described the Sahm rule last month:

For financial markets the Holy Grail is a perfect leading indicator—a gauge that is both simple to monitor and consistently accurate in foretelling the future. In reality, such predictive perfection is unattainable. It is often hard enough to grasp what is happening in the present, let alone the future. 

A perfect real-time indicator would thus be a potent goblet of knowledge, if not quite the Holy Grail, for investors and analysts to drink from. Recently they have turned their attention towards one impressive candidate: the Sahm rule.

Developed by Claudia Sahm, a former economist at the Federal Reserve, in 2019, the rule would have been capable of identifying every recession since 1960 in its early stages, with no false positives. This is no mean feat given that the body which officially declares whether the American economy is in recession sometimes needs a full year of data. The Sahm rule, by contrast, typically needs just a few months.

The BLS’s next  unemployment reading comes out in a month. I’ll be very interested to see if it raises the indicator over 0.5% and declares “recession.”

Bottom line: let’s keep the dial set to “maximum safety” by holding lots of cash, precious metals and dividend-paying energy and shipping stocks.

Why is the Sahm Rule so important? Because the Fed frets more about unemployment than any other economic indicator. And if the unemployment rate keeps getting weaker, they’ll cut rates right away.

Until tomorrow,

Tom

P.S. For new readers, I’ve taken the liberty of republishing my original article on the Sahm Rule from November of last year. Please note the Official List is from November as well, and does not include the latest prices, gains, trailing stops, or buy-up-to limits. The next and current Official List will be published in my weekly update tomorrow (Wednesday, the 10th of July). I’ll also look at what Fed rate cuts mean for stocks.

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Keep an eye on this one economic indicator

November 15th, 2023

By Tom Dyson

This might be a useful website for us next year. It’s called dailyjobcuts.com. Every day its owners scrape the internet for announcements of layoffs and business closings. 

Glancing at this website, unemployment and bankruptcies seem to be growing fast. 

I wonder, are layoffs and business closures going to be the critical variable of 2024? The economic indicator that drives markets lower next year?

This chart shows the Sahm Rule, named for Claudia Sahm, an economist and one-time employee at the Federal Reserve. The Sahm Rule says that whenever the government’s unemployment measure rises 0.5% off a low point, we’re in recession. 

Layoffs are a lagging indicator. They come after a lot of other information--some of which we track in our Doom Index--has signalled to CEOs and entrepreneurs that conditions are slower. They are also easier for the public (and investors) to understand. It's hard to argue the economy has slowed (or is in recession) when hundreds of thousands of people lose their jobs (and their incomes).

The Sahm Rule has a perfect record over the last 50 years (although it did produce some false signals before 1970.) It’s currently at 0.33%, meaning the unemployment rate has risen 0.33% from its recent low. It’s not flashing recession yet. We should keep our eyes on this indicator too. 

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The government published the latest Consumer Prince Index statistics yesterday. It showed no price growth in October… I.E. an inflation rate of zero percent. Over the previous 12 months, the CPI grew by 3.2%.

Regular readers shouldn’t be surprised at the moderation in inflation stats reported yesterday. As we’ve written many times over the last two years, inflation volatility is the primary force driving inflation statistics. Not simple inflation. They’re very different. 

Our inflation volatility thesis has long been that we’d see 1) a collapse in the CPI followed by 2) another panic in Washington leading to an active policy of currency debasement. 

This seems to be playing out. Annual CPI growth has fallen from 9.1% pandemic peak in June 2022 to 3.2% now. If our inflation volatility thesis has any validity, inflation stats will likely keep falling…

In the past we've just ignored the face ripping rallies following Fed decisions or CPI data. Was yesterday's CPI print a game changer of any sorts? 

Debt deflation and money printing seem like a lock to us, based on the issues we cover week in, week out and our “Inflate or die” model.  Nothing has changed this week that makes us question this thesis. 

Our stance remains the same: Avoid the major stock market averages and all bonds. 

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Stress in the commercial real estate business seems to be intensifying. From the WSJ yesterday…

Foreclosures are surging in an opaque and risky corner of commercial real estate finance, offering one of the starkest signs yet that turmoil in the property market is worsening.

