Why historically high unemployment should embolden investors to take more market risk, according to a Wall Street chief strategist

• The still-lofty unemployment rate offers investors the latest sign to return to the stock market, James Paulsen, chief investment strategist at The Leuthold Group, said Thursday.
• The S&P 500's average annual return in years when the unemployment rate exceeded 8% is roughly 25%, the strategist observed. When joblessness slid below 4.5%, the index notched yearly gains of about 8.4%.
• Lofty unemployment rates signal "the outsized potential that future economic conditions are destined to improve because employment will ultimately recover," Paulsen said.
• As economies recover and hiring picks up, so does spending and corporate profit growth, he added.
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Widespread joblessness is the latest sign for investors to position for a stock market run-up, James Paulsen, chief investment strategist at The Leuthold Group, said Thursday.

June's jobs report revealed a 4.8 million increase in nonfarm payrolls and saw the unemployment rate slide to 11.1% from 13.3% the month prior. The reading is the second straight improvement for the US labor market since the unemployment rate spiked to 14.7% at the start of the coronavirus pandemic. Even though joblessness remains at dire highs, history suggests strong market gains will continue, Paulsen wrote in a note.

In every unemployment-rate spike since 1948, the S&P 500 performed better on average. The index posted average annual returns of 18.7% whenever the rate crept above 6.8%. Whenever the rate breached 8%, the benchmark notched an average 25% annual return.

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The correlation is relatively simple. According to Paulsen, high unemployment rates signal "the outsized potential that future economic conditions are destined to improve." Joblessness would recover, incomes would rise, and spending would bounce back. All in all, investors can bet on the eventual reacceleration of profit growth after a bout of economic pain.

Several experts fear the stock market has already run too hot and underestimated the likelihood of a second downturn. Yet Paulsen pointed to the recessions of 1982 and 2009 as precedent. The market's trajectory so far mimics the two prior rebounds, and both past recessions hint at more gains to come in 2020.

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The echoed trend isn't a coincidence, according to the strategist. The 1982, 2009, and 2020 recessions all featured the largest increases in unemployment of the post-war era. In turn, all three economic contractions "possessed the uncommon opportunity for outsized economic improvement."

The economy still faces long-term scarring from the coronavirus pandemic. Trade faces major hurdles as countries recover from the outbreak on disjointed timelines. Consumer confidence is unlikely to fully rebound until a proven coronavirus vaccine hits the market. Yet the recessions of 1982 and 2009 gave way to lengthy bull markets, and the early stages suggest 2020 will be no different.

"Investors should be appreciating how much room there is for 'improvement' in the coming years, how policy officials are aggressively attempting to bring better times, and how the stock market, in these conditions, typically does fantastic!" Paulsen said.

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