Jan 19, 2008

Unemployment report and stock market

Some economists say that we are already into Recession, some other economists say we will not see Recession but a Slowdown is in order, and that includes Fed Chairman Ben Bernanke too. Well, what are the set of events (or any other indicators) that can tell me when a Recession has arrived. I can speculate what those could be, like high unemployment rate, shrinking manufacturing index, etc, but I do not know for sure what exactly marks the TICK of Recession start. However, what matters to me most are two things: My monthly pay and the stock market performance.

Let us see how the Unemployment Report can shed light on Recession, or more accurately on S&P 500. The Employment Report is crucial for Fed's short term interest rate action, and has an impact on stock market investors. It makes sense because people loose jobs, their spending goes down and hence businesses make less money. Not that hard to relate Employment with the performance of stock market!

What is the Employment Report? One of the important measure of economy is the monthly Employment Report that is published by Bureau of Labor Statistics (BLS). The employment report is actually two separate reports. The household survey is a survey of roughly 60,000 households. This survey produces the unemployment rate. The establishment survey is a survey of 375,000 businesses. This survey produces the non-farm payrolls, average workweek and average hourly earnings figures.

With the above points made, let us see how Employment report matters to us. Will Rahal published a very good report on Unemployment rate and its relation to Recession. He made two vital points:

  1. When the year/year change in 3 month Unemployment average shoots up by 0.2 percentage points, the unemployment rate tends to accelerate.
  2. Historically, the number of months into Recession that is needed to up-tick Unemployment rate by 6% is 3 months. (the 6% jump in Unemployment is the highest ever found at the start of any recession since WW-II, with the exception of November of 1948)

Since December 2007 unemployment rate came in at 5.0%, the jump in unemployment rate is above 6% and it means we are already into recession by 3 months (on an average). Wow! we are already into Recession without being aware of it. I wish someone will tell us in the next two months that we are out of the Recession, and us not being aware of it. The onset of Recession does not bring the change instantly, like day and night would do, but it is more like seasonal change. Just like the change from Fall to Winter takes time, the onset of Recession takes little time to reveal its effects. Agree?

I am more interested in how the unemployment rate affects the stock market. I plotted percentage change in unemployment rate against S&P 500. I started this from 1998 so that we can compare how this slowdown/recession will compare against the one from 2000. As you can see from the chart below, the 6% change in unemployment rate matches with the situation during December 2000. The market had already started its downslide by then.

Here is another variation of the same data, but this one can help us get a picture of when turnaround in Unemployment happens and more importantly, notice how the peak of unemployment change precedes the trough (the bottom) in S&P 500 index. Seems a good chart to follow, isn't it?
I am wondering if the chart above can help us catch the bottom in the stock market this time? Let's see.