The US macro data show a mixed picture. GDP – before revisions at least – has contracted for two quarters in a row. For Europeans, that is a recession.
The ISM Manufacturing index fell further, but is still above 50. ISM Services unexpectedly rose to 56.7. More than half a million jobs were added in July. And yet it has felt like a recession for a while.
The Misery Index
The Misery Index offers a good explanation as to why the last few months still feel recession-like. The Misery Index, devised by the American economist Arthur M. Okun, is the sum of the inflation and the unemployment rates. After the lower-than-expected inflation rate of 8.5 per cent and the also lower-than-expected unemployment rate of 3.5 per cent, the Misery Index now stands at 12. That is still above the average ‘misery level’ of 11.7 during recessions.
Variations
Since Okun presented his original Misery Index, many variations have been introduced. Most of them add one or more macro variables such as interest rate level. But a more interesting factor is market returns, as they directly affect people’s behaviour and sentiment. The chart below shows my ‘real time markets-included Misery Index’. This is the sum of inflation and unemployment minus the year-on-year return on a traditional 60/40 ‘balanced’ portfolio (60 per cent equities, 40 per cent bonds).
The markets-included Misery Index
Two things stand out in the chart. First, the average misery level is more comparable over time and thus through recessions than the original Misery Index. The latter, as the first graph shows, is strongly influenced by high inflation during the 1970s and early 1980s.
With the exception of the Great Financial Crisis, the markets-included Misery Index peaks at around 20, during recessions. The average Index reading during recessions is 17.1. In June this year, the markets-included Misery Index, based on daily observations, peaked above 24. And after the latest US inflation figure and subsequent market movements, the index stood at 18.7. Still above the average recession level.
No more misery?
So is the worst over? For the original Misery Index, most probably yes. US inflation is likely to be ‘sticky,’ but it will not go back up overnight. And with July’s strong jobs figure, a sharp rise in unemployment is not likely in the short term either.
But for the markets-included Misery Index, it remains to be seen whether it has peaked. Equity markets have anticipated the end of the Fed’s tightening cycle and falling inflation. Even a small setback can cause a turn in stock sentiment.
Jeroen Blokland is founder of True Insights, a platform that offers independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Thursday on Investment Officer Netherlands in Dutch and on Monday’s on Investment Officer Luxembourg in English.