10% Unemployment: A Remarkable Signal for Stocks
In October the U.S. unemployment rate rose to 10.2% thus capturing much of the economic and financial headlines over the last week. This was the first time unemployment surpassed 10% since June of 1983, and only the second time it has reached this plateau since World War II! With the recent news, many economists updated their economic projections and now believe that unemployment will peak by the middle of 2010 and will continue to remain high for several years. Obviously these unemployment numbers illustrate the recent devastating struggles of the U.S. economy; but investors must keep in mind that unemployment is a lagging economic indicator. So you might be curious how the stock market has performed in the past after peaks in unemployment? Historically the stock market has performed exceptionally well after unemployment has peaked!
The chart plots U.S. stock prices (red) and the unemployment rate (blue) over the last 40 years. Unemployment has decisively peaked 6 times since 1969 and each peak accurately forecasted strong performance for the stock market (green arrows) throughout the following year. After the peak of unemployment, the stock market advanced on average over the next 1 month, 3 month, 6 month and 1 year time periods. In fact, only 2 of the 24 time frames exhibited negative returns (the 3 and 6 month periods in 1975).
Many investors are still fearful to enter the market with unemployment above 10% and on the rise. How can investors expect the stock market to perform prior to the peak in unemployment? In September 1982 the unemployment rate moved above 10% and finally reached a peak of 10.8% in November and December of 1982. The unemployment rate would remain above the 10% plateau for a total of 10 months and the stock market advanced over 37% during that time! Yet another encouraging sign for investors.
Using unemployment history as a guide, investors should expect higher stock market prices in the months ahead!
Thanks for Reading – Jim
Good comment – will be looking forward to further higher equity-prices.
The 1980s might not be a good guide for equity pricing despite the similarity in the unemployment rate. Consider that taxes on the productive sector were declining (Kemp Roth tax cut), whereas this time increasing taxes appear likely.
I believe you regarding the trend — very good insight. Here’s the tough question though – has unemployment actually peaked? If so, then I’d also consider the implications of the recent stimulus that have impacted GDP. Most of the rise was in government spending, not consumer spending or private investment. Our interest paid to foreign entities is a fact on debt that could be an obstacle to a normal recovery.
During the economic downturn a lot of people have been buying puts to protect against falls in stock prices (take a look at where the implied vols went, e.g. on VIX). The theta on these puts means, as maturity nears, market makers are having to buy out of their delta positions leading to short term market buoyancy. This is a well-known phenomena following market crashes; as for long-term growth, my view is that can’t be sustained unless unemployment starts to fall.
Beware of persistent high unemployment. It indicates structural problems in the economy. Also dont take unemployment reports at par, the true unemployment is much higher usually. In other words, trying to get a signal from the job market, is highly risky.
Jim,
Has unemployment peaked? If you think so, why?
@Ersel Korusoy
@Anthis Zogopoulos
@Shawn Jones
Ersel and Anthis you both make good points. I agree that long term (next 5-10 years) the stock market could be in a trading range or secular bear market.
Shawn I am not an economist by any means, however it is generally accepted that unemployment can still rise in the months ahead. With that being said I believe unemployment will peak in 2010. I am not saying that there will be tons of new jobs all of a sudden but at the very least less layoffs.
Do you have the same chart for 1929-1945? Moreover it looks that market started to rally before the peack.
Jim, this is a loose relationship between the economy and the stock market. When the unemployment rate is at its peak, the economy is in deep recession and is ready to bounce back. Of course you would see stock price moving up. Then when unemployment rate is at its trough, the economy is overheated and is ready to move back down. And stock price would go down. Especially when the stock market is always looking forward say 6 months, it moves up (or down) before the unemployment rate is at peak (or trough).
The problem is, we don’t know when unemployement rate is at its peak. We can only confirm it when we look back. And if you look at your graph, you will see we should just buy the market all the way up. The unemployment rate is not useful to predict market movement and it just fluctuates between 4% and 10%.
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