During and after every recession you hear folks say, “Stocks can’t rise until unemployment improves!” But stocks do rise. Unemployment lags the stock market—by a lot usually. In my 38-year career, that’s been the case, and I can’t find a time it wasn’t so historically.
This bunk pervades because it’s intuitive. Folks believe high unemployment means people spend less. That’s bad for profitability since firms aren’t selling much and bad for the economy and stocks too—so the story goes. But markets aren’t intuitive, they’re usually counterintuitive.
You rarely find anyone who says the reverse—that stocks can and should rise while unemployment is high and failing to fall. But it’s always been true! And you know, when almost everyone believes something—believes it with a religious fervor and considers you insane for questioning it—that’s when you most need to check if it’s true. Check history! The data is freely and easily available.

Unemployment Up, Stocks Up Too?

Even if you pause to consider recent history, you start to realize something is wrong. What happened in 2009? Unemployment rose all year—going above 10 percent. Ugh! Yet stocks had a fantastic year—US and world stocks rose 68 percent and 73 percent from the March low, for a 26.5 percent year overall for US stocks, 30 percent for the world.1 Stocks rose, hugely, while unemployment was rising. That wasn’t a one-time fluke. (I even wrote about this 23 years ago in my 1987 book, The Wall Street Waltz—see the 2008 edition from John Wiley & Sons, page 150). Checking history, as far back as we have monthly unemployment data, stocks typically bottom before recessions end. But unemployment typically keeps rising through the end of recessions and often far later. Yes, there are a very few mild exceptions, like the short, shallow 2001 recession—the bear market didn’t bottom until after the recession ended. But that was still way before unemployment peaked. Every single time, recessions end and stocks climb before unemployment drops.
Pretend you’re a CEO. You feel a downturn coming, so you ratchet down on inventories. You don’t want your warehouse full just when your customers decide to shop less. But that’s not enough cost cutting, so you also cut staff. No CEO likes doing it, but for the sake of your business, customers, and remaining employees who depend on you, you must get as lean and mean as possible. (People bash CEOs for downsizing—but they usually shouldn’t. Is it better if they don’t cut staff and the entire firm goes under, causing vastly more unemployed people?)
Now, pop quiz: When do you start hiring? Before you see sales rebounding? No! Utter lunacy! You can’t afford to hire, not yet. You wait for a pick-up in sales, which doesn’t become clearly apparent until well after the economy starts improving.
But hang on. Just because sales pick up a bit, you still don’t rush to hire. Because of cost cutting, you had some productivity gains during the recession (i.e., your remaining staff learned to make do with less). That’s powerfully good, because it means you can see a big earnings pop even on a slight pick-up in sales. Which is great for your shareholders.
So your firm is recovering, sales are better, you’re getting an earnings boost—maybe returning to profitability—and you’re more productive than before. But you’re still not hiring, not quite yet. You learned in the bad times to not hire and you’re sticking with that if you can. You’re nervous it can all go poof again. Maybe a double-dip recession like they always talk about in the media (but are actually beyond rare—which people would know if they checked history) is around the corner. (It probably isn’t, but folks still fear it.)
So instead of hiring full-time employees to whom you must also pay benefits, you start with part-time and contract labor. Cheaper, easier to hire and fire, and you probably don’t have to give them benefits. Only after sales are decidedly going in the right direction for some long time, and your employees are completely maxed out and you could be jeopardizing future sales by not hiring, do you start, finally, adding material full-time staff. And even that takes some time because you must recruit and hire—doesn’t happen overnight.

Dropping Unemployment Lags the Economy

And that’s exactly what you see in Figure 34.1—showing US recessions and unemployment as far back as we have monthly employment data (December 1928). The shaded bars are recession periods, and the line is the unemployment rate. The darker gray bar at the end is my estimate of when the recession that started in December 2007 ended, based on positive US GDP growth and a peak in unemployment benefit claims. (The National Bureau of Economic Research [NBER], which dates recessions, typically doesn’t date the end of a recession until many months after it happens.) And the lag has recently gotten longer—probably the result of ubiquitous computer capability allowing firms to manage employment tighter than they ever have before. That means this lag phenomenon likely doesn’t go away, but probably will get stronger in the future.
Figure 34.1 Unemployment Historically Rises Even After Recessions End
Source: Global Financial Data, Inc., National Bureau of Economic Research, Bureau of Labor Statistics, as of 02/28/2010.
Note that for all the media haranguing that the 2007-2009 recession was a new “near Great Depression,” or more often, “the Great Recession,” fact is: Unemployment never got anywhere near as bad as that and was actually a touch lower than the 1981-1982 recession. But also, in every single recession, unemployment rises the whole time and even after—sometimes for many months. What’s going on is CEOs are still being cautious—keeping their firms lean, which contributes to the big earnings pop that’s typical at the end of every recession. As they cut, they get better and better at doing it and find more and more places to cut and keep being lean into the expansion.
Not to mention that the unemployment rate is inherently wonky. It doesn’t measure what people commonly think it does. It isn’t the number of folks who don’t have jobs divided by the total labor force. What it measures is those who are currently looking for jobs at a point in time divided by those looking, plus those with jobs. So if folks aren’t looking, they aren’t counted. As the economy picks up, some who had given up on finding jobs get encouraged and suddenly start looking again, which actually raises the unemployment rate—even as payrolls increase! This contributes to unemployment being a lagging indicator, not a predictive one.
And of course, stocks are the ultimate leading indicator, so they almost always rise even before the recession ends. If you wait for confirmation from falling unemployment to buy stocks, you can really miss out. Table 34.1 shows 12-month S&P 500 returns following unemployment peaks and returns starting 6 months before the peak. Overwhelmingly, returns are much better for the next 12 months if you buy before unemployment peaks—i.e., while unemployment is still rising. That’s usually because you can capture some of the big, initial powerful upward thrust of a new bull market. Returns are still good if you time the peak—averaging 14.7 percent for the next 12 months. But 12-month returns average a whopping 30.6 percent if you start 6 months prior to the unemployment peak.
Of course, it’s near impossible to time an unemployment peak—I don’t know anyone who’s done it successfully repeatedly. And I don’t know why anyone really would want to try because it’s a klutzy statistic. But the point is you shouldn’t fear stocks just because the official unemployment rate stays high or fails to fall.
Table 34.1 Unemployment and S&P 500 Returns—Stocks Lead, Jobs Lag
Source: Global Financial Data, Inc., S&P 500 total return, Bureau of Labor Statistics, as of 12/31/2009.
All this fear is because people wrongly assume that since consumers are such a big part of our GDP (approximately 71 percent),2 high unemployment means spending can’t recover, and that dings our economy. But that’s a different bit of bunk (Bunk 39).
Unemployment needn’t fall for a recession to end. That’s just bunk. In fact, it would be very odd if it did. It should in fact keep rising—that’s normal and healthy. Repeat: Unemployment should not and will not drop before a recession ends. Growth will begin, and unemployment will keep trending higher. And stocks should move up, big time, before any of that. That’s what history and data tell us.
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