3.9% Unemployment Means This For Stocks

There is a whole “This is as good as it gets” argument against US stocks at the moment. On Caterpillar’s quarterly earnings call, CFO Brad Halverson said the company’s Q1’s earnings might be the “High water mark for the year”. That neatly summarizes investor concerns that it’s all downhill from here.

The same meme applies to Friday’s Employment Situation Report, with its 3.9% unemployment rate. That figure is the lowest since December 2000 and the only better reading (3.8%) during that economic cycle was in April 2000. Any comparison to the year 2000 is not the foundation of a bull case for US equities, so how much of a concern should this latest report be to investors?

There is good information on US employment back to 1948, so here are some data points that frame the current environment against prior periods:

  • There have actually been two post-World War II timeframes with noticeably lower US unemployment than today’s levels. They occurred in 1952-1953 (2.5% to 3.0%) and 1968-1967 (3.4% to 3.5%). These were the result of large scale US military action in Korea and Vietnam, however, making these periods non-comparable to today.
  • Post 1980, trough levels of unemployment through a business cycle have varied considerably. In 1980s, the lows were 5.0% (March 1989). The 1990s cycle bottomed at the previously mentioned 3.8% in April 2000. The last cycle lows were in April 2007 at 4.4%.

We often hear that unemployment is a “Lagging” indicator in comparison to “leading” nature of US equities, but the truth is more nuanced. For example:

  • From March 1989 – June 1990 monthly measures of US unemployment ranged tightly around 5.2% to 5.4%, at levels not seen since the Vietnam War.
    The Iraqi invasion of Kuwait on August 2 1990 ended that streak, as oil prices spiked and economic conditions became less certain. The S&P 500, which had been treading water up to that point for the year, ended the year down 7.3%.
  • The bursting of the dot com bubble in March 2000 came nine months before the actual cycle lows for US joblessness. Those occurred in Q4 2000, at 3.9% unemployment. Recall that the S&P 500 was only down 9.0% in terms of total return for 2000, in part because the real economy continued to perform reasonably well.
    Unemployment only breached 5% to the upside after the 9/11 attacks, and US stocks were down 11.9% in 2001 and a further 22.0% in 2002 on the back of both further dot com bubble deflation and geopolitical concerns/oil prices.
  • US stocks peaked in the last cycle on October 11th 2007, but unemployment had been stuck in a monthly band from 4.4% – 4.7% for over a year before that date. As the Financial Crisis morphed into the Great Recession, unemployment peaked at 10% in October 2009. Stocks had bottomed seven months earlier.

The upshot to all this: modern periods of exceptionally low unemployment do not automatically start the countdown clock on an eventual equity market downdraft. Rather, external factors (oil price shocks/geopolitics and financial crisis) change the outlook for labor and capital markets. For now, the source of any potential dislocation is not yet clear. When it does begin to make itself plain, unemployment and stock prices will respond. But not before.

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