Employment numbers, or unemployment numbers depending upon your perspective, are a very important metric for the U.S. economy. As such, investors watch monthly employment reports released by the government very closely. But, why is the rate of employment, or unemployment, so important to the economy and Wall Street?
At the very macro level, the American economy is made up of two parts, private spending and government spending. Broken down further, private spending can be split into spending by business and spending by individuals. In this country, spending by individuals makes up the largest part of economic spending. In a very real way, whatever direction consumer spending is going in, the economy is going in as well. Some times, there is a lag, but generally, if consumers are spending less, then the economy is shrinking.
While it is true that people who are unemployed will be spending less money, their presence actually creates a bigger effect on the economy. When you see on television that a company is laying off workers, that impacts your mental state on a certain level. If the company isn’t in your state and not in your industry, it may barely register. On the other hand, if the company is local and you work in the same field, that might make you more nervous. However, nothing registers quite as deeply as knowing people who are unemployed. If you have one friend out of work and they are optimistic about their prospects, the impact is limited. If you know several people who are unemployed, and they are all very bleak about finding a job, this will impact your confidence severely. Thus, the more people who are unemployed, the more people there are who, even while employed, will be nervous. In other words, each tiny movement in the unemployment numbers hides a large multiplier effect.
People change their spending habits based on how they perceive their current situation. As an example, consider someone with a job that they feel is stable. A person in this situation would run out and buy a new washing machine if their current one broke down. This person might even upgrade to a pricier model with more features. In fact, the same person might also buy a dryer that matches the newer, better washing machine. Now, consider the same person who has a job, but does not feel as secure about it. That person is more likely to buy only a washing machine. In fact, that person is more likely to stick with a lower-end bare bones mode rather than upgrade.
This lower spending, and tendency to save “just in case” ends up pulling money out of the overall economy and because consumer spending is the largest part of the U.S. economy, that reduced spending has an out-sized impact.
So, next time you see Wall Street reacting strongly to yet another employment number or figure, you’ll know why. On the long-term horizon the direction of employment is directly correlated to the direction of the economy. However, always remember that the stock market is a leading indicator (it moves AHEAD of the actual state of the economy) while employment numbers are a lagging indicator (the numbers tell you what already happened BEFORE). When the predictive nature of a leading indicator proves to be wrong by the data from a lagging indicator, the correction can be severe.
These days, Wall Street and the stock market are setting new records because investors believe that the economy is improving, no matter how slowly. If a series of unexpectedly poor employment numbers prove otherwise, the correction could be dramatic.