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How the Market Works

Why Rising Unemployment Matters: How the Market Works

Posted by kdadmin on October 7th, 2016.

Why Rising Unemployment Matters:  How the Market Works

First off, I’m not in Florida. One tropical storm (Hurricane Hermine) was enough for me. Thanks to all of you who asked or wished me well.

Second, the unemployment data came out today. It continues to rise. Contrary to the pundits’ rationalizations about how it doesn’t matter, just look at the chart above and tell me that over the last ten years there is no direct correlation between the stock market (SPY) and the Unemployment Rate.

Why Rising Unemployment Matters

What do you notice in the chart above? Isn’t there a pretty obvious inverse (opposite) correlation between the two? If unemployment goes up, the stock market goes down, and vice versa.

The back story is that if companies are hiring more people, chances are they are producing more products and services, selling them at a profit and making more money, per share, than last year. That means, that each share of the company produces more income than it did last year, and is therefore more valuable.

If, on the other hand, companies are hiring fewer people, or laying people off, chances are that they are making fewer products and services, still selling them at a profit but probably making less money per share than last year. So, each share of stock produces less income and is therefore less valuable.

The End.

No, I’m serious. It really is that easy.

What Does This Mean to You?

If you own stocks, you are getting yet another indication that they are overpriced. And maybe there will be a few more percentage points to eek out of them over the next few years, but the risk of loss is still massive.

Compare that to owning bonds. Assuming your bonds are of a good quality (you’re not buying the debt of unstable companies), chances are that you’ll earn your interest and dividends even if the company becomes less profitable than in previous years. Even if their stock prices fall. Of course, if they go out of business, and you owned just one bond in one company, you’d be screwed. But I never do that. I always buy bonds of several companies in some sort of fund (exchange traded usually). So if one goes bankrupt, we’ve still got another thousand to buoy the fund.

TheBottom Line: Count Your Blessings

Sure you’ve made some money in the stock market. Heck, there were several years in the early 2010’s where we were doing 15%/year. That’s GREAT. But like I said in my last post, The Secret to Successful Investing – How the Market Works, KEEPING gains is just as important as making them in the first place.

The most dangerous time to invest in a market is the tail end of a bull market, when things start to flatten out (returns, inflation, GDP, manufacturing demand) and others start to rise (unemployment, interest rates). This is when amateurs are most confident and tend to make their biggest bets. It’s also often when they lose the most money.

I have some clients who are in love with certain stock positions. Selling them is nearly impossible. I accept that. However, such positions should never amount to more than 5-10% of their portfolio. If they can stick to that rule of thumb, even if they lose it all, it’s unlikely to have a long term effect on their overall portfolio.

The Next Steps?

Learn about bonds. Start here.

Then, contact me to review your portfolio.

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