What to Expect at Stock Market Top—a Tightening Labor Market

(Updated 11/22/2021)

When Jeremy Grantham was asked the below question:

So you've called the Japanese bubble, the tech bubble, and the GFC. Is there a template to help uncover bubbles? And maybe, how were those bubbles different and how were they the same?

His answer was:

I think they're perfectly straightforward. They're intellectually easy and psychologically disastrously difficult. They're easy because in most cases they're so extreme. It's like how you notice the Himalayas when you're standing in Northern India. I mean, they come out of the plane and they soar up, you can't miss these things. 1928, '29 was just such a massive rally. So the sheer price rise you can't miss. Secondly, just to make it easier, the great bubbles have always tended to rise faster and faster towards the end, and that's a kind of defining feature also. And then thirdly, they have all been accompanied by massive, public, obvious crazy behavior where the headlines migrate from the financial page to the front page, where they migrate to the opening few sentences of the evening news on the radio or the television.

You can watch the whole talk in the Video 1 or read the transcript here. But, remind you that it's one thing to call a bubble, timing it is another thing!

(Updated 09/23/2019)

Where Are We Now in the Business Cycle? ^[6]

Based on the six-month moving averages, we can see that:

1. The Openings are below its record high since the start of the series in December of 2000 and the moving average has been above the hires levels for the last two and a half years.
2. Hires are above their pre-recession peak.
3. Quits are above their levels of last two recessions and just below its interim high.
4. The Layoffs and Discharges series is near its all-time low.

Based on two sources I'm following, both says that:

Low Unemployment Rate Signals Trouble Ahead

First, we will show a rapidly tightening job market based on the latest initial claims; then, we will show why Charles Nenner, Danial Carter, and Lyn Alden Schwartzer said that good job reports could signal trouble ahead for the stock market.

Video 1.  A Journey Through Bubble-Land with Jeremy Grantham (YouTube link)

Initial Claims

Initial claims for state unemployment benefits dropped 10,000 to a seasonally adjusted 210,000 for the week ended 02/24/2018, the lowest level since December 1969, suggesting an increasing demand for labor.^[4]

Charles Nenner^[2]

The following is what Charles Nenner said:

 “When unemployment is low, it’s the end of the bull market." 

Last Sunday, he published a chart that shows every time the unemployment is around 4.1% or 4.2% (e.g., in 1973, 1987, 1990, 2007), you have a market top. 

However, "Market tops are a process," he continued.

“The cycles saw a market top. It doesn’t always have to come down immediately, it just means the market will not go higher. I don’t think we will go back to the highs one more time because the quarterly cycle, and it is a long cycle, did top at the end of last year. I also want to put in a caveat about all this talk that we are in a 10% correction. Somebody came up with 10%, and it is not based on anything... 

The fact is we are totally out of stocks. What is coming is big, but market tops take time. I don’t think it’s going to go down immediately.” 

When will this new bear market hit bottom? Nenner says, 

“We should hit a major low in 2020... I have been on record saying that the next bear market goes down to 5,000. If you are in stocks, I say you could lose everything if the DOW goes to 5,000. This is the price target I have had for a couple of years.”

Daniel Carter^[3]

Because recessions are usually accompanied by market selloffs, an Unemployment Rate bottom is a great signal for telling us when to be more cautious with our equity investments. Below is a chart of the Unemployment Rate vs the S&P 500 (SPY).

You can see that a cyclical bottom in the Unemployment Rate usually closely coincides with a market top. However, like most market timing metrics, this metric is not perfect.

Lyn Alden Schwartzer^[8]

Unemployment picks up shortly before recessions. Markets usually peak before recessions. If you want to see the trend more clearly, look at the year-over-year change of the unemployment rate:

Figure 3.  Year-over-year change of the unemployment rate (source: St. Louis Fed; retrieved: 09/23/2019)

When the blue line goes over the black axis, it's certainly a good time to review your recession plan and make sure your portfolio has the appropriate risk structure for your unique situation.

Follow-up

(08/29/2019)

In [7], Guggenheim in its "Third Quater—2019 Fixed-Income Outlook," says:

While the labor market remains strong, we believe the sharp slowdown in aggregate hours worked—a component of our U.S. Recession Dashboard—foreshadows a deterioration in labor market conditions in 2020.

Figure 4. Aggregate Weekly Hours: Production and Nonsupervisory Employees: Total Private Industries 
(retrieved : 09/23/2019)

References

1. Initial Claims
2. Charles Nenner: "We're Totally Out Of Stocks, What's Coming Is Big"
3. Unemployment Rate Signaling Trouble Ahead
4. US weekly jobless claims drop to lowest level since 1969
5. Are We Really At Full Employment? 
6. Job Openings & Labor Turnover: Clues to the Business Cycle
7. Looking Past the Liquidity-Driven Rally
8. The American Consumer Is More Fragile Than People Realize