Jobs, GDP and Stock Market Return

Last week’s economic data was overall positive. The most notable piece of economic news last week was the Nonfarm Payrolls Report. Last month nonfarm payroll rose by 227,000 according to the Bureau of Labor Statistics (BLS). The BLS also revised up the nonfarm payroll numbers from December and January by 20,000 and 41,000 respectively. The unemployment rate remained unchanged at 8.3% which was most likely due to the increase in the participation rate from 63.7% in January to 63.9% in February.

We now have had three consecutive months with at least 200,000 jobs added. The average increase of jobs within those three months is close to 245,000 while averaging a participation rate of 63.87%. We did some quick math using those two averages along with the population growth rate to determine how long until we get unemployment back to 5%. After running the calculation, we determined it would take approximately 34 months to bring the unemployment rate back down to 5%. If you are interested, here is a nice calculator provided by the Federal Reserve Bank of Atlanta that allows you to try out different scenarios.

Generally speaking, when our economy is at or below 5% unemployment, our GDP tends to grow around 3-4% annually. In fact, you can see from the chart below we have had several periods in the last 50 years where our economy has grown at or above 4%.

Initially, this may comfort you as an investor because it’s logical to assume positive GDP growth correlates to positive stock market returns. However, there is a significant amount of data actually showing a slight negative correlation between GDP and stock market returns.

We get lulled into believing there is a positive correlation between GDP and stock market returns, specifically when discussing emerging markets. We hear about rapid GDP growth in the emerging markets and we think that a rising economy should translate into rising asset prices. This is not necessarily the case for a number of reasons:

• GDP is based on sales/revenue (top line); stock returns are based on corporate earnings (bottom line)
• The stock market is not the whole economy.
• Corporate earnings may be earned outside of its home country
• Estimating GDP is not an exact science
• Shareholders can be hurt by dilution
• Poor corporate governance can negatively impact share price performance

It appears many of us gain comfort in assuming that positive GDP growth will lead to positive returns for their investments, but it turns out to be actually quite the opposite. As you can see from the table directly above, there is a strong positive correlation between GDP growth and lagged equity returns. Thus equity markets appear to be a leading indicator of GDP Growth. Based on this data, we should be looking for favorable valuations in areas with sustainable growth and the potential to provide upside surprises.

If you have questions or comments please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can Email us directly.

Tim Phillips, CEO – Phillips & Company