Unemployment Rates, Recession Periods and Stock Market Prices

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 |  Includes: DIA, QQQ, SPY
by: Naveen Musunuru

The Labor Department reported on Friday that 84,000 jobs were lost in August 2008 indicating a 6.1% unemployment rate. This current unemployment rate is the highest since September 2003.

The purpose of this article is to understand the relationship between unemployment rates and recession periods and finally their link to stock market prices.

The first chart depicts the seasonally adjusted historical unemployment rates starting from 1948 till 2008. Over the last sixty years, unemployment rates varied from a low of 2.5% to a high of 10.8%. The unemployment rate by itself is not a good indicator, however by combing recession periods with the unemployment rate we can find certain interesting relationships. According to the National Bureau of Economic Research, we had 10 recession periods between 1948 and 2001, with an average recession period being approximately 12 months. These historical recession periods are plotted with orange shade on the unemployment rate graph.  

As you can see from the graph, throughout the recession periods, unemployment rates rose sharply. During the entire ten recession periods, the average increase in unemployment rate was approximately 2.6%.

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Data Source: Bureau of Labor Statistics

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Out of the ten recession periods, the last four registered an average of 2% increase in unemployment rates. Consequently, stock market lows don’t happen without first registering the 2% increase in unemployment rates. During the last recession, starting from the beginning of 2001, a 2% increase in unemployment rate happened approximately around December 2002 and this period also coincided with the lows of S&P 500.

If you want to analyze current market conditions, we still haven’t seen the 2% increase in unemployment rate. Starting from the recent consolidation area in unemployment rate which is around 4.7%, we are still short of approximately 0.5% for a full 2% increase.

So the markets have not seen the full bottom yet and the coming unemployment reports will be crucial for the clues regarding future market direction. You should be fully invested whenever you see a 2% increase in unemployment rates because these periods indicate general gloominess about the economy and provide excellent opportunities for further growth in the financial markets.

Readers are also reminded that this is not a definitive answer to market bottoms but an approximate guideline to consider in decision making.