One of the most widely recognized economic indicators is the unemployment rate. There exists a relationship between unemployment rates and recessionary periods, which finally links to stock prices. Institutions and individual investors alike pay special attention to this number to get a bearing on current market conditions that may help them with their investment decisions.
The unemployment rate, as shown in the image, is typically higher during a recession. Over the past 65 years, the U.S. economy has experienced 11 recessions and has seen unemployment rates skyrocket 11 times, peaking at 10.8% back in November 1982. The unemployment rate, a lagging indicator, typically peaks towards the end of a recession and gradually declines as the economy recovers.
The unemployment rate is published by the U.S. Bureau of Labor Statistics once a month through an extensive survey of select households. People are classified as unemployed if they do not have a job, are currently available for work, and have actively looked/are looking for work. The unemployment rate is the number of unemployed people as a percentage of the labor force, with the labor force defined as the total number of employed and unemployed people. The labor force automatically excludes young people (anyone under the age of 16), people in the military, and institutionalized individuals (in prisons, mental institutions, and nursing homes). However, there are other groups of people that voluntarily choose to be excluded from the labor force, including homemakers, students, retirees, and discouraged workers who have stopped seeking employment.
When interpreting the monthly unemployment numbers and how they have changed since the last month, it is important to see if the variation was brought about because of a change in the number of unemployed people, a change in the size of the labor force, or both. For example, if the unemployment rate dropped because the number of unemployed people decreased, that’s a good sign and indicates that the economy improved. If the unemployment rate dropped because a sizable number of discouraged workers stopped actively looking for work and simply dropped out of the labor force, that’s a bad sign. The lower unemployment rate in the latter case gives the illusion of an improving economy, when in actuality the economy hasn’t improved.
Investors should stay informed on current market conditions as they may help explain why portfolio values have changed (for better or for worse) and how they can continue to stay the course. A worsening unemployment trend means more individuals are looking for work and people may have less disposable income to spend, which will negatively affect sales. Poor sales result in lower company profits, putting downward selling pressure on the company’s stock price.
©2013 Morningstar, Inc.