The Stock Market/Unemployment Relationship in USA, China and Japan

This study investigates the relationship between unemployment rate and stock prices in USA, China and Japan; the top three world economies. Recently, there have been some articles by financial analysts asserting that unemployment rate is a strong predictor of stock prices. They refer to certain short-term periods and posit a negative causal relation from unemployment rate to stock prices. They argue that declining (rising) unemployment would display an upturn (a downturn) in the economy, an increase (a decrease) in demand for goods and services, and would therefore lead to higher (lower) profits and stock prices. In this paper, using logical analysis, we argue that these views are misleading to potential investors. We hypothesize that there is no stable long-term causal relationship from unemployment rate to stock prices. Furthermore, using quarterly data in US, China and Japan over the 1970-2011 period, we provide empirical support for our hypothesis. The empirical analysis of this paper is based on cointegration and Granger Causality tests. Our findings have one important implication: it would be a mistake to rely on unemployment rate data to make investment decisions in the stock market.