Don't Worry About the Unemployment Rate

It's not that the theory doesn't make sense. At first blush it makes perfect sense. But when you look at the numbers, the simple-as-pie thesis starts to break down.

I'm referring to the theory about the worrisome unemployment rate in the U.S. The theory goes something like this: The unemployment rate -- most recently measured at 9.7% -- remains doggedly high. That means that folks are out of work and can't shell out for consumer goods like Apple (Nasdaq: AAPL  ) iPods, Starbucks (Nasdaq: SBUX  ) lattes, and Activision Blizzard (Nasdaq: ATVI  ) video games.

That, in turn, means that suppliers of intermediate goods like Intel (Nasdaq: INTC  ) and Qualcomm (Nasdaq: QCOM  ) see demand fall. Businesses become reluctant to spend, eschewing a big tech upgrade with Oracle (Nasdaq: ORCL  ) or canning that new headquarters that would have benefitted materials producers like Alcoa (NYSE: AA  ) . Companies get worried, lay off workers to "optimize" operations, and the cycle deepens.

Hello, reality -- good to see you
Looking at history as a guide, though, I found that the unemployment rate -- though easy enough to track and understand -- isn't really a good measure of what to expect from the economy.

I went ahead and borrowed some data from the U.S. Bureau of Labor Statistics to illustrate the relationship. Thanks to the great people at the National Bureau of Economic Research, I was able to pinpoint the quarter that the U.S. pulled out of recession in every business cycle since 1949 and see what the unemployment rate looked like as the economy bottomed.

Quarter / Year

Unemployment Rate Previous Quarter

Unemployment Rate at Bottom

Q4 1949

6.6%

6.6%

Q2 1954

5.7%

5.6%

Q2 1958

6.7%

7.3%

Q1 1961

6.6%

6.9%

Q4 1970

5.4%

6.1%

Q1 1975

7.2%

8.6%

Q3 1980

7.6%

7.5%

Q4 1982

10.1%

10.8%

Q1 1991

6.3%

6.8%

Q4 2001

5.0%

5.7%

Sources: Bureau of Labor Statistics and National Bureau of Economic Research.

As you can see from the table, in nearly every case, the unemployment rate was rising even as the recession was coming to an end. In fact, in a number of these cycles, if we look at the quarter following the recession's end, unemployment stayed the same or even climbed despite significant economic growth.

What does this say? Well, it certainly speaks poorly of the predictive power of the unemployment rate.

There are plenty of numbers in the sea
Fortunately, the unemployment rate isn't the only employment-related number that we can look at when it comes to evaluating the economy's health. There are actually two numbers that are considered "leading economic indicators" that we can look at -- initial unemployment claims and the average workweek.

Initial unemployment claims skyrocketed during the recession, jumping from a four-week average of 440,000 in early September of last year to more than 650,000 in early April. The most recent four-week measure was 570,000, well down from that April high note.

Be forewarned though, even the monthly average for claims tends to be very volatile and can jump around from week to week and month to month. But what should be noted is the downward trend that claims have taken from the early spring.

The average workweek, meanwhile, slid from 33.9 hours in mid-2007 to a low of 33 hours in June of this year. Preliminary numbers for July and August show that number at 33.1, a tepid suggestion that this data point is also moving in the right direction.

Fishing with fairies
Yesterday, my fellow Fool Amanda Kish penned a piece -- titled "Unemployment: It's Worse Than You Think" -- reviewing the potential to end up unemployed in this economy and how to fortify your financial position in case you find yourself in that unenviable position. Her advice hits the bull's-eye and I think we can all benefit from her defensive tips.

However, investors sitting on the sidelines waiting for a green light from the Unemployment Rate Fairy before putting their cash to work may end up disappointed. Economic recovery generally seems to be fleet of foot compared to the plodding unemployment rate, and investors sitting on the bench may be left wondering how they missed the turn.

Many Fool readers don't share my relatively optimistic outlook. Be sure to check out the case for pessimism.

Apple, Activision Blizzard, and Starbucks are Motley Fool Stock Advisor picks. Intel and Starbucks are Motley Fool Inside Value picks. The Fool owns shares of Starbucks. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy works weekends and does windows.


