Unemployment Rate Signaling Trouble Ahead

Daniel Carter profile picture
Daniel Carter


  • The Unemployment Rate is a highly flawed metric, but its time-series can still be very useful.
  • A cyclical bottom in the Unemployment Rate indicates a recession and equity market selloff in the near future.
  • Now is a good time to reduce equity exposure.

The Unemployment Rate does not actually tell us how many people are unemployed or the true conditions of the labor market. It does not take into account the Labor Force Participation Rate, and it weights part-time and full-time jobs the same, even if the part-time job is for one hour per week. The Unemployment Rate is a pretty terrible metric if you are looking for anything informative on the true employment situation. However, its time-series reveals a great way to anticipate recessions and major market selloffs.

Even though the Unemployment Rate is terrible at its designed purpose, it presents one of the clearest pictures of the business cycle. It falls slowly and consistently when the economy is expanding, and it rises sharply when the economy shrinks.

Right before a recession, the Unemployment Rate finds a bottom and the trend slowly begins to reverse. When the recession occurs, the uptrend that was established months before turns into a rapid increase. The Unemployment Rate bottoms an average of 8 months before a recession. The maximum number of months between an Unemployment Rate bottom and a recession was 18 months, and the minimum number of months between an Unemployment Rate bottom and a recession was 2 months.

Because recessions are usually accompanied by market selloffs, an Unemployment Rate bottom is a great signal for telling us when to be more cautious with our equity investments. Below is a chart of the Unemployment Rate vs the S&P 500 (SPY).

You can see that a cyclical bottom in the Unemployment Rate usually closely coincides with a market top. However, like most market timing metrics, this metric is not perfect. When the Unemployment Rate bottomed in 1979, the market continued to go up until the second of the double recession in the early 1980's. The market most likely rose through this recession

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Daniel Carter profile picture
Specifically focused on macro and top-down research. No method of research is disqualified in making investment decisions. Fundamental analysis, technical analysis and quantitative analysis are all valid tools in finding profitable investments. Being consistently bullish or consistently bearish traps one in confirmation bias. Different market conditions should spark different thoughts on which investments will be most profitable over the mid to long-term. Everything is changing all the time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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