Correlation Between The Unemployment Rate And Actions Of The Stock Market

Another choppy day on Wall Street that included a major economic number and a presser from our president-elect ended on the highs. The Dow (^DJI) finished with a gain of 248 points or 2.9%, but was down 4% for the week. The S&P 500 (^GSPC) also dropped 4% on the week, but was up 26 points or 2.9% today. The NASDAQ (^IXIC) lagged a bit, gaining 2.4% or 38 points.

THE BOTTOMLINE: I do not like to toot my own horn, but yesterday I highlighted the massive sell-off in front of the employment number this morning and how Wall Street was baking in a worse than expected number. My fears about the Obama speech were also brought to light. In the end, the employment number was below estimates and the market rallied. Also as soon as Obama began speaking, the Dow fell from up 200 points to up only 75 points. Thankfully he stopped by before the closing bell rang because as soon as he finished, the market began rallying again and up to the highs of the session.

The fact the market rallied on very poor economic numbers coupled with a strong last hour of trading is one reason to smile this weekend. The 4% loss over the week is no reason to frown, but we should be ready to act. Keep in mind that last week was the best the markets had experienced in 34 years with the S&P 500 rallying 14%. Giving back 4% the following week is not all that bad in my mind as long as we hold the lows of Thursday. The bottoming process is about to head into its fifth week and what I require is that the lows continue to be held and volume does not spike on down days. So far so good and I will keep you up to speed throughout the coming weeks.

BUY AS THINGS GET WORSE

Today I spent my early morning hours researching the correlation between the Unemployment number and the action of the stock market during a recession. I was somewhat pleased with the results.

The research involved looking back at the last five US recessions dating back to the early 1970s. Three of the five recessions saw the unemployment rate continue to rise even after the recession was officially over. This is why the number is often referred to as a lagging economic indicator. Today’s reading of 6.5% unemployment is the highest since the 1990’s, but well below the 10.8% reading in November 1982. I do believe we will see the reading rise to the mid-7% level before we top out, however the market will likely be well off the lows by the time this occurs.

During all five recessions the stock market (S&P 500) bottomed months before the worst unemployment reading was released. When the worst news hits the news wires, the S&P 500 was up on average 30% from the lows over the last five years. For example if the unemployment rate decides to climb another 1% and peaks early next year, there is a good chance the stock market would have already bottomed months earlier. Possibly October 2008? Sure, why not.

I am not suggesting everyone run out and begin buying, however the point I am trying to convey is that once investors receive the “all clear” flag to get back into the market it is too late. When the news is at the trough, the stock market has already begun the new bull market and when the news begins to improve stocks are even further from the bottom. Therefore, as an investor I do not suggest you attempt to pick a bottom, but at the same time do not cash in all your chips - leave some on the table.

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Comment by Shanker

2008-12-05 23:48:21

Excellent advice! Given the current data and state of affairs, the unemployment is likely to peak around Nov’ 2009, so the Dow and S&P would probably hit rock bottom anytime between now and April ‘09. The stock market can be thought of a window into the country’s economy 6-8 months ahead of time. For a new investor, this is probably the best opportunity of a lifetime.

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