The unemployment rate is already at its lowest level in 17 years, and still job growth continues to chug along at a solid pace. More workers are starting to voluntarily quit their jobs to take new jobs. And wages are starting to inch higher, too.
All of these trends are great for American workers. Why then, does the U.S. stock market decline when there’s good news about the job market?
Recall last month, when the Department of Labor showed wages grew at their fastest pace since 2009, stocks plunged that day. The Standard & Poor’s 500 index fell 2.1 percent, and the Dow Jones industrial average sank 2.5 percent — its biggest one-day drop since the Brexit panic in 2016.
[See: 7 of the Best Stocks to Buy for 2018.]
Investors are now gearing up for what could be another bumpy ride this Friday, when the Labor Department releases its February jobs report. Economists surveyed by Bloomberg predict the report will show the economy added 205,000 jobs in February, and wages rose 2.9 percent over a year earlier, before adjusting for inflation.
Could stronger numbers trigger another market pullback? It’s possible, particularly if strong wage growth stokes inflation fears.
“It is an odd thing to see some of the strongest economic news in years and watch the market fall because of it,” says Drew Gearhart, client consultant at Warren Averett Asset Management in Birmingham, Alabama. “Nevertheless, that is exactly what happened to U.S. markets just a few weeks ago.”
In every economic cycle, there’s a point where the good news just can’t get any better, says Anne Chernish, president of Anchor Capital Management in Ithaca, New York. “Then, the cycle busts,” she adds.
Perhaps, the U.S. economy is there now? It’s true, the economy is on its healthiest footing in years, and that strength coincides with more robust growth abroad, as well. For those reasons, investors are starting to worry increasingly that inflation could pick up, which could eat into corporate profits, and as a result, pose a headwind to stocks.
“Good news for workers doesn’t necessarily mean good news for stocks,” says Rick Brooks, portfolio strategist for Blankinship & Foster in Solana Beach, California. “Higher wages have to be paid by someone, and that typically comes out of corporate profits. Furthermore, inflation often means higher commodity prices, making manufactured goods more expensive to produce.”
[See: Warren Buffett’s 8 Favorite Stocks.]
Likewise, investors are also weighing every economic report against the Federal Reserve’s signals on interest rates. In December, forecasts from Fed officials showed the central bank is expected to raise interest rates three times this year. But since then, many analysts have speculated that the Fed will raise rates four times instead, in an effort to ease some brakes on the economy.
Indeed, new Fed chief Jerome Powell recently described “solid growth and a strong labor market,” adding that he expects inflation will “move up this year” combined with wage growth that “should increase at a faster pace as well.”
But he also was careful to temper those statements. “There’s no evidence the economy is currently overheating,” he said. “We don’t see any strong evidence yet of a decisive move up in wages.”
(The Federal Reserve’s next policymaking meeting is scheduled for March 20-21, and investors will have to wait until then to receive updated forecasts from the central bank.)
“Higher inflation usually leads to higher interest rates,” says George Kiraly, founder and chief investment officer for LodeStar Advisory Group in Short Hills, New Jersey. “Stock and bond investors are always concerned about inflation because it erodes the purchasing power of whatever money they earn on their investments. For example, if you earn 4 percent on an investment, but inflation is also running at 4 percent, your real return is actually zero. That’s why it’s so important for investors to keep pace with inflation.”
Gearhart adds that as interest rates rise, so too do borrowing costs for consumers and business owners, which would have an “adverse effect on their desire to buy houses or start businesses and ultimately stagnate growth in the economy.”
[Read: 5 of the Best Stocks to Buy for March.]
With stock valuations already high, Gearhart says, slower economic growth could cause a contraction in the market. “It is fear of this chain of events that ultimately changed good news into something scary,” he says.
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When the Market Hates Good News originally appeared on usnews.com
