One of the things we keep hearing these days is that unemployment figures are a “lagging indicator”. It’s a classic response you hear from bulls nearly every day so I figured I’d investigate. I’m a firm believer that markets are very inefficient discounting mechanisms and are much more a function of psychology and a “feeling out” process. Most investors believe that markets are forward looking by many quarters or years, but I have argued in the past that the market is actually very poor at forecasting out more than one quarter. There is no conclusive evidence that markets are efficient discounting mechanisms out further than a few months.
I believe the market is constantly feeling out price as opposed to efficiently pricing assets. Markets are inefficient because the participants within any market are inefficient. This inefficiency is due to multiple factors, but primarily due to the fact that human psychology is incredibly inefficient. Human beings are not engineered to deal with the stresses and risks involved in market participation. Our brains are engineered to avoid risk and survive by any means. When you see your portfolio and your livelihood (and perhaps your family’s livelihood) disappearing in front of you during a sharp sell-off it is human nature to want to sell and survive. Too often that is the exact wrong instinct in a market because the crowd is acting all at once. This is one of the primary reasons why markets appear to be good economic leading indicators. In fact, fear is simply the highest when things are the worst. The market rebound that ensues is not actually due to the markets great forecasting ability, but the great inefficiency in markets that was the result of the inefficiency in its participants. Thus, markets often appear to bottom before the economy. This is a classic example of confusing causation with correlation.
Upon researching past employment information it appears as if there is no convincing evidence that jobs as a whole are a lagging indicator:
The following charts are year over year unemployment rate and non-farm payrolls along with the S&P 500 since 1970. We’ve had 4 major recessions since 1970 excluding the current one. In 2001 NFP bottomed well in advance of the market. NFP bottomed in Q4 of 2001 while the market actually continued to decline throughout most of 2002. In the 1990-91 recession NFP bottomed in Q1 1991 while the market bottomed well in advance. In the 1981 recession NFP reached its worst levels in the middle of 1982. The market, however, did not rebound until Q4 1982. During the 1974 recession NFP bottomed in Q4 1974 while the market bottomed in Q4 of 1974. In just 2 out of 4 cases the market actually led job losses.
The unemployment rate gives slightly different results. The unemployment rate topped out in Q1 1975, Q4 1982, Q1 1992 and Q1 2003. Three instances of the four were in fact lagging indicators while one coincided with the S&P bottom.
Weekly jobless claims give similar results. Claims bottomed in January of ’75, January of ’82 and January of ’03. The 1991 data is mixed with 872K claims in January of ’91 aand 882K claims in January of ’92. Claims are a lagging indicator based on this data.
Overall, the data is relatively inconclusive. while unemployment rates and weekly claims certainly appear to lag there is no evidence that NFP is a lagging indicator and with all three on the march higher at present time there is little we can decipher from the jobs figures. Regardless, beware those who broadly paint unemployment figures as a lagging indicator.