Data Brief - The Unemployment Rate Indicator

The Unemployment Rate Indicator

Friday, June 6, 2008

This morning's surprise jump in the Unemployment Rate has unnerved a lot of traders, and rightfully so - it was the largest jump in the Rate, versus the consensus economist estimate, in at least a decade.

But let's go back over the past 58 years and look at large one-month changes in the Unemployment Rate to see if it was a good signal to expect downside in the stock market, using the S&P 500 as a proxy for "the market".

Well, that doesn't look too bad. Three months later, the S&P was up three-quarters of the time, and sported a +6.5% average return. A year later, the average was +25% with only 2 instances out of 20 being in the red.

Let's add another wrinkle, this time looking for month/month changes greater than 5%, and also requiring that the Rate be at a new three-year high at the same time. Sometimes we get big one-month jumps from very low levels, and that might not give us the same kind of information we're facing in our current situation.

Pretty much the same story here, and in fact the three-month returns and percentage of time positive actually increased from the previous study.

It isn't just the big jump in the Rate that scared traders this morning, it was the fact that it was so much higher than almost everyone was expecting. So let's look at the largest upside surprises in the Rate and see how the market fared going forward.

The "CHNG" column in this study refers to the amount that the actual Unemployment Rate was over and above the median economist estimate via Bloomberg.

This data only goes back to late 1996, so we have much less history than the other studies. But again, it didn't look like a great sell signal for stocks, except perhaps in the short-term of a month or so.

Over the years, we've taken a lot of different looks at how the market responds to economic indicators, and usually we've seen that extreme reactions are "false" in the sense that the market has a tendency to reverse the initial reaction.

Based on the data above, it does seem likely that today's huge surprise in the Unemployment Rate could be enough to unnerve traders in the short-term, causing a re-evaluation of the whole "are we in a recession" question. But based on historical stock market reactions to extreme changes in the Rate, it's tough to make the argument that big increases in unemployment are a major longer-term negative.

Also, we should be on the lookout for revisions to this rate, especially as the largest increase in the Rate was due to teenagers, and we're entering a period that makes seasonal adjustments particularly tricky for the government.