Due to Covid-19, America’s unemployment rate reached as high as 14.7% in April 2020, its highest level since the Great Depression. But things improved fairly quickly, with unemployment falling to multi-decade lows in the two years that followed. What happened to stocks in 2020 and 2021 was evidence of the unemployment-stock market correlation at play.
Here’s what that correlation looks like on a 25-year chart, dating back to September 2000. (The black line is the S&P 500, the blue line is the unemployment rate.)
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The 25-Year Unemployment-Stock Market Correlation
This is certainly just a lesson in stock market basics. 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 you may not have realized just how correlated they are, historically.
Just look at that chart; the two lines are almost perfect inverses of each other, either crisscrossing or narrowing during major events such as the dot-com bubble burst at the turn of the century, the 2008-09 recession, in 2014 as the unemployment rate returned to pre-recession lows and stocks climbed to new highs, and, of course, the extreme movements from March and April of 2020 due to the coronavirus pandemic, when the two lines accelerated in opposite directions.
In the roughly 21 months that followed, through the end of 2021, unemployment plummeted while the S&P more than doubled.
Since then, however, something funny has happened. (Funny is probably the wrong word choice for those of us who are heavily invested.) The unemployment-stock market correlation failed. The employment rate continued to trickle lower — from 4% in January 2022 to 3.5% at the end of the year — yet stocks experienced a bear market.
And for the last few years, the unemployment rate and the stock market have both been moving higher at the same time.
Suddenly, the inverse relationship between stock market performance and the U.S. employment rate doesn’t look so strong. Take a look:
That looks more like a direct relationship than an inverse one, with the two rates rising and falling virtually in tandem. The question is why?
The answer appears to be a combination of inflation and mean reversion.
Inflation & Reversion to the Mean
Prior to November 2021, the last time the U.S. inflation rate breached 7% was from April 1978 through May 1982 (that’s right – four whole years of inflation in excess of 7%!). What happened to the unemployment rate during those four years? It rose – from 6.1% in April 1978 to 9.4% in May 1982, and as high as 10.8% by the end of that year. Not surprisingly, as unemployment soared, stocks fell.
But this time around, we haven’t seen persistent (and borderline unsustainable) inflation. Instead, we’ve seen inflation running moderately hotter than it had been prior to the Covid pandemic.
Moderate inflation, even if it’s higher than the Fed’s 2% target, isn’t an unhealthy backdrop for stocks.
And while unemployment has been rising, it’s risen from historically low levels at 3.5% to a higher but still healthy 4.3%.
Remember the job market in 2022 and 2023, when workers could pretty much pick and choose their jobs and there were far more job openings than employees to fill them?
What we’ve seen in the last couple of years has, so far, just been a return to normal.
Of course, the stock market and unemployment rate can’t move in lockstep forever. One of those two figures will need to blink if unemployment starts approaching (or surpasses) 5% and the market remains at its all-time highs.
But until that happens, the unemployment-stock market correlation will no longer be the reliable visual it has been for decades.
Strange times.
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*This post has been updated from an original version, published in 2018.
