writers, I feel a sense of community and a personal bond with readers. Many of you have taken time out of your lives to email me with your comments and concerns, an effort always reciprocated. In light of last week's terrible tragedies, incomprehensible in the true sense of the word, I'd like to borrow some words from Abraham Lincoln speaking after the Battle of Gettysburg and return them to you with a measure of prayer:
The world will little note, nor long remember, what we say here, but it can never forget what they did here.
It is to those great heroes of the World Trade Center, the police officers and firefighters who gave, in Lincoln's words, the last full measure of devotion, that I dedicate myself below.
Should we work to live or live to work? One of the U.S. economy's strengths since the early 1980s has been its almost miraculous ability to assimilate new workers into the labor force, even as vast investments in productivity eliminated entire job classifications, such as secretaries, that were once well-populated.
While the American practice of rapidly shedding workers may be regarded as callous and inhumane, it has allowed U.S. businesses to adjust quickly to changes in economic conditions and to keep their cost structures in line. This practice stands in stark contrast to the European welfare states, wherein "being on the dole" is an actual career choice and to the Japanese, who refuse to acknowledge anything bad has happened, is happening or, for that matter, ever will happen. Sayonara, Nikkei-san.
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The reaction Sept. 7 to the monthly employment situation report was a classic demonstration (as if we needed more) that, in a bear market, all news is bearish. The connection has been made that higher unemployment will decrease consumer confidence and consumer spending, and thus, depending on your point of view, either initiate or prolong a recession.
In March, I
wrote about retail sales and stock prices as a function of consumer confidence. The conclusions were that higher stock prices boosted confidence, but not vice versa, and that a negative wealth effect -- reduced consumer spending in response to lower stock prices -- was far more observable than any positive wealth effect. Let's see if we can throw unemployment into the mix and reach any conclusions based on a lengthy data sample, 40 years in this instance.
A Secular Economic Trend
The unemployment rate is one of the trendier economic statistics; it tends to move in the same direction for months on end, reverse suddenly and then proceed in the other direction for months on end. During the past 40 years, four periods of rapid increases in unemployment occurred: 1970, 1974, 1979-80 and 1991. Each of these periods was preceded by a period of weakness in the stock market. The 1970 episode, which was accompanied by rising inflation and interest rates, presaged a short-lived stock-market recovery and the establishment of a new all-time high on Jan. 11, 1973 -- a high that would stand until July 17, 1980, nearly 1,900 trading days later.
The 1974 episode also was followed by a strong rally from December 1974 to June 1975, a rally that dissipated quickly. The jump in unemployment in 1979-80 came amid double-digit inflation, the highest interest rates in modern U.S. history and the second energy shock of the decade. Needless to say, no one stepped up to the plate to buy stocks until the historic bull market began in August 1982.
The jobless-rate jump that came during the 1990 Persian Gulf War continued into 1992. Like the 1970 and 1974 episodes, it, too, was followed by firmer stock prices. The long bull market of the 1990s led and was accompanied by a long decline in the unemployment rate. Only when the stock market peaked in early 2000 did the unemployment rate stop declining.
The conclusion is similar to those reached for consumer sentiment and retail sales: Falling stock prices precede economic weakness and rising unemployment, while rising stock prices don't appear to be a consistent leading indicator of economic strength. A rise in unemployment, which is a lagging indicator, generally occurs after the worst economic news has already been discounted.
Unemployment and Interest Rates
before that the bond market is often more effective than the stock market in anticipating economic trends. This may be true in the long term, but in the short term, bond traders can embarrass well-meaning imbeciles, as they demonstrated last week in their reaction to a slightly higher, but still recessionary, Chicago Purchasing Managers' report. Their minute-to-minute reaction inevitably adheres to the discredited Phillips Curve notion of a trade-off between inflation and unemployment.
But, with the notable exception of the disinflationary early 1990s, note that yields and unemployment have tended to move more in the same, rather than in the opposite, direction. Falling unemployment creates a greater pool of savings and lower demand for government services, while rising unemployment usually stimulates poorly conceived and executed government stimulus programs that raise the risk level in the financial system.
What will the outcome of the present situation be? Given the Hooveresque fixation in Washington on a balanced budget amid an economic downturn, we're likely to remain in a contractionary policy mix of too-tight monetary policy and too-high tax levels. Monetary policy is ineffective in a surplus-capacity environment; why borrow to expand capacity when you can't sell what you're making already? Unless we see some tax cuts to spur demand -- and I mean some real tax cuts on marginal rates as opposed to the rebate nonsense of the present -- we'll stay in a recession and witness higher unemployment.
Past history suggests the market has discounted much of this outcome by now. Unfortunately, there's still nothing yet to suggest we're about to turn higher.
Howard L. Simons is a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of
The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to
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