Read/Post Comments (20) | Recommend This Article (28)

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  • Report this Comment On September 16, 2009, at 11:37 AM, Varchild2008 wrote:

    Major problems with your Thesis there:

    1) Unemployment IS a factor when there exists little to no upcoming incentive to hire coming out of Local, State, or Federal legislation.

    In many of these recessions we saw incentive to hire spur better unemployment numbers, spur higher consumption, create stronger economy.

    Where's the incentive to hire once former Pres. Bush's tax cuts expire and businesses face 1990s style taxation?

    2) No one is factoring unemployment alone.... If you are looking at unemployment, you should know that it is tied to other things that are under pinnings of America's economic future:

    2A: Trade Policy.... Smoot-Hawley Tariff?

    2B: Competitiveness: Tire Tariffs cause no one wants to buy American Tires?

    2C: Legislative Regulatory Restrictions: Ranging from Cap and Tax to Health Care Reform Regulations to etc.

    3) Unemployment didn't improve in 1982 much until Pres. Ronald Reagon's Supply Side Economics Legislation, lowering taxes across the board, took effect in 1983.

    We have NO massive upcoming legislation that will generate job growth, economic prosperity around the corner like World War II....Reagon's economic Bill.....etc....etc... There's nothing out there.

    4) Consumers can't spend if they are jobless and Video Game Sales have shown that. If people aren't buying video games then what will happen next year if unemployment DOUBLES?

  • Report this Comment On September 16, 2009, at 1:02 PM, streetflame wrote:

    Matt - I think you are missing an important point. Unemployment and the price of the market are both indicators of the underlying value of the economy. The price of the market is known, so there is no point for value investors to have an indicator pointing to it.

  • Report this Comment On September 16, 2009, at 1:55 PM, plange01 wrote:

    dont worry about the 20% of the US workforce already unemployed or about the growing depression in the US either..take a trip to dreamworld like wall street has. its all good there at least until reality joins the party!

  • Report this Comment On September 16, 2009, at 2:17 PM, dswing wrote:

    Previous recessions and correlated unemployment were related to loss of manufacturing jobs which rapidly returned with a recovery. *This* recession has effectively destroyed *permanently* many service-sector jobs that will not come back. Instead, industry is going to have to develop entirely new jobs, based on *real growth* and somehow do this on the broken back of the consumer. You can't just count numbers of jobs without considering the types of jobs involved. It will lead you to very wrong conclusions.

  • Report this Comment On September 16, 2009, at 3:20 PM, TMFKopp wrote:

    @Varchild2008

    I'm curious if you read the article... The argument isn't that unemployment itself is a non-factor, it's that the unemployment rate isn't a good measure to be basing expectations on. As I noted in the article, there are employment measures that are used as forward predictors of economic health and they have been improving.

    @streetflame

    Unemployment and the price level of the market can be signposts to how the economy is performing, but if you're looking for the value of the economy, why not just look to GDP?

    On that note, in the article, I'm trying to assess whether the unemployment rate is a good indicator of what will happen with the economy / GDP. From the past numbers it would appear that it is not.

    @plange01

    I feel like you post the same comment on every article I write.

    @dswing

    Is this a conclusion that you've come to based on data or is it a gut feeling?

    Economic recovery is not dependent on a return to the same place that we were at prior to the recession. The U.S. economy has contracted for the past four quarters and has shrunk five out of the six previous quarters. We don't need to bank on jumping right back to exactly where we were, what we're looking for is a change in direction.

    As I've noted in the past, I don't expect a sharp recovery (http://www.fool.com/investing/general/2009/09/08/one-more-si..., but I expect we're going to see recovery nonetheless.

    Matt

  • Report this Comment On September 16, 2009, at 3:39 PM, wuff3t wrote:

    TMFKopp,

    Try not to take it personally - plange01 posts the same comment on every article he comments on, not just yours...

  • Report this Comment On September 16, 2009, at 5:30 PM, streetflame wrote:

    Matt - You are right actually, I didn't read closely enough. It seems like unemployment is often compared to market bottom, not GDP bottom. That just rubs me the wrong way since it is a circumstantial technical correlation, not a fundamental one.

