The United States’ unemployment rate is the focus of our featured chart this week. It’s something nearly everyone has heard of, and it’s the economic metric that people probably care the most about. To state the obvious, we don’t like a high unemployment rate. A lot of folks out of a job is a sign of an unhealthy economy. So, surely when unemployment is high, the stock market would perform terribly, right?
Not so fast. The stock market is generally forward-looking, meaning its price today reflects expectations for the future. When economic variables like the unemployment rate reach extreme levels (good or bad), it’s likely already priced in by the market.
Take last year, for example. When the pandemic first reached our shores and the economy shut down, the unemployment rate skyrocketed to a post-WWII high of roughly 15%. Of course, this was bad news for the economy, and everybody obviously knew that. However, as the saying goes, “what is obvious is obviously wrong.” The stock market had already (quickly) priced in the lousy unemployment news and was looking forward to what lie ahead.
And what did lie ahead? Not only a rapid reversal and decline in the unemployment rate but also an unprecedented amount of fiscal and monetary support from the U.S. government. That helped backstop the strong increase in stock prices that we’ve experienced the past year and a half or so.
Which brings us to the current environment. As you can see on the chart, the unemployment rate fell to 4.2% last month. That’s good news for workers. The labor market has certainly improved dramatically. However, the rate is now at such low levels that, historically, the S&P 500 stock index has struggled to make significant gains in this type of environment.
Looking at the performance box, we learn that an unemployment rate below 4.3% has historically led to an average annualized gain of just 1.7% for the S&P 500 stock index. This is a much lower return than when the unemployment rate has been at higher levels. The general explanation for this is that low unemployment can lead to inflationary pressures, which may lead to a more restrictive monetary and fiscal policy, which could hurt the stock market. This sounds a lot like our current environment.
The primary takeaway from this chart, then, is that most of the low-hanging fruit has likely already been picked from this recovery and that return expectations for stocks going forward should probably be lowered.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.