Economic data and stock market: How can you tell what the unemployment rate and markets are going to do next? Economic data and markets go hand in hand. And, the latest unemployment numbers show that the economy continues to advance. Unemployment came in at 3.9%, down from 4.2% the previous quarter. There are market jitters in the stock market. The S&P 500 sold off sharply this morning despite the unemployment rate showing that there is still plenty of opportunity moving forward. The stock market jitters were owed to the future of the Federal Reserve raising interest rates. But, for now, I will show how the unemployment rate and stock market correlation work.
Interest rate increases are expected after the monstrous efforts the Federal Reserve has done to prop the economy up due to the pandemic. Now, the Federal Reserve is on track to raise interest rates back up to normal levels. The market is expecting anywhere from 2-4 rate increases this year as well as the dwindling of asset purchases.
Keep in mind, this is normalization. And, the stock market may hesitate here and there. But, if you look at the unemployment rate, the economy is running on full steam and 2-4 interest rate increases are not going to halt the economy.
Let’s look at how the unemployment rate and markets coincidently move.
Unemployment Rate & Markets
If you look, it is easy to see that the unemployment rate and stock market correlation are very strong. In order to grasp this all, I will start at the beginning cycle of the economy and work through from personal incomes and personal expenditures all the way to the unemployment rate.
This is the unemployment rate on a whole number basis:
As I mentioned, unemployment moved down from 4.2% to 3.9%. This is near the all-time high of 3.5% that I observed just before the pandemic hit. While this tells a solid story, the unemployment chart above can be converted into something more useful in helping us determine how economic data and markets move together, and more specifically, how the unemployment rate and markets are correlated.
Unemployment Rate YoY Change
Here is the same chart above, the unemployment rate, but instead of the whole number, this is the Year-over-Year (YoY) change:
By converting the unemployment rate from a whole number to a YoY change, we can see the growth rate of the unemployment rate. This is helpful simply because we can also see the YoY changes of many economic data releases we get monthly. Then, we can convert that and start to predict how economic data and markets move together on a gradual basis from the perspective of YoY changes.
One of the most important things to understand about the unemployment rate is that it is a delayed indicator. Businesses are a little slow to hire and fire employees despite there being enough information for them to make an early decision. The delay is usually about 3, 6, or up to 9, and 12 months out after we start to see economic activity expand or contract.
Economic data and stock market: How Unemployment Rate and Markets tells us stock market moves
Since the unemployment rate is a delayed number, you will want to start somewhere else in analyzing the economy and the stock market. The biggest portion of the economy is the consumer and services sector. This part of the economy is approximately 72%.
Given that, if we look at personal incomes and personal expenditures, you can find correlations between incomes and expenditures, and then other economic data including the unemployment rate.
Also, another important thing to have as a concept is the idea of what all of the expenditures amount to: Profits for companies. I’ll get into that a little more below.
As I mentioned, personal incomes and personal expenditures are solid places to start looking at the economy. First, individuals earn their incomes. Then, they spend their earnings. While the correlation between the two is strong, it is not perfect. But, it is very close.
Here is the YoY change in personal expenditures:
I started this chart off in 1990. But, the data points will start to show up in 1991. This is because I am using the YoY change. So, I am showing how 1991’s numbers changed compared to 1990’s numbers.
If you look at the bottom numbers, you can see when there were recessions and when there were economic booms.
Personal Expenditures versus Unemployment
There are many other economic data releases that I could show but, in this posting, I am showing how economic data and markets correlate. So, continuing off of personal expenditures, here are the two charts from above, the YoY change in personal expenditures and YoY change in the unemployment rate.
If you think this through, personal expenditures really drive profits for companies and, if people earn more and more at an increasing rate, they will spend more and more at an increasing rate. This drives profits at an increasing rate. But, if there is contracting in economic activity, such as expenditures at a slower and slower rate, this drives the entire economy to contract more and more.
Businesses will react to an expanding and contracting economy. As the rate of growth of expenditures increases or decreases, demand for products will move similarly. Companies will hire and fire employees in response to these demands.
Therefore, increases in personal expenditures have ripple effects throughout the economy and start with personal incomes, and move all the way through to unemployment.
Personal Expenditures and S&P 500: How Unemployment Rate and Stock Market Correlation
If there is an increase or decrease in the rate of growth of incomes, there will be an increase or decrease in the annual rate of growth of personal expenditures. This powers demand for products and services in the economy. That, ultimately, drives profits. As consumers push consumption higher or lower, this will ultimately drive the rate of growth of the price of the broader stock market. Giver all of this, we can determine how the unemployment rate and stock market correlation move together.
Here is a look at the YoY change in the monthly closing price of the S&P 500 versus the annual YoY change of personal expenditures:
If you want to know what is going to happen to the profits of companies trading on the stock market, start by following the rate of growth of personal incomes and personal expenditures. The correlation is very strong, albeit, not a perfect 1.
Yes, I can put the very same charts from above and overlap them onto inflation. If i did, you would see the rate of growth of prices correlate strongly with the YoY change in personal incomes and personal consumption
And, yes, the rate of growth in prices is heading higher. Much higher:
The most important thing to keep in mind is that this is the rate of growth. What this shows is that prices today are some 5%- 6% higher than they were from last year’s prices.
Does this mean we will necessarily see continued price increases? Not necessarily.
For example, let’s say that the Big Mac cost $10.00 one year and it increased in price by 5%, or $0.50, it may be that the price stays exactly the same for some time. Because of that, the rate of change may start to fall since we are comparing next year’s price to today’s prices. So, I do not necessarily see price increases going higher and higher for all of eternity. Sure, prices are higher. But, the rate of growth may start to mellow out.
Truth is, we don’t know just yet. And, economic data does not give us the opportunity to determine this since the price increases are not driven entirely by economic data but, price increases have largely been driven upwards because of the supply chain shock to the system because of the pandemic.
Unemployment Rate And Markets
So, we started today off with a lot of selling because of the fear of interest rate increases. But, interest rate increases are largely going to normalize the economy, not necessarily halt it because it is overheating.
My calls on the stock market remain: I am bullish. I fully expect that the stock market will break new, all-time highs. Look for interest rates to moderate over the next couple of quarters. And, the stock market may bobble up and down during that time. But, with the information I have now, I believe that the eventuality is that we proceed higher for a period of time.
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