This invites the famous quip of the late Paul Samuelson: the stock market has predicted nine of the last five recessions. However, this means the market has done better than economists, who have predicted zero of the last five.
In fact, there are two strong reasons why the market should predict unemployment.
One is that there’s a direct causal link. Low share prices mean firms face a high cost of capital, which prevents them expanding and hiring more workers.
The other is that there’s a diagnostic link. If investors anticipate bad times, share prices will fall before firms start sacking workers.
It shouldn’t surprise us, therefore, that Professor Farmer’s finding also applies to the UK. For example, share prices rose strongly in the mid-80s and mid-90s, just before unemployment fell sharply. And the stock market falls of the late 80s and 2008 preceded rises in unemployment.
And here’s the problem. It’s not obvious that share prices have risen sufficiently to presage a big drop in unemployment. Sure, they’ve done well in recent months. But, adjusting for inflation, the All-share index is only six per cent higher than it was in May 2011. This is way short of the 30-per cent gains that preceded big falls in joblessness in the late 80s and mid-90s.
Of course, the relationship between share prices and unemployment – like any macroeconomic relationship - is a noisy one, so this doesn’t entirely rule out a sharp drop in joblessness. But it warns us that there’s a danger of unemployment staying high for a while longer. And it also tells us that a rise in share prices should be welcomed not just by equity investors but by cash savers and workers too.
