Where Do Stocks Go Now that the U.S. Unemployment Rate Can’t Go Much Lower? Is There an Unemployment-Stock Market Correlation?
America’s unemployment is at its lowest point in a half-century—an incredible accomplishment just a decade removed from the worst recession since the Great Depression. And while the fourth-quarter 2018 market correction knocked stocks back, they’ve fully recovered since – and then some. And that got me wondering about the unemployment-stock market correlation.
Here’s what that correlation looks like on a 10-year chart, starting from just after the 2008-09 recession. (The red line is the S&P 500, the purple line is the unemployment rate.)
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The 10-Year Unemployment-Stock Market Correlation
I realize that it’s not exactly like discovering fire to say there’s an unemployment-stock market correlation. When a lot of people are out of jobs and the economy is bad, of course stocks are low. And when the unemployment rate drops, of course stocks rise. But that’s almost perfect divergence, at least after the initial market crash when the unemployment rate doubled from 5% in April 2008 to 10% in October 2009.
Stocks bottomed in March 2009, about eight months before unemployment hit its 10% high. The bounce-back from rock bottom brought a 23.5% jump in the S&P 500 in 2009. Since then, the two best full years for stocks have been 2013 (+29.6%) and 2017 (+19.4%). Those just so happen to be two of the three years with the largest percent drops in the unemployment rate; it fell 16.3% in 2013, and 14.6% in 2017. (Unemployment tumbled 15.1% in 2014, which was also a double-digit return year (+11.4%) for the S&P.)
This year’s stock returns could top both those years; as of this writing, the S&P 500 is up 31.7% with just six full trading days left to go in 2019. Perhaps not coincidentally, the unemployment rate dipped another 12.5% this year, from 4% to 3.5% through November (December statistics won’t be available until January).
Where do stocks go from here now that the unemployment rate can’t go much lower?
2020 should be a good litmus test. The unemployment rate fell for nearly 10 years, resulting in what is approaching a decade-long bull market. The last time unemployment dipped below 4% and stayed there for more than a year was from 1966 though 1969—way too long ago to really glean much that could translate to today’s world.
So, from that perspective, this is uncharted territory on Wall Street. Unemployment can go no lower for the first time since the turn of the century, right when the Internet bubble burst, prompting the unemployment rate to jump more than 5% in two years.
Thus, the best investors can hope for is that some other bubble (real estate?) doesn’t burst, and that unemployment continues to hover at least in the neighborhood of 4% (or lower). History tells us that if unemployment spikes again, stocks will tank. But relative stasis in the jobs numbers shouldn’t scare investors off, especially now that stocks are cooking again and volatility has subsided.
Bottom line: As the chart shows, the unemployment-stock market correlation has been a reliable inverse relationship for the last decade (and beyond). Now that unemployment can’t drop much further, stocks are kind of on their own.
We’ll see whether that’s a bad thing or a good thing.
Timothy Lutts heads one of America’s most respected independent investment advisory services. Each week, Tim personally picks the single best stock in his exclusive Cabot Stock of the Week advisory. Build your wealth and reduce your risk with the top stock each week for current market conditionsLearn More
*This post has been updated from an original version.