    Furthermore GDP, unemployment and the market have all put in double bottoms before, so just because we have a small uptick in GDP growth does not mean GDP has put in a long-term bottom.

  • Report this Comment On September 16, 2009, at 5:34 PM, automaticaev wrote:

    unemployed = lazy

  • Report this Comment On September 16, 2009, at 5:57 PM, TMFKopp wrote:

    @streetflame

    Maybe I'm misunderstanding you, but I would hardly characterize the unemployment/GDP relationship as a "circumstantial technical correlation." It seems pretty clear that a recovery in the unemployment rate very often lags the beginning of an economic recovery.

    What we're looking for here is a turn in the economy that would support better future macroeconomic conditions for the businesses that we're looking to invest in. The point of the article is to say that just because the unemployment rate is still high doesn't mean that economic recovery isn't on the way.

    As for the double bottom, yes, it could happen, but you're talking about a few exceptions here rather than the typical experience. While we don't want to ignore the potential for a quick plunge into a second leg of economic contraction, you're playing the short odds if that's what you're betting on.

    I'd also note that it depends on what you consider a "double bottom." Economic cycles don't typically run the way they did in the 90s -- that is, eight or nine years between contractions. Generally expansionary cycles have been a shorter 2, 3, or 4 years. Even if what we're looking at is a short 2-year expansion before the next down cycle, I'm not sure that I want to be sitting on the sidelines for those two years.

    Of course, in all of this, I believe you need to pick your spots wisely when you're choosing where to invest. As I've already noted (http://www.fool.com/investing/value/2009/09/11/the-real-ques..., I'm not so sure that the market's current overall valuation is sustainable. But that doesn't mean that there aren't still great opportunities available if you're willing to do some digging.

    Matt

  • Report this Comment On September 16, 2009, at 6:24 PM, streetflame wrote:

    We're on the same page. I'm saying unemployment/GDP is a fundamental relationship but unemployment/market price is just technical.

    I don't think GDP falling further is likely but on the other hand I don't think it's going to snap back up for the next two years either.

    "I'm not sure that I want to be sitting on the sidelines for those two years."

    I certainly wasn't sitting on the sidelines the last 6 months (and have had great investment returns particularly among small caps), but as the market continues to surge higher, selling equities is starting to look a lot more attractive.

  • Report this Comment On September 16, 2009, at 7:33 PM, TMFKopp wrote:

    @streetflame

    Gotcha.

    "as the market continues to surge higher, selling equities is starting to look a lot more attractive."

    Agreed, but I think it depends on what you're selling. Like I said, I think there are individual stocks out there that are still attractive, but I also think there are some that have gotten ahead of themselves. I don't know that the overall S&P has gotten out of control, but it's high enough that I'm saving my money for good individual stocks rather than then the indexes.

    Matt

  • Report this Comment On September 16, 2009, at 9:05 PM, akbuyme wrote:

    Silly question, but isn't this why the analysts say that unemployment is a trailing indicator of the economy as opposed to a leading indicator?

    It still seems counterintuitive to me, but if the numbers don't lie, then the numbers don't lie.

  • Report this Comment On September 16, 2009, at 10:25 PM, glenby52 wrote:

    @automaticaev

    Under what used to be "normal" circumstances, I would agree with you, but decent manufacturing jobs are few and far between. Becoming "voluntarily retired" after 20 years and meeting the age 55 requirement, I was given "an offer too good to refuse". There's not too many jobs available in the area (Central Ala) and I can't imagine what it's like in the auto/rust belt areas.

  • Report this Comment On September 17, 2009, at 7:20 AM, CarryOnAgain wrote:

    The problem is, unemployment rates do not necessarily map onto economic activity. In the early eighties, after Thatcher pulled money out of the British economy, unemployment rose sharply, and remained stubbonly high while the economy grew. More recently, before the recent recession, France and Germany had years of unemployment levels stuck at 7 or 8 percent, and this was for structural reasons.

