The Unemployment Rate and the Stock Market

The U.S. Unemployment Rate has moved down to 3.9%, its lowest level since December 2000. If you ask the average person on the street what that means for the stock market, they would likely say it’s a bullish sign. What does it actually mean? Let’s take a look…

US unemployment tare chart from 1948 till 2015

Data Source for all charts/tables herein: FRED, Bloomberg, Robert Shiller

We have data on the Unemployment Rate going back to 1948. Breaking the data up into quintiles, we observe the following:

  • A positive correlation between the level of unemployment and the forward stock market returns. In general, the lower the unemployment rate, the lower the forward stock market returns and vice versa. In the current quintile (2.5% to 4.4% unemployment), the average S&P 500 return over the following year is 5.6% versus an average of 12.7% in all periods. The best returns historically have come after periods of high unemployment.

S&P 500 average forward annualized total returns from 1948 to 2018

  • Lower odds of a positive S&P 500 return with lower unemployment rates. In the current quintile (2.5% to 4.4% unemployment), the S&P 500 has been positive 64% of the time over the following year versus 79% in all periods.

S&P 500 average forward positive total returns from 1948 till 2018 chart

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

Unemployment rate vs Avg CAPE ratios in different quintiles chart

Why? Because when there’s good news in the economy (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’s important when it comes to stocks because higher valuations tend to be associated with below average forward returns.

S&P 500 average annualized forward returns from 1928 to 2016 chart

Note: Above table uses CAPE Ratio.

In January, the S&P 500’s valuation hit the 97th percentile, higher than every period in history with the exception of the late 1990s and early 2000s.

S&P 500 CAPE ratio vs Historical average graph

Historically, the combination of higher valuations and lower unemployment has been unfavorable for stocks, with negative returns on average over the following 1-year through 5-year periods.

S&P 500 average annualized forward total returns from 1948 to 2017

Does that mean that the S&P 500 has to go down from here? No, these are just probabilities and tendencies; there are always exceptions.

But it does mean that investors probably shouldn’t view a low Unemployment Rate as a bullish sign for stocks. The evidence seems to suggest that the opposite may be true.


Related Posts:

The Uncertainty Principle in Markets



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. Charlie 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.

Charlie 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 also holds the Certified Public Accountant (CPA) certificate.

In 2017, Charlie was named the StockTwits Person of the Year. He has been named by Business Insider and MarketWatch as one of the top people to follow on Twitter. His work has been featured in Barron’s, Bloomberg, and the Wall Street Journal.

You can follow Charlie on twitter here.


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