While the normal folk lost their jobs and their houses, Wall Streeters got off relatively easy. Sure, maybe some of them lost their jobs as well — but the general feeling was that the big banks set the middle class up to fail, then were let off the hook with mass bailouts.
Well, the middle class may soon have its revenge, albeit in indirect fashion, according to recent commentary from Minneapolis-based Leuthold Group.
That’s because as Main Street workers enjoy their lowest unemployment rate in 18 years, the fact that it’s so low could be portending a very dangerous period ahead for markets, according to Leuthold’s chief investment strategist, Jim Paulsen.
And when the market melts down, Wall Street trims the fat.
At first glance, it may seem counterintuitive that a strong Main Street labor market is a signal of future market wreckage. But, as Paulsen points out, it’s when positive conditions get stretched too far that markets are most vulnerable to a shock — largely because everyone is overly confident and complacent.
He also notes that low unemployment is generally characteristic of upward pressure on resource costs, high business confidence, higher inflation, rising yields, and restrictive policies. None of those things are particularly conducive to prolonged market strength.
“Low unemployment highlights an economic character which simply has not historically been hospitable for financial markets,” Paulsen wrote in a recent note. “Investors should appreciate the ‘rare air’ they are currently breathing.”
If you still don’t believe Paulsen, consider the chart below, which plots the S&P 500 alongside the US unemployment rate. As you can see, periods when unemployment has been below 4% (signified by the red dots) have usually preceded stock market declines throughout history.
You’ll note that the last time unemployment slid below 4% was in 2000 — the height of the tech bubble, and perhaps the most glaring example of both investor and consumer overexuberance in US history.
This dynamic also played out to a degree around the financial crisis of 2008. While unemployment didn’t break the 4% threshold, it came mighty close, and we all know what happened next.
“During the post-war era, the stock market has never done well when the unemployment rate is at or below 4%,” Paulsen said. “Yes, ‘never’ is a strong word, and while some of the red dots in this chart do go up, they have never risen in a persistently successful fashion.”
And as the mid-2000s financial crisis showed, the health of markets has a direct effect on Wall Street employment. By the end of 2008, in the meltdown’s immediate aftermath, banks had cut more than 200,000 jobs.
Wall Street has always been more directly intertwined with financial markets than Main Street. That’s because deals — and fees — immediately grind to a halt when everyone gets nervous. Financing becomes nearly impossible to obtain, and capital markets grind to a standstill.
Not to mention the huge hits traders usually take during times of turmoil. In addition to the outright losses associated with big declines, the type of overconfidence that usually precipitates a major market event usually keeps traders from adequately hedging.
It’s during times like these that Wall Street firms look to streamline operations by cutting costs — which inevitably means laying off employees.
“While admiring how great the underlying stock market fundamentals are today, Wall Street employees may also want to locate the closest government unemployment office,” Paulsen said.