There is compelling evidence of a predictive relationship between the unemployment rate
and future performance of stock and bond markets. Across developed economies, stock and
bond returns are weak when labor conditions are strong, and vice versa. A natural tension
has been observed between the rewards for capital and the rewards for labor in the short
How Is This Research Useful to Practitioners?
The authors explore the link between labor markets and asset markets by examining the
relationship between three measures of labor markets—the employment rate, the
unemployment rate, and changes in the unemployment rate—and future stock and bond
market returns. They find a surprisingly powerful and predictive relationship between how
well labor is faring in the present and how well capital will fare in the future. The
rationale could be a simple substitution effect: The more a company must pay for labor, the
less shareholders and bondholders can expect to earn on their investments. In the long run,
a healthy economy must allow for increasing rewards to both labor and capital, but in the
short run, rewards seem to be divided between labor and capital.
The authors’ univariate regression analysis demonstrates that (1) the unemployment
rate has marginally stronger predictive power for future stock excess returns than for bond
excess returns and (2) in the 24-month period after an unemployment rate announcement, the
stock market return will move more than 3 percentage points for each 1% change in the
unemployment rate. The link between unemployment and asset returns is material. The
multivariate regression, controlling for macroeconomic variables, again shows the strong
influence of the unemployment rate on the stock and bond markets.
How Did the Authors Conduct This Research?
The authors use return data from Global Financial Data for 22 developed countries and three
asset classes (stocks, bonds, and cash) over 1970–2013. They use monthly total returns
of a generally accepted major stock market index and a 10-year long-term government bond
index, as well as the country’s equivalent of the three-month US Treasury bill or
money market monthly total returns as a proxy for cash.
To test the relationship between the unemployment rate and future excess returns on stocks
and bonds, relative to either cash returns or one another, the authors perform univariate
regressions. They find a strong predictive link. They also perform a multivariate regression
to test the relationship between the unemployment rate and future excess returns on stocks
and bonds. The independent variables in the multivariate regression are the unemployment
rate, dividend yield, term spread, and real short-term rate. The unemployment rate’s
strong influence on the stock and bond markets persists, largely unaltered, after
controlling for the three macroeconomic variables when the country fixed effect is
The authors perform a Fama–MacBeth regression analysis to investigate the
relationship between the unemployment rate and capital market returns in a cross-sectional
context. It confirms the findings in the time-series analysis: A higher unemployment rate
suggests higher future capital market returns.
The key vulnerability of this approach is that changes in government policies or economic
conditions can alter economic statistics over time. The authors also tacitly assume that the
country effect remains constant over the entire study period.
This research raises several questions. Do labor and capital share a fixed pie whereby a
gain for one implies a loss for the other? Does this dynamic lead to important policy
implications for governments and economists? Will promoting labor over capital affect
capital investments? What impact on the labor markets can one expect from a policy that
promotes capital over labor? A great deal of further research in this area is warranted and
would be immensely useful in determining major macropolicy actions.