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What Unemployment Means for the Stock Market

Jun 04, 2010
Simon Maierhofer

How things have changed. For most of 2009, the stock market rose even though unemployment figures kept deteriorating. Now, unemployment numbers are getting better but stocks are selling off. What does that tell us about what lies ahead?

How do investors get ensnared or misled? They believe in never before seen and probably nonexistent phenomenon like a “jobless recovery.”

Like a baker presuming he can make a cake without flour, investors thought rising employment wasn’t an ingredient needed for an economic recovery. Well, the cake didn’t rise and about a month ago the stock market started to agree.

Following the April 26 highs, the Dow Jones (DJI: ^DJI), S&P 500 (SNP: ^GSPC), and Nasdaq (Nasdaq: ^IXIC) tumbled as much as 15% in 22 trading days. Last month’s unemployment data (released on May 7) was eclipsed by the May 6, meltdown that briefly reduced the Dow by over 1,000 points.

Even though the S&P trades 7% below the May 6 level, investors felt that the market had stabilized (at least for now). Before we delve into May’s numbers and their meaning, we should point out that April saw seasonally unadjusted unemployment numbers rise for both “rosy stats” and “real stats” (more about that in a moment), yet the market sold off sharply. Today the opposite is true.

The Real Numbers

The numbers released by the Bureau of Labor Statistics show that unadjusted unemployment numbers inched from last month’s 9.9% to 9.7%. Even though this isn’t terrible news, Wall Street sold off as only 411,000 workers were hired, less than the 513,000 analysts expected.

What is concerning, is that the real unemployment still is at 16.6%. Yes, 16.6%! This is the official number reported by the Bureau of Labor Statistics (BLS).

The BLS publishes different sets of data on a regular basis. The main focus tends to be on the unrealistic U-3 unemployment rate (currently 9.7%, seasonally adjusted).

U-3 is the “official” unemployment rate and illustrates total unemployed persons as a percentage of the civilian labor force. Another category, U-4 – includes unemployed workers plus discouraged workers. A discouraged worker is someone who’s available to work but has stopped actively seeking work.

U-5 unemployment includes the number of unemployed workers, plus discouraged workers, plus marginally attached workers. A marginally attached worker is someone who is able and willing to work but is not actively seeking work.

U-6 is as close to the real unemployment figure as government reporting gets. This number includes unemployed workers, discouraged workers, marginally attached workers, plus workers that are forced to work part-time because they are not able to find a full-time job.

According to the Bureau of Labor Statistics, the number of U-6 unemployed workers is 16.6%.

 

Keep in mind that neither of the above categories encompasses “unemployed self-employed.” Your handyman or contractor next door, or small business owner who can’t secure clients are not included. Adding those to the mix would put the real unemployment number above 20%.

No One is Spared

Unfortunately, job cuts have affected every industry sector. Job cuts in the technology sector (NYSEArca: XLK) have reached the highest level in four years. Hewlett-Packard just announced that an additional 9,000 jobs are at risk of being eliminated.

After attempts at delaying pay raises and implementing furloughs didn't work, New York Governor David Paterson indicated he will seek layoffs starting January 1st.  Thousands in the state workforce will be affected to achieve the targeted $250 million in budget savings.

According to a report by global outplacement firm Challenger, Gray & Christmas, U.S. employers began the year 2010 by announcing 71,482 planned job cuts, the highest tally in five months. The report, however, said that the increase in layoffs should not be seen as a sign of “recession relapse.”

Recession Relapse?

How do you define a recession relapse? Exactly when did the recession end that we might relapse?

Up until April, there has been a huge disconnect between what’s happening on Wall Street and on Main Street. From March 2009 to April 2010, the stock market (NYSEArca: TMW) has been steadily rising, as has unemployment. You’d expect stock prices to go up and unemployment claims to go down, but that hasn’t been the case.

When trying to figure out what’s next for stocks, we must first understand the pieces of the puzzle that caused the relentless 13-month rally.

From October 2007 to March 2009, the Dow Jones (NYSEArca: DIA), S&P 500 (NYSEArca: SPY) and secondary indexes like the MidCap SPDRs (NYSEArca: MDY) and small caps (NYSEArca: IWM) have lost more than half their value. Financials (NYSEArca: XLF) lost over three quarters of the market capitalization.

It’s nearly forgotten now, but in March 2009, investor pessimism had reached an extreme of historic proportions. In fact, on March 9th, the Wall Street Journal made a case for Dow 5,000 and Goldman Sachs slashed earnings growth by over 37%.

Exactly at that time, the ETF Profit Strategy Newsletter sent out a Trend Change Alert (on March 2, 2009) predicting the biggest rally since the October 2007 all-time highs, with an upper target range of Dow 10,000. For 18 months (10-2007 – 3-2009) investors had resisted their urge to buy. This was about to change.

I Want What I Want

It was this pent-up urge to buy that sent stocks higher. No bad news could prevent the market from rising. Investors simply wanted to own stocks again and recapture some of their hefty losses. Like a swimmer who had been under water for a couple of minutes, the stock market had to take a deep breath.

Just as extreme pessimism marked the bottom of the down-turn, the ETF Profit Strategy Newsletter predicted that extreme optimism would mark a top. Concerning that top, the newsletter stated on April 16, 2010 that “historically there’s rarely been a more pronounced sell signal. The pieces are in place for a major decline.”

The One Constant

On a daily basis, economic news (such us unemployment reports) comes and goes. Some will influence the market, others won’t. If you’ve been following news reports and corresponding stock prices you will have noticed that the correlation between good news and higher prices or bad news and lower prices, is less than obvious.

One example still fresh in investors’ minds is that the blockbuster Q1 2010 earnings season was followed by the worst May in decades.

What remains constant, however, is the pattern of behavior investors have established for hundreds of years. Extreme sentiment readings result in extreme reactions. Reflections of such extreme sentiment are the VIX (Chicago Options: ^VIX), which dropped to the lowest level since July 2007 about six weeks ago, or investor bullishness which had risen to the highest level since either 2000 or 2007.

Crowd behavior of investors is largely driven by perception. The perception that stocks will continue to rise has given way to the sobering realization that stocks can and will move in both directions. Investors concerns about stock valuations did become a self-fulfilling prophecy in 2008.

Soon, investors will once again refocus on valuations to see if a stock is worth its price tag. It was the return to due diligence that pummeled stock prices throughout 2008.

Just as in April 2010, the 2008 declines were also preceded by extreme optimism and a feeling that stocks have nowhere to go but up.

Historically, stocks are grossly overvalued and due for another major correction. How major?

The ETF Profit Strategy Newsletter includes a detailed short, mid and long-term forecast. This includes a target-range for the ultimate market bottom based on historically indisputable evidence. 

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