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.

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 applied.

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.