What You Don’t Know About Stocks and The Unemployment Rate

The unemployment numbers are widely watched by market observers. Last Friday’s report had some conflicting results. On the positive side the unemployment rate fell to 7.6% (down from the 2009 high of almost 10%).

But the main reason for the slide was the fact that the labor force participation rate fell to 63.3%, its lowest reading since 1979. That means that more people have simply given up looking for jobs. Part of this has to do with the high number of near-retirees dropping out of the workforce.  It is also much harder for younger people out of high school and college to find jobs.

I think another reason is that the gains we are seeing from technological advances and globalization have added to the unemployment rate and may keep it higher than we are used to seeing it in the past.

Stocks sold off on the unemployment news release last Friday. This got me thinking about the relationship between stocks and the unemployment rate.

Here are some interesting facts to consider about stock returns in different unemployment rate environments:

  • The start of the 30 year bull market for stocks in the early 1980s was at a time of double digit unemployment.
  • During the Great Depression the unemployment rate hit upwards of 25%. Yet the single best three-year period to own stocks was during the Great Depression (the period from 2009-2012 is not far behind).
  • Since 1951 stocks have had their best returns during years with the unemployment rate above 8% (Source: BCA Research via The Reformed Broker). The worst returns have actually occurred during 4% unemployment. Here is the breakdown by rates:

So what does this all mean? It’s hard to say. Unemployment can be a lagging (as opposed to leading) indicator for the economy. It also shows how much expectations matter. Good or bad numbers don’t necessarily matter as much as things getting relatively better or relatively worse.

And investing can be very counterintuitive.  Most of the time stocks perform better when things go from terrible to bad as opposed to going from good to great.

In the end this is just one more reason why following the economy is not the best way to manage your investment decisions. Focus on the numbers you can control, not the ones that the government releases on a monthly or weekly basis.

Now onto your common sense reads for the week: