Employment obviously has a significant impact on the overall strength of the U.S. economy. Such an impact, in fact, that it is one of the three explicit directives governing U.S. Central Bank conduct. Per The Federal Reserve Act, the Federal Reserve is mandated to conduct monetary policy “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
As we all know, Covid brought with it significant economic harm in addition to the physical harm it wrought and the unemployment rate reached 14.7% in the spring of 2020, a level not seen since the Great Depression.
Thankfully, since then, the unemployment rate has returned to close to pre-pandemic levels (4.8% in September, which is the most recent data point as of the time of writing).
That’s still higher than it was at any point in the three years prior to 2020 (since October 2016, in fact). But investors are focused on the improvements in the rate, and that’s reflected in the unemployment-stock market correlation.
Here’s what that correlation looks like on a 20-year chart (courtesy of Ycharts.com), dating back to June 2001. (The orange line is the S&P 500, the purple line is the unemployment rate.)
The 20-Year Correlation Between Unemployment and the S&P
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.
Just look at that chart; the two lines are almost perfect inverses of each other, either criss-crossing 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 last March and April due to the coronavirus pandemic, when the two lines accelerated in opposite directions.
But look what’s happened since then.
The unemployment rate has been reduced by roughly two-thirds since reaching 14.7% 18 months ago. What have stocks done during that recovery? Risen 94%, at least from the late March 2020 bottom. (The market is forward-looking, and thus anticipated “better” unemployment rates after April, which is why stocks started to improve before the jobs market did.)
So, if people are still scratching their heads as to why stocks are just below all-time highs (despite some recent weakness) at a time when the Covid-19 pandemic is still lingering, inflation concerns are bubbling to the surface again, and U.S. unemployment remains above historical levels, just show them this chart. As long as the unemployment rate continues to fall, stocks will continue to rise.
A year from now, the U.S. unemployment rate is likely to be lower than it is now. And that means stocks are likely to be higher. How much higher will likely depend on how many people are able - or willing - to get back to work.
Regardless of what happens, the relationship between jobs and stocks is clear. As the chart shows, the unemployment-stock market correlation has been a reliable inverse relationship for the last 20 years (and beyond). What happens to the jobs market in the coming months will be a clear indication of where stocks are headed next - and vice versa.
What do you think: Do you disagree that there is an unemployment-stock market correlation?