The Sahm Rule has flashed, but there’s a simpler recession indicator investors should be watching

Countless recession indicators have flashed over the past few years, from an inverted yield curve to the Sahm Rule, and yet the economy continues to grow in defiance of the signals.

However, there is a more straightforward recession indicator that investors should pay attention to, and it could be a more timely indicator of when an economic downturn may occur.

GlobalData TS Lombard managing director Dario Perkins coined the “Perkins Rule” in a series of notes over the past month.

The recession indicator triggers when the jobs market contracts.

That means instead of using a three-month moving average of unemployment or looking at signals in the bond market, the Perkins Rule is activated simply when a negative monthly payroll report is received.

“The Perkins rule asks whether payrolls are declining. Not rocket science,” Perkins said in a note on Monday.

And so far, with the US economy consistently adding well over 100,000 new jobs per month, there have yet to be any signs of a negative monthly payroll report, suggesting the economy is likely to continue to grow.

“True uncertainty is where we cannot assign probabilities, because the world is behaving in a way we haven’t seen before. I think this applies to the current recession debate,” Perkins said in a note this month.

He added: “You have to keep an open mind, and not assume the economy will follow classic cyclical patterns. Leading indicators, yield inversion, perhaps even the Sahm rule, none of these rules seem reliable.”

The Perkins Rule doesn’t suffer from the potential flaw of the unemployment-based Sahm Rule, which experts say is being distorted because a rise in labor supply has driven the unemployment rate higher over the past year, rather than a decline in labor demand.

“If the unemployment rate is rising because the labour force is growing quickly, it is not clear that this can set off the true recessionary dynamic – because it is not such an obvious source of reflexivity,” Perkins explained.

The Perkins Rule hits on the “reflexivity” of employers and the Federal Reserve, as a negative jobs report could quickly send shockwaves across the labor market and ultimately cascade into a painful economic downturn.

“People lose their jobs (or they become fearful of losing their jobs), spending goes down, which reduces corporate revenues, which leads to further rounds of redundancies. You can see why even small employment cuts lead to bigger ones,” Perkins said.

But that’s not happening right now.

Even when accounting for the BLS’ major downward revision in job gains from April 2023 through March 2024 of 818,000, the US economy is still adding an average of about 175,000 new jobs each month.

Compared to the Sahm Rule, the Perkins Rule has had more false positives, Perkins admitted.

“While it is rare for US payrolls to decline outside of recessions, it does happen occasionally,” Perkins said. “Usually this is due to obvious distortions, such as extreme weather events.”

The Perkins Rule flashed a false signal during the 1995 soft landing, and in the late 1960s.

“So the Perkins rule isn’t fool proof. But that’s not the point. The important thing is that when you look at every time the Sahm rule has triggered since WW2, there were only three occasions where payrolls weren’t ALREADY negative,” Perkins said.

He added: “Usually when the Sahm rule triggers, the Perkins rule has already triggered. That matters because this is NOT what is happening today. The latest triggering of the Sahm rule looks very different to the average recessionary experience.”

Investors will get to see if the Perkins Rule triggers next week when the August jobs report is released on September 6. Economists expect the report to show 114,000 jobs were added to the economy in August.