Why Stocks Go Up as Jobs Go Away

Stocks are up. Jobs are down. So if you're an investor you're enjoying a vibrant recovery and if you're a worker it still feels like a grinding recession.

Since bottoming out in March, the stock market has soared by about 60 percent, one of the most awesome rallies in market history. The Dow Jones Industrial Average cracking 10,000 may not be strategically significant, but it's a psychological breakthrough that's worth cheering after the demoralizing crash that preceded it.

[See 5 myths about the economic "recovery."]

While the Dow has been racing upward, however, the unemployment rate has also skyrocketed, from 8.5 percent in March to 9.8 percent now. The economy has lost 7.2 million jobs since the recession began at the end of 2007, and the trend is still going the wrong way. The unemployment rate will almost certainly hit 10 percent and hover near there for awhile in 2010, before gradually declining.

So are job losses good for the stock market? Actually, yes. At least for a while. Stocks are rising because many companies are earning more money than analysts have expected. But earnings aren't up because companies are selling more stuff; most companies are still selling less stuff and grappling with falling revenue. Instead, earnings are rising because companies have cut their costs more than revenues have fallen. And "costs" are often the same as "jobs." Consider these snippets from some recent earnings reports:

Johnson & Johnson (JNJ): Third-quarter revenue was down 5.3 percent but net earnings rose 1.1 percent.

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Domino's Pizza (DPZ): Third-quarter revenue down 6 percent; net earnings up 77 percent.

Abbott Labs (ABT): Third-quarter revenue up 3.5 percent; net earnings up 36.5 percent.

Pepsi (PEP): Third-quarter revenue down 1.5 percent; net earnings up 9.5 percent.

Alcoa (AA): Third-quarter revenue up 9 percent, compared with the second quarter; net earnings swung from a $459 million loss to a $124 million profit.

[See 8 industries that will sit out a recovery.]

All of those companies have laid off workers over the last two years, probably necessary to keep the company healthy. And it's worth keeping in mind that when earnings outperform revenue, it's a sign that the company is well-run (assuming there's no Enron-style hocus-pocus). But CEOs also know that you can't grow a company or keep juicing the stock price by cutting costs and slashing jobs. Real growth only comes from new customers, new business, and increased revenue. And on that measure, the outlook is murky for the stock and job markets both.

The same workers who have been getting laid off, improving the cost profile for many companies, are also consumers running out of money to spend. Some are going bankrupt, defaulting on bank loans, and losing their homes. That's a major risk to corporate profits—and stock prices—down the road.

[See 10 retailers gaining strength from the recession.]

Some companies will be able to coast for awhile. The weak dollar and relatively strong economies in Asia and parts of Europe and South America, for example, are good news for U.S. exporters, since it helps them offset weak U.S. sales with stronger business overseas. And more-efficient companies can withstand lean times longer. But most American companies still rely on American consumers to keep business humming. Sooner or later, the U.S. job and stock markets need to go in the same direction.

The question is whether the job market will hitch onto the coattails of the stock market, with companies starting to hire as their fortunes improve—or stocks will turn south as the ranks of the unemployed swell. Good thing workers and investors both have become familiar with uncertainty.

Comments

[cyclingscholar:]

To public employee hacks and those in the thrall of the Anointed One, the idea that cutting workers is the solution to bloated costs and unresponsive businesses is anathema. To them its always hire more, spend more. Look at our publik skools. Steadier worse performance for decades: but ever greater funding for teachers, programs, and facilities.

Oct 15 12:22 PM

[CautiousInv...:]

According to Thomson Reuters S&P 500 companies' revenue is expected to fall 11.4 percent in the third quarter from the year-ago period versus a 14 percent drop in the second quarter.

Obviously cost cutting has been responsible for companies beating continuously revised (reduced) estimates. And based upon various surveys, most executives intend to keep payrolls lean for the next six months or so; companies hunkered down are not positioned for growth.

What happens in the second quarter of 2010? Companies have slashed payroll to the bones and I think that will be the first quarter in which we will have an opportunity to observe the financial performance of companies operating under the new normal and the limits of improvements through cost cutting.

