April 2010
Higher Unemployment Followed by Higher Returns?
Jeff
DeMaso
Key Points
• Many investors believe that the economy and stock market will suffer until the employment situation starts to improve.
• Historically, however, stock market returns tend to be above-average when unemployment is relatively high – and vice versa.
Unemployment. It is a common reason (or excuse) we hear for staying out of the markets. We have all experienced unemployment, either directly or indirectly, and it is painful. It is in newspaper headlines and on street corners. It can make us uncomfortable and uncertain about the future. Given the personal impact of unemployment and a constant media blitz, I can't fault anyone who thinks “Geez. With unemployment so high, how can the economy recover? How can stocks possibly perform well?”
But has it proven advantageous for investors to sit on the sideline until they are more comfortable with the unemployment picture? Rusty Vanneman, Chief Investment Officer and Portfolio Manager, touching upon this topic in a recent Research Perspective, noted that unemployment is a lagging indicator; it trails the economy and the stock market. In this article we look to probe that claim (or to see if investors have been rewarded for avoiding stocks when unemployment is high) by examining the historic relationship between unemployment and stock market performance.
The Bureau of Labor Statistics (BLS) provides monthly unemployment data going back to 1947. With this data we can examine how the stock market has performed in (and following) different employment environments. Let's begin by breaking months into quartiles based on the level of unemployment for that month. The top quartile includes months with unemployment of 6.6% and above. The median unemployment level was 5.7%. And months with the lowest unemployment (the bottom quartile) had unemployment levels of 4.6% and below.
Once we have these quartiles we can calculate average returns for each quartile. The two graphs below compare the average performance for months falling in the top quartile versus the average performance for months in the bottom three quartiles (unemployment of 6.5% and below), for months in the bottom half (5.7% and below), and for months in the bottom quartile (4.6% and below). The first chart considers performance for the month of the unemployment print. The second chart examines performance over the following 12 months.
Chart 1. Average One Month Total Return of the S&P 500.
Source: Bureau of Labor Statistics and Bloomberg as of 1/31/2010.
Chart 2. Average Total Return of the S&P 500 Over the Following 12 Months.
Source: Bureau of Labor Statistics and Bloomberg as of 1/31/2010
As seen above, the stock market tended to have higher performance during and following periods of higher unemployment. In fact, the chart shows a strong trend of lower market returns when the unemployment rate is below average.
The current unemployment rate (as of 1/31/10) of 9.7% falls in the top 2% of this data series. As citizens and neighbors this is troublingly high. But as investors, there has been a cost to waiting for the “all-clear” sign of low employment – missed returns. What is comfortable in investing is rarely profitable.
Jeff DeMaso
Senior Research Analyst
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