You can find so-called recession indicators all over the place. Some people might even be experiencing indicator overload.
One recession indicator that hasn't been wrong in 56 years suggests that a recession is on the way. Another indicator that has been foolproof for 70 years agrees. On the other hand, the seven top indicators used by the organization that actually declares a recession -- the National Bureau of Economic Research -- aren't so definitive.
Allow me, though, to add one more to the mix. There's one indicator that has accurately called every recession since 1960. Here's what it's saying now.
Image source: Getty Images.
The Sahm Rule
There have been some problems in the past with how quickly the federal government diagnosed that the U.S. economy was in a recession. In 2019, Federal Reserve economist Claudia Sahm proposed a solution.
Sahm suggested that an indicator be used that was based on only one data set -- the national unemployment rate. Using unemployment data offers a couple of key advantages. First, it's simple and understandable. Many other recession indicators are complicated, relying on lots of different data. Second, it's timely. The U.S. Bureau of Labor Statistics (BLS) provides updated unemployment numbers each month like clockwork.
Her idea was to look at the three-month moving average of the U.S. unemployment rate. When this moving average rises by 0.5% or more above its previous 12-month low, it signals the beginning of a recession.
This approach was dubbed the "Sahm Rule." The indicator is known as the "Real-time Sahm Rule Recession Indicator." It's now tracked by the St. Louis Federal Reserve Bank.
A great track record -- with a giant asterisk
Even though the Real-time Sahm Rule Recession Indicator wasn't created until 2019, it can be applied retroactively. Doing so shows that the indicator has a great track record.
There have been nine U.S. recessions since 1960. The Real-time Sahm Rule Recession Indicator flashed a signal in each of them, with the three-month unemployment rate moving average rising at least 0.5% above its previous 12-month low. (Shading on the chart below indicates periods when the U.S. economy was in a recession.)
Real-time Sahm Rule Recession Indicator data by YCharts
Most recession indicators have what are called false positives. They flash as if a recession is coming or underway, but no recession comes. That isn't the case for the Real-time Sahm Rule Recession Indicator. It hasn't had any false positives.
There is a giant asterisk with this recession indicator, however. It's no Nostradamus at predicting recessions. Although the Real-time Sahm Rule Recession Indicator has indeed accurately called every U.S. recession for more than 60 years, it doesn't always call those recessions before they occur. The indicator often flashes a few months after the start of a recession.
No recession for now
You might be tempted to throw your hands up in the air after hearing about that drawback. Why even bother with this particular recession indicator?
For one thing, the National Bureau of Economic Research sometimes takes six months or more after a recession begins to officially declare that the U.S. economy is indeed in a recession. The Real-time Sahm Rule Recession Indicator helps government economists make decisions and recommendations more quickly.
There's also good news for investors. This indicator is actually declining now. The three-month U.S. unemployment rate moving average is well above its previous 12-month low. That's a pretty good sign that there's no recession on the horizon.
Note, though, that unexpected events can cause a rapid recession. For example, the Real-time Sahm Rule Recession Indicator was negative in October 1973. But after the U.S. provided aid to Israel following the Yom Kippur War, Saudi Arabia and other Middle Eastern oil producers placed an embargo on oil exports to the U.S. This threw the U.S. economy into a recession.
The reality is that there's always a risk that a recession could be around the corner regardless of what any indicators say. Investors have two great ways to mitigate this risk, though.
First, you can invest in recession-proof stocks and other assets that hold up well regardless of what the economy does. Second, you can have a long-term perspective. Recessions don't last forever. Stocks also often rise well before the end of a recession (and sometimes don't decline much, if at all, during a recession).
Whether there's a recession in 2023 or not, investors have no need to panic.
