Stock Market 'Logic' Says Don't Worry About Unemployment

In case you are new to the game, it is important to understand that “stock market logic” can quite often be an oxymoron. You see, many times the “logic” behind the news and the market’s reaction to that news may seem more than a little counterintuitive.

If you’ve invested in stocks for any length of time, you have undoubtedly experienced markets where bad economic news has actually been good for stocks (and vice versa). While this is easily explained away by the market recognizing that bad news will usually bring rate reductions from the Fed, I am willing to bet that there are not many investors out there (professional or otherwise) that can understand and/or explain why high unemployment has actually been a good thing for the stock market in the past.

If your reaction to the last sentence was something along the lines of “huh?” you can join the club because when I first saw this data I too was a bit perplexed. But make no mistake about it, history shows that periods of high unemployment have been accompanied by much better than average returns in the stock market.

This would seem to run counter to the bear camp’s assertion that high unemployment and a crummy housing market will not only keep stocks from moving higher this year, but also be a cause of the market’s demise. Well, that and maybe some renewed problems with the PIGI’S, that is.

Make no mistake about it; the last two jobs reports have not been stellar. The December 3rd report was actually much worse than even the most dour forecasts as the “household survey” showed that the private sector had produced job losses in five of the last seven months. And although Friday’s report did show an uptick in jobs, it was clearly not the blow-out report economists have been hoping for (which would signal the job market has turned the corner).

In fact, it was the disappointment over the nonfarm payroll numbers that was cited for the mid-morning dive of nearly 100 points on the DJIA. Thus, it would appear that traders (or at least those in control of the sell programs) feel that bad employment data is bad for the stock market.

Now toss in an idea that Ms. Meredith Whitney has been floating lately – namely that the state and local governments of the U.S. are in deep doo-doo (our term, not hers) – and it isn’t hard to imagine that there will soon be a rash of job cuts at the local government levels. This too has been used by the bear camp as a reminder that we’d better watch out because stocks are likely going down hard – and soon.

But here’s the rub: Since 1948, the stock market has returned, on average, 6.6 times more per year when unemployment has been considered historically high than when it has been low. According to the computers at Ned Davis Research, when the rate of unemployment has been above 6%, the S&P 500 has gained ground at a rate of +13.9% per year. Yet, when the unemployment rate was considered “low” (4.3% or below) the S&P has gained at an annualized rate of just +2.1% per year! Hmmm….

I will have to admit that there is some mental gymnastics required in order for this concept to make sense. However, let’s give it a shot. There are actually a couple of points here. The first is that during periods of high unemployment, interest rates also tend to be low as the Fed is usually trying to stimulate the economy. And the bottom line is everybody knows that low rates are (usually) good for corporate profits.

Next, an environment of high unemployment also generally means that corporations (a) are “lean and mean” from a workforce standpoint and as such, (b) have excess capacity. In short, both of these can lead to increased productivity and higher profits. And again, profits are almost always good for stock prices.

So, while it may not be logical, periods of high unemployment have been kind to owners of stocks.

 

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