Employment and Stocks Over the Intermediate Term
Posted in Economic Indicators
May 3, 2012
U.S. job gains or losses are a prominent element of the monthly investment-related news cycle, with the the business media and expert commentators generally interpreting changes in employment as an indicator of future economic and stock market health. One line of reasoning is that jobs generate personal income, which spurs personal consumption, which boosts corporate earnings and lifts the stock market. Are these data in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted nonfarm employment data from the Bureau of Labor Statistics and contemporaneous S&P 500 Index data for the period January 1950 through March 2012 (747 months), we find that:
The following chart compares the behavior of seasonally adjusted non-farm employment and the S&P 500 Index (on a logarithmic scale) over the entire sample period. Visual inspection suggests a recent positive relationship between the two series, but the relationship appears to be inconsistent over the long run with no obvious lead-lag.
For a closer look, we compare the monthly changes in employment (employment growth) to monthly future stock market returns.
The following scatter plot relates next-month S&P 500 Index return to monthly employment growth (released near the beginning of the next month) over the entire sample period. The Pearson correlation for the two series is 0.00 and the R-squared statistic 0.000, indicating no relationship between the two series.
Over the subperiod since 1990, the Pearson correlation for the two series is 0.09 and the R-squared statistic 0.01, indicating that monthly variation in employment growth explains about 1% of the variation in next-month stock market return.
Results do not encourage belief in a useful relationship.
In case there is a material non-linearity, we calculate average future stock market returns by range of employment growth.
The next chart summarizes average next-month S&P 500 Index returns by quintile of monthly employment growth over the entire sample period and two equal subperiods. There are 149 (75) observations per quintile for the entire sample period (subperiods). The non-systematic variations across quintiles and inconsistencies across subperiods undermine belief in any useful relationship between employment growth and future stock market behavior at a one-month horizon.
Might the relationship between employment growth and stock market return be stronger over some longer measurement/forecast interval?
The next chart plots Pearson correlations for various lead-lag relationships between quarterly employment growth and quarterly S&P 500 Index return over the entire sample period, ranging from stock market returns lead employment growth by 12 months (-12) to employment growth leads stock returns by 12 months (12). Results suggest that:
- A relatively strong (weak) stock market indicates relatively strong (weak) employment growth over the next year or so.
- In contrast, relatively strong (weak) employment growth gives slight contrarian indication of a relatively weak (strong) stock market over the next year.
For indications of the strength of the latter contrarian indication, we look at quarterly and annual scatter plots.
The next two scatter plots relate next-quarter (upper chart) and next-year (lower chart) S&P 500 Index return to quarterly and annual employment growth over the entire sample period.
At quarterly intervals, the Pearson correlation for the two series is -0.11 and the R-squared statistic 0.01, indicating that quarterly variation in employment growth explains about 1% of the (inverse) variation in next-quarter stock market return.
At annual intervals, the Pearson correlation for the two series is -0.26 and the R-squared statistic 0.07, indicating that annual variation in employment growth explains about 7% of the (again inverse) variation in next-year stock return.
In other words, there is some indication that relatively strong (weak) employment growth forecasts a relatively weak (strong) stock market at a one-year forecast horizon.
In summary, evidence from simple tests offers no support for a belief that monthly changes in U.S. employment usefully predict next-month U.S. stock market returns. Over longer horizons, the relationship appears to be inverse.
Cautions regarding findings include:
- The sample is not very long in terms of number of economic cycles.
- Analyses are in-sample. An investor operating in real time would not have access to data for the entire sample period.
- Since employment data releases occur after the end of the month by a few days, there is some offset between employment growth rates and stock market returns as calculated above. This offset could affect the statistics.
- Employment data used above is as-revised rather than as-released. The effect of revisions on statistics could be material.
This analysis does not rule out the possibility that surprises in employment changes, relative to some measurable expectation, usefully forecast intermediate-term stock returns.
See also “ADP Employment Report and Stock Returns”.
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