In addition to unemployment and business closures above, rising debt delinquency is another sure sign that our inflation volatility thesis is playing out.

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Without bonds and conventional stock investments, how are we going to grow our capital next year?

Right now we’re holding 40% cash and ultra short-term government bills. We’re earning 5.5% a year here. Given falling inflation stats, rising credit stress, and growing unemployment, I’m happy to keep holding this position.

We’re also holding 35% gold and silver. The gold and silver hedges us against an active policy of currency debasement in Washington. 

In this stage of inflation volatility, I wouldn’t expect gold and silver to perform well. Cash is paying interest for the first time in 16 years. Gold and silver pay no yield. Inflation statistics are falling. And there isn’t much pressure on the Fed to cut rates yet. 

Despite this, I’m impressed with gold’s strength. As we’ve said before, if the most aggressive Fed rate hiking campaign in 40 years can’t sink gold, then nothing can. 

Finally, we’re investing for income in the energy and shipping sector, where valuations are attractive and supplies of new ships and new energy resources are being constrained by politics and environmental regulations. We’ve allocated 25% to cheap energy and shipping stocks. 

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Our equipment leasing business Danaos [DAC] reported earnings yesterday. DAC reported $7.26 in quarterly earnings. DAC closed at $68.76 tonight, which means it’s currently trading at a P/E ratio of 2.5. DAC continues to buy back shares, pay dividends and diversify away from containership leasing into dry bulk shipping. 

DAC has raised the quarterly dividend from $0.75 to $0.80 and at current prices yields 4.6%. 

Petrobras [PBR-A], one of the two state-owned oil companies we hold on the Official List, has announced another dividend. Petrobras will distribute its Q3 profit via a $0.54 dividend per ADR to shareholders on record on November 21. Petrobras will pay this dividend in two equal instalments next year. 

Petrobras’s Q3 dividend represents a 6.9% dividend yield for us, based on our cost basis of $8.11 for the stock. In total, we will have made about 35% in dividends in our first year of holding Petrobras. 

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QUESTION:

Your portfolio currently has zero allotment to bonds. My question: is your view of bond holding skewed towards US bonds and thus does not apply to holding, say, UK gilts for example? Or do you see all bonds as the same animal?

MY RESPONSE:

I can’t see any reason to hold low-yield long-term government bonds from any country when ultra short-term US treasury bills are paying 5.5%, yield curves are inverted, and the Fed is still talking about “higher-for-longer.” I definitely would not touch long-term UK government paper when it’s so clear the UK government is bankrupt.

Could global interest rates fall next year? Sure… market prices never move in a straight line. But we won’t be making any bets on that. 

QUESTION:

When the Fed cuts interest rates, will you be suggesting to switch to 2-year notes for those who want to lock in a higher Treasury rate for a bit longer?  And are there any telltale signs that the Fed is about to cut?

MY RESPONSE:

Predicting interest rates is hard. There are no telltale signs that I know of. But even if I could predict when the Fed was going to cut interest rates, I wouldn’t buy 2-year notes. I’d buy energy stocks and other types of dividend paying stocks. 

QUESTION:

I own some SRUUF, and look to buy more. Tom, your recommendation is to "accumulate on weakness." What would you consider a good "buy more" price? It's down to about $17 in trading today from a recent high of just over $18. Do you think it could drop further?

MY RESPONSE:

Oh boy, that’s a tough question. I don’t have a specific number in mind. I’m going to listen to my trading instinct to know when it’s “oversold.” I don’t think SRUUF reached “oversold” last week at $17, even though SRUUF has rebounded back above $18 since you sent me this message. Based on the chart it looks a little overbought right now, if anything.

On the other hand, see below. Some governments are making a concerted push for nuclear energy as part of the 'climate change' and 'energy transition’ agenda.

Even with the setback in SMR technology Dan mentioned last week, there's great demand for nuclear energy (much greater than supply). 

A  report published last month by the World Nuclear Association shows three scenarios in which demand for nuclear energy could double or even triple by 2040.

Things could change by then. Things could change by next month. But the simplest way to play this is physical uranium itself. The technologies are intriguing. But not ready for prime time, investment wise. I am watching closely and will definitely let you know as soon as I think we should buy physical uranium again.