Is It Really Different this Time?

As the saying goes, “History doesn’t repeat itself, but it often rhymes.” This rings true for so many circumstances in life, but it is particularly relevant in the investment world.?

Various patterns and investor behaviors observed throughout history have correlated with similar results over time: yield curve inversions have preceded economic recessions; October is historically the most volatile month for stocks; and wacky events, such as Tulip Mania, the Dot-com Bubble, and the NFT frenzy, remind us to be cautious of overspeculation.

Thinking “this time is different” has often been a costly mistake for investors, but sometimes it is the case. Patterns break down, and one variable can change the outcome. Right now, I see several patterns that are unraveling right in front of us and may end up surprising investors who are expecting the status quo. In this month’s edition of “Dialed In,” we dive into three patterns I believe are breaking down, or will soon, and the rationale behind why this time really is different.

The Sahm Rule

One historical pattern that set off alarm bells for investors in July was the triggering of what is referred to as the Sahm rule, which states that when the three-month average unemployment rate rises 0.5% above the low point over the last 12 months, a recession is likely to follow. It has been pretty much spot-on, with a recession arriving within eight months of achieving the criteria in all but two instances since 1950. Will the pattern hold this time? I don’t think so. There is one variable that I feel is drastically different now and likely to alter the consistent pattern seen with the Sahm rule.

Federal outlays cannot be ignored and are a significant variable this time around. As shown in the chart below, Federal outlays account for ~22% of GDP?. To put this in perspective, during the depths of the global financial crisis levels in 2008- 2009, we hit 24%.?Looking deeper, government social benefits make up roughly a quarter of disposable personal income, and there is no end in sight. All of this provides a significant boost to consumer spending and corporate revenues. It also bolsters the economy, making it very difficult to have a recession over the eight month span.

Post-Fed Cut, Core Bond Returns Historically Positive 100% of the Time

Of the many historical patterns observed, few have held up more reliably than core bonds delivering positive total returns after the Fed starts cutting interest rates. Looking at the last 11 Fed cutting cycles, core bonds have delivered positive returns for the following 12 months in every single one, and logically so. Interest rates go down, bond prices go up—right?? This has been the case in the past, but I strongly believe this time is different.

Since the first jumbo cut in September, the U.S. Aggregate Bond Index is down ~2.7% (as of 10/29/24), and the 10-year has risen ~0.60%. This is not the start many expected, but why is this the case? First, as we discussed in depth last month , the Fed only directly controls the short end of the yield curve. Other maturities trade on expectations and a term premium. In my view, expectations were, and continue to be, overly aggressive for this ?Fed cutting cycle, and the term premium is negative. Investors have become so accustomed to zero interest rate policy and low inflation they appear to have forgotten that the average Fed funds rate over the last 50 years has been 4.75%.

Since the cut, inflation expectations are up, investors have walked back expectations for the Fed (still more to go here, in my opinion), and the term premium has picked up. We see a good chance that the 10-year Treasury moves back above 4.5% and hangs around that level next year. This time appears different, and the story is already playing out.

Election Volatility

The final patten, which we have written quite a bit about over the last several months, is the tendency for equity volatility to rise heading into a presidential election. Elections tend to bring uncertainty, and uncertainty is not something investors like. Over the last eight cycles, the VIX has risen an average of ~60% in the 60 days leading up to the election, but this cycle looks very different from the norm, as show in the chart below. The VIX Index is right around where it was on September 5, two months prior to Election Day.?

Why has this been the case? I believe one reason is that investors already have a reasonable sense of clarity on certain issues, that might have been pain points. Some of the more extreme policy proposals that could negatively impact the market—like increasing the capital gains and corporate tax rates—seem very unlikely to pass. Betting markets, as measured by Polymarket as of 10/29/2024, currently suggest only a 14% chance of a Democratic sweep and a 46% chance of a Republican sweep. A divided government points to a clearer outlook for the next two to four years. So, unless we see a drastic shift over the next week, this time has may in fact prove to be different.

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Tim Urbanowicz is the VP of Research & Strategy at Innovator. This material contains the current research and opinions of Tim Urbanowicz, which are subject to change without notice. This material is not a recommendation to participate in any particular trading strategy and does not constitute an offer or solicitation to purchase any investment product. Unless expressly stated to the contrary, the opinions, interpretations, and findings herein do not necessarily represent the views of Innovator ETFs or any of its affiliates.

This material is provided for informational purposes only. Readers should consult with their investment and tax advisers to obtain investment advice and should not rely upon information published by Innovator ETFs or any of its affiliates. The information herein represents an evaluation of market conditions as of the date of publishing, is subject to change, and is not intended to be a forecast of investment outcomes.

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