In January 2020, I closed one of my stock market lectures with a one-word warning:
Since then, every year has seen a new concern grip the stock market.
In 2021, it was the Fear of Missing Out (FOMO) over meme stocks, crypto and “moon-bound” NFTs.
Then in 2022… we had Inflation. Shares of energy stocks would soar, and commodity producers thrived.
Investors who foresaw these trends would have made millions. Work-from-home stocks like Peloton (NASDAQ:PTON) would see unprecedented gains during the pandemic. And my lighthearted recommendation of Dogecoin (DOGE-USD) during peak FOMO in 2021 returned 300% within months.
As we turn the page to 2023, a new concern is brewing. And much like my previous worries about the stock market, this one has the potential to upend investing in 2023:
The One Word Investors Should Fear in 2023: Unemployment
Recessions and unemployment have long come hand in hand. According to the St. Louis Federal Reserve, every recession since 1945 has been followed by at least a 2% increase in American joblessness. Larger crises like the 2008 financial crisis saw rates rise by over 5%.
Today, these concerns remain muted at best. In November, researchers at Goldman Sachs forecast only a 0.5% increase in unemployment.
“This cycle is different from prior high-inflation periods,” the researchers note. “… Long-term inflation expectations remain well-anchored, especially relative to the 1970s.”
The upbeat sentiment is echoed by Goldman’s peers, with Citi Global Wealth forecasting a 5.25% unemployment rate and Bank of America at 5.5% by 2024.
At first glance, these figures seem like an all-clear for stocks. Since 1945, unemployment levels following recessions have peaked between 6% to 14.7%; a 5.5% rate seems almost like good news. And this time around does seem different. The most recent Bureau of Labor Statistics (BLS) figures showed unemployment remained flat through November 2022.
Still, unemployment is my top concern for 2023 precisely because it’s getting overlooked. And as the past several years of stock market returns have shown, it’s these unexpected issues that have the most impact.
The 3 Reasons Unemployment Keeps Me Up
Start with the “this time it’s different” mentality. As a fundamentally focused stock market analyst, I’ve seen all of the typical warning signs of an impending recession.
Earnings guidance is getting cut…
Credit standards are tightening…
These are all indications of corporate belt-tightening. Last month, shares of women’s retailer Lululemon (NASDAQ:LULU) sank 15% after its management offered weaker-than-expected guidance.
“We also recognize that the external environment remains challenging with several high-volume weeks still in front of us,” CEO Calvin McDonald said in his Q3 earnings call. Many other retailers from Macy’s (NYSE:M) to Amazon (NASDAQ:AMZN) have echoed similar concerns and seen their share prices punished accordingly.
Next, consider the “shadow” unemployment rate. Since 2000, the U.S. labor participation rate has dropped from over 67% to 62% today.
The drop has been particularly acute among men, and those in younger working years. According to the St. Louis Federal Reserve, labor participation for men has fallen from 85% in 1958 to 68% today. Among people aged 20-24 years, the participation rate dropped from 75% in 2006 to 71% in the years after the financial crisis.
In other words, today’s low unemployment rate hides a significant underemployment issue. And as excess savings from the Covid-19 pandemic wear thin, consumers too will join corporations in belt-tightening.
Finally, there’s an emotional factor. In the scenario where unemployment “only” rises to 5%, today’s low starting point means that 2023 unemployment will be 35% higher than the level today. And if unemployment reaches 7% — a figure more typical of past recessions — that’s almost a 100% increase.
Similar changes have upended the finance world before. The increase in mortgage rates from 3.25% to 6.5% in 2022 was enough to halt an entire mortgage underwriting industry (and the homebuilding one too). When you’re coming from a low base, it’s the relative change that often means more than the absolute one.
Taken together, these three factors suggest that unemployment will punch well above its weight in 2023, even if it remains below 6%.
How to Invest in Periods of Unemployment
Investment sites have long touted job search and for-profit education companies as ideal ways to profit from high unemployment.
The truth is more nuanced.
That’s because there’s no pure “winner” from unemployment. Job search firms such as Robert Half (NYSE:RHI) tend to perform miserably during recessions as money from customers (i.e. employers) dries up. And struggling for-profit education firms like the now-defunct Corinthian Colleges have been replaced by profitless for-profit teaching sites like Coursera (NYSE:COUR). High unemployment makes it harder for people to afford these services!
The relationship between unemployment and stocks also depends on confounding factors. A working paper by the National Bureau of Economics Research (NBER), for instance, found that corporate earnings influence both during contractionary phases, while interest rates are more important in expansionary ones. It’s not a straightforward correlation.
That means investors are better off buying less-intuitive picks like consumer staples, consumer discretionary and healthcare stocks. As I outline in this article, these sectors tend to do well as a group during market downturns and rise during early stage recoveries
In a sense, there’s a bit of deja vu with my pandemic lecture in 2020. A global wave of misery is about to wash over a period of relative economic prosperity. But for those expecting the bad news, it makes it all the easier to pivot to protecting your net worth from the incoming wave of bad news this year.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.