INSIGHTS

On September 07, 2010

The Cyclical Nature of the Unemployment Rate

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The jobs report gets scrutinized and then discarded. We anticipate its number every month only to dissect and disregard it. Who can blame the reader, investor or politician in the wake of volatile projections, its estimated results and only to have last month’s number revised in a most volatile manner? We argue that the month-to-month data mining is of very little use in coordinating ones portfolios; however, there is a more substantive way of measuring that is often overlooked.



Viewing economic data points resembles Chaos theory. The most basic premise of Chaos theory is that order exists where disorder primarily appears. The viewing of economic data from a granular stand point often lets one confuse noise for substance, or rather the existence of sap from viewing the trees rather than the forest. Patterns exist if the proper perspective is taken. Though we understand that the metric and its measurement is a very parochial perspective, it appears we have disregarded its historical importance.



On a long term trend we see 5 clear unemployment cycles with a new one appears to begin its descent. Consider the last 43 years of the cyclicality of the unemployment rate.

Unemployment Rate

Source: Bureau of Labor Statistics. See Charts/Graphs Disclosure.



The chart tells a tale of keeping proper perspective, but so too does measuring the returns of the S&P 500 (SPX) during the tales of each cycle. From trough to peak (rising unemployment), the S&P 500 returned an annual price decline of over 2.00%. On the other side of the equation, measuring peak to trough (declining unemployment), the S&P 500 averaged 9.40% annually on a price basis.



By smoothing out the numbers in an 18 period moving average (blue line), one can get a sense of when new directions in trends are in place. The number we got last Friday has put us at an inflection point. The 9.6% current unemployment rate is sitting right on the 18 month moving average. Historically the smoothing out of the line has proven fairly effective. There were several occasions where it breached the moving average (several in the 1980s and once in the early 1990s).



Many may feel that this time is different and a new upward stage in the unemployment cycle is waiting around the corner, or they may argue that this number does not measure the true level of the unemployed. We feel that this isn’t a new paradigm, a new normal or new frontier, rather a reversion to a more pragmatic consumption and leveraged economy. However, this is not a static position, rather a dynamic one. Just as every recession flushes out the system and erases excessive leverage from the previous expansion; it also builds a recovery that begins in a conservative manner. The recovery then proceeds to a full fledged expansion with each success resulting in a bit more leverage, a bit more consumption and a bit more confidence. Recoveries always start with stability translating into a feeling of progress. These incremental steps of progress evolve into expansion, and this expansion then leads to excesses. Thus, the economic game of chutes and ladders begins again with another roll of the dice.



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