Chart 64

Unemployment and the 1 Percent Rule

There has been a historically tight relationship between the stock market and economic recessions (see Chart 25). But, there has also been a tight relationship between unemployment and recessions. So, with a twist, you can use unemployment as a nifty warning signal of major buy signs. Here's how.

This chart shows the unemployment rate against a backdrop where periods of economic recession are shaded red. The white sections represent economic expansions. The unemployment rate is defined to be those seeking jobs divided by the total of all employed workers and job seekers. Notice that unemployment falls during expansions and rises during recessions. That may not surprise you. But notice how evenly unemployment rises and falls throughout recessions. For instance, there is not a single case of unemployment rising a full percentage point during an expansion (see left-hand scale). But it regularly rises at least one full percentage point during the first two-thirds of a recession. In contrast, as you see in Chart 25, the market drops before a recession begins; by the time the recession is halfway over, the stock market is already anticipating a better future and soaring upward.

This leads to my “1 percent” rule, which states: If you want to benefit from a major stock market bottom, you had better be fully invested whenever the unemployment rate has just risen one full percentage point. While neither this indicator, nor any other, will perfectly ...

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