Subscribe to Entrepreneur for $5
Subscribe

What Does High Unemployment Have to Do with Your Investments?

What does all this talk about unemployment have to do with your investments? Let's find out.

By
This story originally appeared on MarketBeat

The unemployment rate jumped in April 2020 to a level not seen since the 1930s. The unemployment rate (currently 5.9%) and the number of unemployed (9.5 million), has decreased from April 2020, according to the Bureau of Labor Statistics. However, unemployment remains higher compared to levels prior to the COVID-19 pandemic. Unemployment hovered at 3.5% and 5.7 million people in February 2020.

Depositphotos.com contributor/Depositphotos.com - MarketBeat

Unemployment data from Census’ Current Population Survey and the Department of Labor, show that millions of people are out of work and struggling to afford adequate food and pay the rent. Households with children also continue to face especially high hardship rates

Furthermore, the Household Pulse Survey says that 63 million adults reported that they've had trouble covering their living expenses. This number equates to 27% of all adults in the United States. 

Though the economy has added jobs in recent months, 6.8 million fewer jobs existed in June 2021 compared to February 2020. Most lost jobs include jobs that pay low average wages. According to the Labor Department, the lowest-paying industries account for 30% of all jobs but 53% of the jobs lost from February 2020 to June 2021.

So, does all this really affect your investments, and how? 

It can absolutely affect your investments. As we've seen, the influx of the more infectious Delta variant recently caused the Dow to drop 2.1%, the S&P 500 to tumble 1.6%, and the Nasdaq to go down 1.1%. The Delta variant has caused increased hospitalizations — and it could also affect Americans' ability to maintain employment down the road.

Beyond altruistic reasons, it's a great idea to help those in your community get jobs.

Consumer Spending Goes Down

A lack of jobs results in a lack of spending and this contributes to a stalled economy. The higher the unemployment rate, the slower the economy's recovery. When fewer people spend money, businesses can't succeed and may ultimately close their doors. 

In fact, according to the Federal Reserve Bank of Cleveland, personal consumption expenditures represent approximately 70% of the nation’s GDP. Factors that have contributed to past growth include improved housing market conditions and a slowly improving labor market all working to support growth in personal consumption.

However, in the case of high unemployment, even those with jobs may spend less money because they're scared to spend it. Less spending and more fear of unemployment discourages individuals to spend. In fact, they're more likely to save just in case that job loss does occur.

Therefore, less spending affects your investments. For example, if you invest in consumer cyclicals (goods and services not considered necessities, but discretionary purchases), the economy affects how well consumer cyclicals perform. 

Inflation Affects Your Investments

Average hourly earnings rose 3.6% to $30.40 in June. That’s the biggest spike since January 2009, according to data compiled by the Economic Policy Institute.

Meanwhile, the consumer price index jumped 5.4% over the same period — the most since August 2008, signaling significant inflation

In other words, consumers face a 1.7% loss in buying power, according to the Bureau of Labor Statistics. 

What does this mean for stocks? Higher inflation increases borrowing costs, increases input costs and reduces expectations of earnings growth, putting downward pressure on stock prices.  

Rising Interest Rates Also Affect Stocks

When interest rates remain low, people feel more comfortable borrowing for big things, like mortgages, for example. This can mean that a lower house payment can make them feel more comfortable spending money on other things, which boosts the economy. 

On the other hand, higher interest rates mean that consumers don't have as much disposable income and must spend less across the board. (The Federal Reserve probably will need to begin raising interest rates in late 2022 or early 2023 as increased government spending keeps inflation above its long-run average target, according to the International Monetary Fund.)

Naturally, during this time, banks make fewer loans because people will be less willing to borrow at these higher interest rates and due to higher lending standards. The cycle continues: Consumers cut back on spending, which affects businesses, which affects stocks.

Fewer Employees Means Fewer Profits

Finally, companies often don't make profits when they have fewer employees. Furthermore, they get charged higher taxes as well, to help the government afford unemployment benefits. 

The spiral continues: Companies have less money to hire employees, and when they face less demand for their goods and services, their stocks can plummet. 

What does this do for their current and future customers? They could start to lose faith in the company due to declining company health, which could affect stock prices.

Be Hypervigilant When High Unemployment Occurs

So, not a big surprise that the stock market becomes affected by unemployment, right?

  • Undeniable truth No. 1: When a lot of people face unemployment and the economy is bad, stocks don't perform well.
  • Undeniable truth No. 2: When the unemployment rate drops, stocks go up. 

However, as you've seen, stocks have recovered 91% from their March 2020 tumble. 

So, why has that happened, despite the fact that we've cited the reasons above? 

There are a few reasons, but we can point to a couple: Low interest rates have stimulated the economy. As part of the Federal Reserve's huge action to support the economy, it dropped the federal funds rate to zero. Furthermore, government action could have sparked confidence. The $2.3 trillion CARES Act, grants for businesses and low-cost loans could have helped give the stock market the kick that it needed last year.

However, it remains to be seen what will happen with the new Delta variant. For example, when schools reopen across the country in late August or early September, rapid employment growth could occur. Employment could go up when women return to work and don't have to worry about childcare. On the other hand, school closures or partial school closures could also affect unemployment, as women have to make choices between work and child care. This can affect the growth of the economy.  

No matter what happens, for better or worse, it can all affect your investments.