Employment and Stocks Over the Intermediate Term

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 July 2011 (739 months), we find that:

The following chart compares the behavior of seasonally adjusted non-farm employment and the S&P 500 Index over the entire sample period. Visual inspection suggests the possibility of positive relationship between the two series, but the much higher volatility of stocks makes comparison difficult.

For a closer look, we compare the monthly changes in employment (employment growth) to monthly future stock market returns.

The following two scatter plots relate next-month returns for the S&P 500 Index to monthly employment growth (released near the beginning of the next month) over the entire sample period and over the subperiod since the end of 1990.

Over the entire sample period, the Pearson correlation for the two series is -0.01 and the R-squared statistic 0.000, indicating no relationship between the two series.

Over the recent subperiod, the Pearson correlation for the two series is 0.08 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 returns.

Results are not encouraging of a belief in a useful relationship.

To check for 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. The non-systematic variations across quintiles and inconsistencies across subperiods undermine belief in any useful relationship between employment growth and future stock market behavior.

Quintile subsample size is about 147 (74) for the entire sample period (subperiods).

Might the relationship between monthly employment growth and monthly stock market returns be stronger over some longer forecast interval?

The next chart plots Pearson correlations for various lead-lag relationships between monthly employment growth and monthly S&P 500 Index returns since 1950 and since the end of 1990, ranging from stock market returns lead employment growth by 12 months (-12) to employment growth leads stock returns by 12 months (12).

Over the entire sample period, results suggest that a past stock market advance (decline) offers slight indication that employment growth will be relatively strong (weak) over subsequent months. In contrast, relatively strong or weak employment growth says practically nothing about future stock returns, with a hint of a contrarian indication.

Over the recent subperiod, results confirm that a past stock market advance (decline) offers indication that employment growth will be relatively strong (weak) over subsequent months. Unlike the longer term results, relatively strong (weak) employment growth is slightly positive (negative) for future stock returns. Results for this recent subperiod, with all positive correlations, suggest that the duration of any major trends in employment and stock returns during this time may exceed the lead-lag intervals considered.

The differences in results between the entire sample period and the recent subperiod could be due to some structural change in the economy or to some fairly long-term random fluctuation in the employment-stocks relationship.

In general, the predictive power of monthly employment growth appears too weak to be useful as an stock market timing signal. Could aggregating changes in employment over quarterly and annual intervals enhance predictive power?

The next two scatter plot relate next-quarter and next-year returns for the S&P 500 Index to quarterly and annual employment growths (with 2010 a partial year), respectively, over the entire sample period.

At quarterly measurement 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 returns.

At annual measurement intervals, the Pearson correlation for the two series is -0.27 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 returns.

In other words, there is some indication that relatively strong (weak) employment growth forecasts a relatively weak (strong) stock market over these forecast horizons.

As a final robustness test, we look at average future quarterly stock market returns by quintile of quarterly employment growth.

The final chart summarizes average next-quarter S&P 500 Index returns by quintile of quarterly employment growth over the entire sample period. The non-systematic variation across quintiles undermines belief in any useful relationship.

Quintile subsample size is about 49. The sample period is too short for reliable subperiod breakdowns.

In summary, evidence from simple tests offers little support for a belief that monthly or quarterly changes in U.S. employment usefully predict intermediate-term U.S. stock market returns. Over longer intervals, the relationship appears to be inverse.

Cautions regarding findings include:

• Analyses are in-sample. An investor operating in real time would not have access to data for the entire sample period. Given the relatively few business cycles in the sample period and the less than encouraging results with an in-sample tailwind, out-of-sample stock market forecasting based on historical employment growth data is problematic.
• 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 growth 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.

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