Why Good News is Bad News for Stocks

stock market crash

It’s hard to argue that having fewer people out of work isn’t good news for the economy. More employed people means people are earning money, consumers have confidence to spend and it reduces government spending on unemployment benefits.

The good news is the number of unemployed people in the United States is at a seven year low. The number of jobs has now grown for 60 straight months. The unemployment rate fell to 5.5% in February, down from 5.7% in January and from 6.7% this time last year.

Surprised? Most economists are.

But we’re investors, not economists. Of all the indicators, the unemployment rate has historically had the largest influence on stock markets. Companies can make more money in a healthy economy, obviously.

But according to the stock market right now, low unemployment is nothing to celebrate. The US market responded to the news by dropping sharply — its worst day in more than seven months.

US benchmark index the Dow Jones, lost 330 points on Tuesday — its largest single day loss since October — more than wiping out its 2015 gains. And it was lower again last night.

Here’s the thing…the drop was attributed to the ‘good news’ of lower unemployment.

How does that make sense? Well, it’s nothing new.

For six years, the market has been spurred on by bad news, and even more bad news.

Because when the economy looks in trouble, out comes the Fed with more help to prop up the market with quantitative easing and low interest rates to encourage borrowing and spending.

It’s the same here in Australia. Bad news for the economy is seen as good news for the stock market.

Take last month. Disappointing economic growth and the high Aussie dollar pushed the RBA to cut interest rates in February. The local market rallied higher on the news of the rate cut. There’s good reason to be worried about the economy, but that weak economy is being celebrated.

And now good economic news in the US is seen as a bad thing for stocks.

But the question is now whether the improvements in the economy are enough to support the stock market at its record high levels? Or has the economy not actually improved as much as it might appear?

That looks to be the case with this week’s unemployment data at least. Taking a closer look, you’ll notice that while the unemployment rate fell impressively, wage growth was low, rising just 0.1%. That’s because nearly half of the new jobs created were in low-wage categories that do little to spur economic activity.

Additionally, the labour force participation rate fell, meaning fewer people were either employed or looking for work. Since 2008, the participation rate has fallen sharply. With jobs so hard to come by, people have given up their search.

The US market seems to believe rates will soon rise.

I question whether the economy can withstand higher interest rates and whether the Fed will be confident enough to test that in the next few months. Problems in Europe are pushing the US dollar even higher, and at some point, this will carry over to hit company earnings.

As for the market, it’s already looking expensive on a PE basis — that is, the price that stocks are trading at as a multiple of their earnings. That hasn’t been enough to derail markets up to this point, but if the Fed raises rates, many will question whether the market can remain at these levels.

A pause or correction to let earnings catch up to company valuations doesn’t necessarily mean the end of the bull market. The recent stock market falls could be nothing more than an overreaction.

Locally, the job data is due out today. With good news being bad news, you can expect the local market to take a hit if employment numbers are good.

Meagan Evans
Investment Analyst, Albert Park Investors Guild

Meagan Evans
Meagan Evans, has seen from the inside of the investment industry how easy money can lead to bad management decisions. She holds a degree in Finance and a Master’s in Business Administration and, as a Certified Financial Technician, Meagan employs both technical and fundamental analysis to make solid investment decisions

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