Unemployment is in the news a lot these days, with the numbers that are reported sometimes being so important that they move markets. But there are many kinds of unemployment, including cyclical unemployment, perhaps the most important for investors. Read on to learn more about this.
What is cyclical unemployment?
Cyclical unemployment is a very specific kind of unemployment that isn't simply tied to the fortunes of a few companies, but is instead related to business and economic cycles.
When the economy contracts, there's less need for goods and services, and companies often reduce their labor force to save money, creating soaring unemployment. As the economic picture looks better, companies hire more people so they can produce goods faster or offer more services, and unemployment goes down.
What are the causes of cyclical unemployment?
The primary cause of cyclical unemployment is simple: Businesses just do not have enough demand to justify their labor forces. Since public companies are beholden to their shareholders, they can't simply hold on to labor that's not being used to its potential, so companies have to lay off workers to streamline expenses when consumers aren't spending as much.
Unlike other types of employment, cyclical unemployment tends to hit the entire job market at once, instead of specific companies or sectors.
Cyclical unemployment versus seasonal unemployment
It would be understandable to confuse cyclical unemployment with seasonal unemployment -- and people often do. The difference, however, is that seasonal unemployment is somewhat predictable year after year, and is not so much related to economic cycles as short-term consumer trends.
With seasonal unemployment, you know when the job market is likely to kick up again. For example, there's always a ton of hiring for retail workers for the holiday shopping season. Another example would be many types of tradesmen who are temporarily laid off during the winter because it's too difficult or dangerous to work on homes in their region.
Cyclical unemployment, on the other hand, is not as reliably predictable and simply happens when it happens. When consumers stop spending, there's less need for everything, and that's when cyclical unemployment kicks in. Fewer shoppers means fewer goods are needed, and fewer goods means fewer workers to produce them.
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Why does cyclical unemployment matter to investors?
Cyclical unemployment should be very important to investors because it's yet another signal that speaks to the health of the economy. When you see a lot of unemployment across a wide range of industries, you should be wondering what's happening and look deeper into where we may be in the economic cycle.
If things are sliding toward contraction (recession), this is a good time to check your positions, make sure you understand why you're invested in the companies you're invested in, and hold on tight to the companies you believe in. This might also be a good time to purchase stocks on sale while the economy is stalling, but remember that timing the market is a fool's game (not a capital "F" fool as in "Motley Fool," either).
On the other hand, cyclical unemployment can also tell you when good times are coming back. If you start to see widespread hiring, unemployment shrinking across the board, and consumer confidence returning, this is a great sign that the economy is expanding again. If that's happening, your stocks may gain a lot of value.
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