Other than exporters who are benefiting from the weaker dollar, I'm inclined to think most companies will report rather flat year-over-year results in Q210 unless they would cut costs further which would signal a further deterioration in the economy. Measured in operating earnings, companies earned around $14 in Q209 and the street is looking at $18 in Q210; if they come in flat we could see the market throw a temper tantrum.

Next year the debate between those who see a new normal and those who see a return to normal will be resolved with huge consequences for the market

Oct 15 01:17 PM

[markfl:]

Rick Newman wrote:

"The question is whether the job market will hitch onto the coattails of the stock market, with companies starting to hire as their fortunes improve. . . ."

According to minutes from a September FOMC meeting quoted by the AP, companies will be "cautious in hiring and investing even as demand for their products . . . [increases]."
www.google.com/hostedn...

Oct 15 01:42 PM

[Gary A:]

Cost cutting is so last quarter! Top line is where it counts. Either xmas sales will be way down or people will blow out their credit cards one last time and then default. Either way Wall Street will suffer.

You cannot have continuing decline in employment and earnings and have this smoke and mirrors of Wall Street gains continue.

Then you have Geithner stealing from the treasury for bonuses and to make his bankster friends whole, and you have some really PO People out there.

Oct 15 02:31 PM

[Gary A:]

One more point, it would not be such a problem to have high unemployment in a society where the consumer is less responsible for GDP. But in the US, the consumer is responsible, not the banks, not tech, not retail businesses. Therefore, for Geithner to help everyone except the driver of our and the world economy is not only theft, but it is treason. It is an outrage that Geithner got away with this and that no growth will result from these bailouts.

Oct 15 02:34 PM

[Kimball Corson:]

I have another take. Stocks are up because income is now so badly skewed toward the wealthy in America (half of all U.S. income goes to those earning over $85k/yr) that, in the absence of good orginal investment opportunities, much U.S. income gets dumped into secondary financial markets and together with low interest rates, drives prices up in those markets. In the early sixties a busy day on the NYSE was 5 million shares traded. Now, we have hit 5 billion a few times. That times average share price is serious mega bucks.

Oct 15 06:51 PM

[Moon Kil Woong:]

Asides from AMD most company's revenue is falling. Thus any upside from their earnings is coming off operating expenses. Or anotherwords they are getting rewarded for cutting costs, slimming down, and laying off employees.

Combined with the rest of the world going protectionist or pegging their currency to the dollars so the US will never balance their trade deficit, I don't see a bright shining future out there for US workers. Do you?

Oct 16 08:44 AM

[buoy:]

Did it ever occur to you that we are in a process. The US is in a process of cost cutting and leaning down to compete with are biggest challenge, the global economy.

Oct 16 09:45 AM

[ebworthen:]

You could apply this logic to the individual consumer as well; they have cut back out of necessity and planning.

This does not mean that they are fine because they may lose their job next month. Some have continued to debt spend, because...well...isn't that what the banks and our government are doing?

Others still have the disposable income and are buying because things are cheap and the government is offering incentives. I'm willing to bet a large part of cash for clunkers and home purchases were Parents buying for their kids just starting out. That is a limited spurt and does not have legs.

If reality ensues and earnings fall, debt repayment failures increase, unemployment increases, tax and sales revenues stay depressed or fall further; well, the party of the last seven months will end.

The powers that be are attempting an "all-or-nothing" slingshot at the Goliath of debt created over the past decade. If the momentum of the swing, the weight of the stone, and the release is not perfect; Goliath will not fall.

Oct 16 06:54 PM

[ebworthen:]

No, we are in the process of further defrauding the average worker of their hard earned money, destroying the middle class, growing the dependency class, and enriching the aristocracy of the banking, corporate, legal, medical, and political aristocracy.


On Oct 16 09:45 AM buoy wrote:

> Did it ever occur to you that we are in a process. The US is in a
> process of cost cutting and leaning down to compete with are biggest
> challenge, the global economy.

Oct 16 09:03 PM

[ebworthen:]

"...enriching and growing the oligarchy of the banking, corporate, legal, medical, and political aristocratic classes."

That is what I meant ;-)

Oct 16 09:08 PM