Is a Low Unemployment Rate “Great News” for Stocks?

We’ve come a long way, baby.

In October 2009, the U.S. Unemployment Rate stood at 10%, the highest level since the deep recession in the early 1980’s. Since then, it has moved all the way down to 4.7%.

U.S. Unemployment Rate since 1948 to 2015

Payrolls have now expanded for 77 consecutive months, by far the longest streak in history.

Non farm payrolls and longest positive streaks chart2

With economic news improving, the pundits are out in full force declaring “this is great news for the stock market.”

Seems intuitive, but is that actually the case? There’s only one way to find out: test it.

We have data on the Unemployment Rate going back to 1948. If we break down the rate into quintiles what we find is an interesting relationship with forward stock returns.

As you can see in the tables below, the highest Unemployment Rates have been followed by the strongest returns on average and the highest probability of a positive return. Conversely, the lowest Unemployment Rates tend to be followed by below average forward returns and a lower probability of a positive return.

S&P 500 average forward total returns 1948 to 2017 chart3

What’s driving this relationship? Valuation. On average, lower unemployment rates tend to be associated with higher valuations and vice versa.

Quintile from 1948 to 2017 chart4

Why? Because when there’s good news (low unemployment), people are willing to pay a higher multiple for a given level of earnings than when there’s bad news (high unemployment).

That is important because on average, the higher the valuation, the lower the forward return.

Annualized S&P 500 average forward returns chart5

That’s not to say that stocks can’t do well following low levels of unemployment. They certainly can and have done so in the past. In fact, the all-time low in the Unemployment Rate was in 1953 (at 2.5%), after which stocks had an annualized return of 17.7% over the next 7 years. But stocks were very cheap in 1953 with a CAPE ratio of only 11.6. Today’s CAPE ratio of over 29 is not a fair comparison.

If we take all of the data points with an Unemployment Rate of 4.7% below and break them into two groups, one with a CAPE ratio above 20 and the other with a CAPE ratio below 20, we find a clear dichotomy. The group with a CAPE ratio below 20 actually outperforms the average from all periods while the group above 20 underperforms by a wide margin.

Unemployment rate and CAPE ratio from 1948 to 2017 chart6

So is a 4.7% Unemployment Rate “great news” for the stock market? It would be hard to say that it is because that low Unemployment Rate today is coinciding with high valuations. That doesn’t mean it has to be bad news (stocks are still positive on average), it’s just not nearly as good for stocks as a high Unemployment Rate.

For the layperson, I understand that’s not intuitive, because we’re often told the stock market is the economy. But as we learn time and again, it is anything but. By the time the Unemployment Rate rises to a level that concerns people again, stocks will likely be much cheaper than they are today. When that happens it will be “great news” for stocks but it won’t feel great at all because the news will be bad. Until that time, let’s just say the lower Unemployment Rate is great news for anyone who has found a job and leave the stock market out of it.


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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.


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