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Low Jobless Rate Is Good, Unless You’re a Stock Investor

(Bloomberg Opinion) -- When it comes to the unemployment rate and the stock market, lower is not always better.

Investors cheered Friday’s jobs report, which showed that the unemployment rate in May dropped to 3.8 percent. That was a shift from much of the rest of the year, when investors have reacted to strong earnings numbers and positive economic news with concerns that it might signal a top, not to mention light a fire under a Federal Reserve already intent on raising interest rates. The S&P 500 Index is up just 2 percent through the first five months of 2018.

Low Jobless Rate Is Good, Unless You’re a Stock Investor

History suggests trepidation might be the right reaction. 

Going back to 1955, there have been 45 months in which the unemployment rate has been as low as or lower than it is now. The average stock market return, as measured by the S&P 500, of those months: Just 0.3 percent. By contrast, when the unemployment rate has been 10 percent or higher, the market has clocked an impressive average monthly return of 3.4 percent.

Nor has a low unemployment been any guarantee the market would rise at all. The unemployment rate has been below 4 percent 60 months going back to the start of 1955, and stocks have tumbled in half of them.

Some of this is reversion to the mean and extremes, but not all. An unemployment rate in the 4 percent range has produced an average S&P 500 monthly return of just 0.7 percent. And returns are worse in the 5 percent range. Joblessness has to get up above 6 percent before the average monthly return tops 1 percent.

What this says is that when it comes to the unemployment rate alone, stocks have been in the danger zone for a while. But also that the unemployment rate alone probably has little to say about the direction of the stock market. What matters more are inflation and interest rates, which typically rise when unemployment rates get in the 5 percent range or lower.

Low Jobless Rate Is Good, Unless You’re a Stock Investor

And that could be why this time around has broken the mold and could continue. Inflation and interest rates remain historically low. And while the Fed is pushing to raise the short-term rate it controls, the 10-year Treasury rate is back below 3 percent, most likely putting a ceiling on how high the central bankers can go. And the good jobs report still showed muted wage inflation, particularly given the low unemployment rate. (There’s a suggestion that the unemployment rate is not as low as it actually appears because of  the relatively low labor force participation rate.)

Still, if history is a guide, investors running out to cheer the low unemployment rate are likely chasing the bulls, not leading them.

©2018 Bloomberg L.P.