COTW: Equity Returns from Cycle Lows in Unemployment

February 5, 2019

The U.S. unemployment rate (U3) increased to 4% in January after hitting an almost 50-year low of 3.7% in September 2018 and again in November 2018.  The unemployment rate has now increased for two straight months. There's no doubt that the government shut-down muddied the waters for all labor market data last month, but the impact on the unemployment rate may not have been that severe. Furloughed workers still had jobs and their positions were still counted in the Establishment survey that populates the headline unemployment number.


We do not know if the September to November period marked the high point for the labor market (and low point for unemployment) for this cycle, but we believe it is safe to say that we are near the high point.  That is great news insofar as it tells us how strong economic and company performance was in the recent past, but it is not helpful for forecasting.


This week's chart views equity returns from the cycle low in unemployment for the ten economic cycles since 1948 (we do not count the brief drop in the unemployment rate between the 1980 and 1982 recessions). Based on the historical evidence, if the September to November 2018 period does indeed turn out to be the cycle low in unemployment, investors should expect substantially lower equity returns, larger drawdowns and higher volatility in the short term.




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