Horses, Not Zebras
There’s a saying in the medical field, “When you hear hoofbeats, think horses, not zebras.” What this adage emphasizes is when a patient presents with certain symptoms, the diagnosis is most likely whatever the common diagnosis for those symptoms is. In a world where any outcome is possible, start with the most likely scenario. Adjust from there if it turns out that something more exotic is afoot.
On Friday, August 2nd, the US Employment report indicated that unemployment increased to 4.3%. This started people talking, as it triggered the Sahm Rule. The Sahm Rule states: if the moving average of U.S. unemployment rate rises by 0.5% or more over a 3-month period, a recession is likely to start soon.
The ingestion of this data was immediate. The three major US stock indices, the Dow Jones, S&P 500, and NASDAQ, all closed down more than 1.5% on Friday, August 2nd. On Monday morning, we woke up to see that the Japanese Nikkei closed down 12% on the day. That is a significant reaction.
I would argue the horses and zebras metaphor works for market behavior as well. When certain symptoms present, start with the most likely scenario. Let me offer our team’s perspective.
We have seen a substantial rise in the US stock market this year, buoyed by AI optimism and stronger first half earnings than expected. Many times we’ve talked about the Magnificent 7 balloon, and when it might “pop.” When the Fed maintained interest rates last week, coupled with Friday’s employment report, we started to see air come out of the balloon.
This is a healthy reaction, for two reasons. First, many companies in the stock market were overvalued, with earnings and fundamentals that did not support their price. This is not unusual nor abnormal. Price movements of individual companies often swing beyond where one might expect.
Second, since 1980, the S&P 500 has had an intra-year decline every year. In 30 of those years, the decline was 10% or more. At midday on 8/5/24, the S&P is off 8.1% from the peak. Despite these intra-year declines it is also true that the S&P has experienced a negative return for the year only 10 of the last 44 years.1 In other words, the market goes up and down a lot.
Market contractions are natural. In my opinion, the “horse” here is that the Fed’s restrictive measures are working as intended. Will there be some short-term discomfort? Most likely. Is there cause to think something more exotic is afoot? Certainly not yet.
Claudia Sahm, the economist who created the Sahm Rule, said it well in her interview with Bloomberg on August 5th. “Calm is important in a moment like this, regardless of what indicator data points you’re looking at.” I would add that perspective helps too.
Grace LovelandAugust 6, 2024
1. https://www.mfs.com/content/dam/mfs-enterprise/mfscom/sales-tools/sales-ideas/mfse_intryr_fly.pdf
There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing materials are accurate or complete. The S&P 500 is an unmanaged index 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. Nikkei is short for Japan's Nikkei 225 Stock Average, a price-weighted index composed of Japan's top 225 blue-chip companies traded on the Tokyo Stock Exchange.
Any opinions are those of Grace Loveland and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a complete description, nor is it a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results. Raymond James & Associates, Inc., member New York Stock Exchange/SIPC.
