Sunday, March 8, 2015

Stock Market & Jobs: What A Stupid Reaction

(Drivebycuriosity) - Last week we got another example how stupid the market can be. On Friday the Dow Jones lost 1.5%, the S&P 500 gave up 1.4% and Nasdaq slid 1.1%. Did we get bad news from the economic front line? Nope. Quite the opposite. On Friday morning we learned that the US job market is growing faster than expected: The US economy created 295,000 new jobs in February and continued the solid job growth of the recent months.

The market didn´t like the job report. Fund managers and other traders responded negatively and sold stocks. Good news are bad news? It seems that the solid job market report raised the possibility that the Fed will hike her interest rates next June (bloomberg). And the market hates nothing more than rising interest rates.

There is some mathematics behind the aversion: Stock prices (value of the company) reflect expected company profits. The current value of a company is the sum of all expected profits in the future, discounted with an interest rate (because a dollar tomorrow has less value than a dollar now). Rising interest rates mean bigger discounts, reducing the current value of the (expected) future profits. Everything equal rising interest rates translate into a lower value of the stock.

                                        One-dimensional View

But this equation shows just a one-dimensional view of the economy. We live in a world where nothing stays unchanged. On Friday the stock market ignored that more jobs will lead to rising incomes which will create more demand for goods and services and eventually translate into higher company profits. The market also ignored that the job report is a sign that the US economy is getting stronger and that economic growth is accelerating which also beneficial for company profits. So the interest rise will be over-compensated by gains in the profits. Even the discounted sum of the future profits is rising because company earnings are getting better.

I believe that Friday´s stock market reaction was just the usual hiccups and that the smooth rally of the recent months will resume soon.

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