Market Synopsis – September 2024

Market Synopsis – September 2024

Sep 3, 2024 | 0 comments

Strictly speaking, the Sahm rule was not triggered

Last month global news was awash with headlines declaring that the Sahm rule had been triggered and that a US recession was upon us. Strictly speaking, the unemployment rate did not increase enough to trigger the Sahm rule. Unrounded, the 3-month average of the unemployment rate rose by 0.49337% off its 12-month low, falling just short of the 0.5% threshold.

Having said that, the exact threshold used to declare whether the Sahm rule has been triggered is not really that important. Instead, what does matter is the underlying trends developing in the labour market. Of the nearly 50 bps increase in the 3-month average of the unemployment rate from its 12-month low, 22 basis points have come from new entrants and re-entrants joining the labour market. In other words, unemployment has risen because of a greater number of people available to work.

Figure 1 shows that labour supply has been the constraining factor limiting employment growth over the past three years. Meanwhile, labour demand has barely increased, over that period. Therefore, if the lack of growth in labour demand persists, labour supply will likely exceed demand by the end of 2024 or early 2025. Once that happens, unemployment will likely rise. At least initially, the increase in unemployment could in fact be caused by an increase in people looking for work as they enter the job market rather than from the number of available jobs shrinking.

   Figure 1 – Labour supply has been flat for several months

The headlines also implied that because the Sahm rule has been triggered a recession could follow soon. However, as Figure 2 below indicates, the Sahm rule is not typically a leading indicator for the economy. In fact, it is usually only triggered 1-2 months after a recession has begun. The Sahm rule simply looks like a leading indicator now because the unemployment rate has been inflated by supply-side factors and possibly weather-related distortions.

Figure 2 – The Sahm rule is not a leading indicator

Given that the Sahm rule only triggered because of idiosyncratic factors we believe that our view that the US economy is not yet in a recession still holds. But make no mistake, the economy’s temperature is cooling. One only needs to look at the stressed US housing sector, weak manufacturing activity, and depleted consumer spending as pandemic savings and consumer credit become exhausted to see that. Therefore, we continue to believe that the economy will eventually freeze over, most likely by the end of this year or in early 2025.

How we are positioning client portfolios for a recession

In a recessionary scenario, BCA Research expects the S&P 500 forward P/E ratio to compress from the current 22x to 16x and for earnings estimates to decline by 10% from the current levels. Resulting in the S&P 500 falling to 3,800, a 32% decline from where it is trading at the time of writing.

We also believe it is quite likely that the US Federal Reserve (“Fed”) will cut rates to 2% next year and that the 10-year yield will drop to 3%. As a result, we are beginning to go overweight long-duration US Treasuries in our Global Flexible Fund. In addition, the VIX (Chicago Board Options Exchange’s Volatility Index, a popular measure of the market’s expectation of volatility based on S&P 500 options), has gone back below 20. Providing us with the opportunity to add additional downside protection to the Global Flexible Fund by buying puts on the S&P 500.

In our local and global equity portfolio’s we are building exposure to undervalued counters in defensive sectors such as consumer staples and health care. This also echoes BCA Research’s sector ratings depicted in Figure 3 below:

Figure 3 – BCA Research MacroQuant’s Sector Selector model

Another tool to improve the defensive nature of one’s equity portfolio is to increase the allocation to cash, and more specifically, to defensive currencies. In this regard we have allocated a portion of our global portfolio’s cash holdings to the Japanese yen. Relative to its purchasing power parity (“PPP”) exchange rate, the yen is 45% undervalued against the US dollar – see Figure 4.

Unlike other central banks that have already started to ease monetary policy, the Bank of Japan (“BoJ”) is only beginning to raise rates while slowing their asset purchases. Even though we do not expect the BoJ to hike rates much, as other central banks cut rates in response to slowing growth, the interest rate differential should still move in the yen’s favour. As a result, we see the Japanese yen as a very cheap hedge against a global economic downturn.

Figure 4 – The yen is very undervalued

Investment takeaways

We disagree with the broader financial media that the Sahm rule has been triggered and thus a recession is already upon us. We do, however, still believe that the economy is cooling and expect that it will freeze over by late 2024 or early 2025.

Given that equity markets typically peak months before the onset of a recession we are positioning our client portfolios more defensively as detailed above. This to show how our real-world actions may serve as a practical example of how one could respond to the slowing economic outlook. Importantly, the views we express in the Market Synopsis are not purely theoretical but rather represent our honest opinion on economic indicators and how we incorporate shifts in the macro-economic backdrop into our investment decisions.

If you are interested in finding out more about how cognisance of the macroeconomic backdrop impacts our investment decision making process, connect with Integrity Asset Management and let us help you navigate your investing journey.

For more information on this synopsis or to discuss solutions provided by Integrity Asset Management, please contact us at:

Tel: (021) 671 2112
Cell: 072 513 2684 / 084 601 1025
E-mail: nic@integrityam.co.za / herman@integrityam.co.za


Source: Bloomberg, 30 August 2024

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