The unemployment rate is one of the most important economic indicators policymakers and investors have in gauging the health of the U.S. economy. More recently, it has become the central barometer for how investors view the direction in which the Federal Reserve may take its monetary policy.

While investors and the media are hyper-focused on the headline unemployment rate, it’s important to understand there’s more to the unemployment picture.

Components of Unemployment Index

The headline unemployment rate is calculated by dividing the number of unemployed people by the total labor force. The headline unemployment rate, or what the Department of Labor refers to as the U-3 unemployment rate, does not measure how many people are without work; rather, it measures how many people who are actively seeking work are unemployed. In other words, it ignores retirees, students, homemakers and others not actively seeking a job (sometimes labeled as “discouraged workers”).

There are other measures of unemployment, however, that can provide insight into health of the labor market, specifically:

• U-1, which includes only those who have been unemployed for 15 weeks or longer
• U-2, which only includes those who have recently lost a job
• U-4, which includes those who are actively seeking work and discouraged workers
• U-5, which includes those populations comprising the U-4 index, plus marginally attached workers (i.e., want and are available for work, and who have looked for a job in the last 12 months, but have not searched for work in the four weeks preceding the survey)
• U-6, which includes the categories in U-5, plus those who work part-time for economic reasons

Of course, the monthly unemployment rate report is backward looking, so its utility in assessing current economic conditions is limited. A better idea of what is happening more currently is gained through the weekly initial jobless claims report, which captures when people first file for unemployment.

Investors will also sometimes notice that the monthly employment report will indicate a strong increase in new jobs added over the previous month and a simultaneous increase in the unemployment rate. This appears counterintuitive, but it’s often a sign of an improving economy since it reflects individuals’ growing optimism of finding employment by coming off the work-search sidelines and entering into the “actively-seeking category,” which has the effect of raising the headline unemployment rate.

Assessing the labor market can be tricky and basing investment decisions on the health of the labor market alone is problematic, which is why investors should discuss with their financial professional how to integrate this important consideration into their tactical investment thinking.

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