Thanks to Covid-19, America’s unemployment rate reached as high as 14.7% in April 2020, its highest level since the Great Depression. Things have improved dramatically since then, with the rate either falling or holding (mostly) steady every month since, and now down to 3.5% – the lowest it’s been since 1969. 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 20-year chart, dating back to August 2003. (The black line is the S&P 500, the blue line is the unemployment rate.)
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The 20-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 has continued to trickle lower – from 4% in January 2022 to 3.5% now – while stocks have fallen 7% since the start of 2022.
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 falling virtually in tandem. The question is why?
The answer appears to be high inflation.
Inflation vs. Unemployment
Prior to last year (or November 2021, technically), 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.
For the most part – especially in late 1981 and early 1982, when the unemployment rate shot up and stocks plummeted – the inverse relationship between the two was intact.
Why is this time different? The answer likely lies in the unusual – borderline unprecedented – lack of correlation between inflation and employment in the last year. As inflation has exploded to four-decade highs, the unemployment rate has continued to fall to five-decade lows. This is what is confounding the Fed right now: Inflation remains stubbornly high despite their efforts to reel it in via relentless rate hikes, and yet the jobs market hasn’t been this robust since Richard Nixon was in office, at least from a headline-number standpoint.
Naturally, Wall Street is confused too.
In 2022, investors sold stocks like they normally do when inflation balloons. Now, the rate is still higher than the Fed’s 2% target (3.2% in July), but falling (down from a peak of 9.1% last year), and yet unemployment remains at a half-century low. So, investors aren’t sure what to do, which is why the market is so data/Fed-dependent at the moment, with stocks struggling to regain their footing after reestablishing a bull market over the first half of the year.
Until there’s some sort of resolution – namely, that inflation starts falling fast enough for the Fed to finally cool it with the interest rate hikes – the market is likely to be very sensitive to headline numbers. And it’s possible that won’t happen until the unemployment rate rises a bit, which is likely to cause another short-term leg down in the market.
It’s a complicated knot to untie, and one that will take some time. Perhaps Powell will strike a more dovish tone in Jackson Hole, and stocks will begin to rise again. But it’s doubtful the rate hike talk will be fully put to bed until inflation dips below 3%, if not lower. Meanwhile, 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.
