Unemployment and share prices

With the health of many economies in question, investors are worried about the performance of their stocks and shares. For instance, how do stock prices respond to bad news about unemployment?

In one study, three economists argue that rising unemployment potentially sends three distinct signals to stock markets. A higher unemployment rate conveys the information that:

Future interest rates are likely to fall, as the threat of wage inflation subsides.

There is an increased risk of a slowdown that could raise the equity premium – the additional return or risk premium shareholders demand over government bond rates.

Corporate earnings growth will slow, and future dividends will be lower.

The study analysed both stock and bond prices, because the latter are clearly affected by changes in interest rates, but are not affected by expected changes in the equity premium. During contractions (when corporate earning are on a decline), average stock prices fall in reaction to rising unemployment but bond prices do not.

On the other hand, during expansions both bond and stock prices rise significantly on negative unemployment news. Bond prices rise because of lower interest rates; stock prices also rise on the expectation of lower future interest rates – outweighing the prospect that higher unemployment is usually followed by slower growth.

Source: Why Bad News is Generally Good for Stocks, Economic Intuition, Winter 2001; based on John Boyd, Rai Jagannathan and Jian Hu, The Stock Market's Reaction to Unemployment News: Why Bad News is Usually Good for Stocks, NBER Working Paper w8092, January 2001, National Bureau of Economic Research.

For more on Economic Intuition research summaries http://www.economicintuition.com
For NBER text http://papers.nber.org/papers/W8092
For more on Stock Markets and Other Financial Markets
http://www.ncpa.org/pd/economy/econ11.html


FMF/11 September 2001