The "Sam Rule" has finally been triggered! Is the U.S. stock market doomed to a recession? What will happen to the U.S. stock market next?
Before the release of the "non-farm payrolls" last night, the entire market was still discussing the "rate cut trade", but after the release of the data, the characteristics of the "recession trade" were obvious: risk assets (US stocks) fell, and safe-haven assets (US bonds, gold) rose. The reason is that the "Sahm Rule", which has an amazing 100% accuracy rate in predicting economic recessions, was triggered. The keyword "Sahm Rule" has completely topped the hot topic list on US social media.
The core theory of the "Sam Rule" is that when the three-month average of the unemployment rate is 0.5 percentage points higher than the 12-month low, it usually means that the economy is already in recession. Economists have previously pointed out that a rise of only 0.1 percentage points in the unemployment rate in July would trigger this rule. However, the latest data released on the evening of August 2 showed that the US unemployment rate in July rose 0.2 percentage points from the previous month to 4.3%, exceeding the market expectation of 4.1%.
Judging from the market performance, before the data was released last night, although the short-term amplitude of this wave of adjustment was exaggerated, the overall decline was within a reasonable range. The gap in the K-line on Friday, accompanied by a sharp rise in gold and long-term government bonds, was obviously trading on "recession expectations", which deepened the amplitude of this wave of adjustment. So the question is, what do you think of the US stock market next?
First of all, is it possible that the "Sahm Rule" which is currently 100% correct could be an accident? Seeing 10,000 white swans does not mean that black swans do not exist. This rule is actually a posterior probability. Sahm also has his own evaluation of the Sahm Rule. When economic growth is good and inflation drops to 2%, it does not necessarily constitute a recession, just like the inverted U.S. Treasury yield curve in the past two years, it was believed that there would be a recession, but it has been inverted for so long. In addition, according to the report of the Department of Labor, the "accidental" and "temporary" factors accounted for two-thirds of the 0.2 percentage point increase in the unemployment rate this time. The report shows that in July this year, 436,000 non-agricultural employees and 461,000 agricultural employees in the United States did not go to work due to bad weather. This data not only set a record for July, but also more than 10 times the average level in July since the Bureau of Labor Statistics began tracking this indicator in 1976. In addition, more than 1 million people can only work part-time due to weather reasons, which also set a record for the highest data in July in previous years. "Accidental" and "temporary" factors constitute the final push for economic data to trigger the "Sam Rule". Perhaps from this perspective, it is understandable that Powell and others would rather be scolded than cut interest rates in July.
Secondly, if a recession comes, the market's upward trend will most likely move towards a volatile trend rather than a bear market risk. History will not simply repeat itself, but there are many data that can be used as a reference.
1. As for the valuation level of the overall market, according to the latest data from CICC Research Institute in July, the current market's 12-month dynamic PE is 20.98 and the static PE is 25.55, which is still far behind the 25.07 and 30.61 during the Internet bubble in 2000.
Second, the formation of recession expectations is more due to the suppression of investment returns caused by the sharp increase in financing costs, which has led to credit contraction. There is no obvious sign at present. Taking a step back, as long as it is not a debt problem on the balance sheet, a larger and faster interest rate cut can still solve the problem.
That is to say, the market is beginning to predict that the interest rate cut in September will be 25 basis points or 50 basis points. Overall, the Fed still has a response strategy and initiative. These all constitute the basis for the possible "recession trade" volatility trend in the future rather than the risk of a bear market. Therefore, if subsequent economic data confirms a recession, from a strategic perspective, volatility strategies such as covered call ETFs, JEPQ, JEPI, QYLD, etc. will outperform the market; from an industry perspective, essential consumption, medical care, utilities, precious metals, and high dividends will perform better, which is the logic why McDonald's and Coca-Cola strengthened last night.
Finally, let's talk about a variable in the market: the election. Macro uncertainty will naturally lead to increased volatility, which is manifested in the fact that the market volatility in the July earnings season is higher than that in the April earnings season. There is obvious confusion in the recent market transactions between the "Trump trade" and the "rate cut trade". According to data from Bloomberg and CICC Research Institute, a review of historical situations shows that before the November election month, the intensive election situation will lead to a suppression of risk appetite, an increase in the VIX index, and poor performance of US stocks. The time of this round of election debates was moved forward by one quarter, which led to the advancement of election transactions. The rise in Harris's polls after Biden withdrew from the election also increased the variables of the election situation, resulting in a reversal of the Trump trade that heated up in the early stage. But on average, after the presidential election, the market is likely to rise in the later stage.
Finally, let's make a conclusion. Recession trading has led to market breakouts, but this recession indicator itself has some water content and needs to be verified by subsequent data. But even in recession, the US economy still has greater policy flexibility support, so the market tends to fluctuate. Macro variables, such as elections and international wars, will also exacerbate this volatility. The current market retracement has already reflected these factors to a large extent. Based on the expectation of volatility, we are not pessimistic overall, so "if it falls too much, you can buy it back."
After all, when it comes to "if the price falls too much, it will rise again", they have never failed to do so for decades.