    So, the lesson is, the economy may grow while unemployment remains high. The other point is that the economy will be hobbled as consumers and financial institutions deleverage. I believe that the market is beginning to price in more rapid growth than this analysis would justify. Nevertheless, I keep waiting for a correction that never seems to come!

  • Report this Comment On September 17, 2009, at 10:20 AM, Izznogood wrote:

    For those of you who see indications that we are out of the recession, and moving forward just from a lower point, I suggest you take a good look at what I consider an excellent leading indicator for the market namely the Baltic Dry Index (BDIY). This index moves 2-3 months ahead of the market and is not subject to speculation.

    The index is pointing down down down, while the S&P is up up up in the last three months. I expect a sharp negative correction of share prices in the near future, probably around Q3 reporting, when it will become evident that the upswing in Q2 was related to re-stocking - somthing which is also visible in the Baltic Dry Index reaching a peak on June 3rd.

  • Report this Comment On September 17, 2009, at 12:03 PM, ryanalexanderson wrote:

    The argument that unemployment is a trailing indicator is based on the idea that industry leans down and becomes more productive, boosting the economy and taking up slack, before employees are needed again.

    This phase-lag makes sense in a production-oriented economy.

    But when consumption accounts for 70% of GDP, it doesn't work so well. So much of the US economy has been based upon borrowing. Retail, government, and the general service industry dominates. I don't think you'll see the historical employment phase-lag in these areas, that was there when the US actually -produced- things.

    Not to mention that retail capacity has been ridiculously over the top - by which I mean redundant big box stores built on top of one another. This is an entire economy of inefficiencies built upon cheap imports and cheap credit. The latter is gone, and the former is going. The associated inefficiency is not cyclical - and the jobs associated with it are not coming back.

    Eventually, the job opportunities will be in production again...and that's the goal that the US should aim for.

  • Report this Comment On September 18, 2009, at 3:52 AM, memoandstitch wrote:

    The government has managed to mimic the symptoms of a recovery with extraordinary life support. You need to factor out the unprecedented supports, both fiscal and monetary, before you compare the numbers of this recession to history. Once the drugs are depleted, you will see the real face of this recession.

  • Report this Comment On September 19, 2009, at 12:04 AM, 30dollaroverload wrote:

    As the unemployment rate continues to climb during the current recession, we frequently hear and read in the financial news the number of jobs lost is a lagging indicator, destined to continue rising after the official end of the recession. Historically, however, job losses are more of a coincident, and not lagging, economic indicator.

    In seven of the last ten recessions the economy actually started creating jobs at, or near, the end of the contraction. Only in the last two economic downturns did we see a significant deterioration in the employment situation after the recession ended and after the recession of December 1969 - December 1970 the net number of jobs basically drifted sideways for about a year before significantly improving.

    A close look at the post-war recessions shows just how atypical the last two recessions were regarding jobs.

    Consider the first recession after World War II: at the end of the November 1948 - October 1949 downturn the unemployment rate was 7.9%. This was the high of the business cycle and it began a downward trend in December, falling to 2.5% in May and June of 1953.

    As the July 1953 to June 1954 recession came to a close, the rate was 5.6 percent. It did continue to rise for the next three months, peaking at 6.1% in September of 1954, but the one half percent increase, and the fact that net job losses increased for only three months after the recession ended, leaves the increase relatively statistically insignificant.

    ---------------------

    Money is like muck, not good except it be spread.

    http://www.topinvestingtips.com

  • Report this Comment On September 23, 2009, at 8:02 AM, uppjdw wrote:

    Employment growth will be constrained by two factors:

    1) higher taxes on small business (70% of new job formation)

    2) increased productivity

    How much employment growth will be constrained is debateable but I'm not sanguine about a rapid production of new jobs from small business.

    Large business could produce some new jobs with a falling dollar but not if the administration and congress tax profits of over seas subsidiaries. I predict the US based companies with contract US employment after they sells their overseas units.

    Comment?

  • Report this Comment On September 23, 2009, at 12:27 PM, plange01 wrote:

    the unemployment rate is over 20% of the workforce and its getting worse.unemployment is the only thing to worry about .no jobs no recovery and the depression in the US gets worse....no kidding!

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