Opinion: How bad news on Wall Street can be good news
The meaning of stocks' positive reaction to Friday's bad jobs report
CHAPEL HILL, N.C. (MarketWatch) — You can pretty much rule out the possibility that the U.S. economy is in a recession — Friday's weaker-than-expected jobs report notwithstanding.
That's because of the stock market's strong rally in the wake of that report. According to a fascinating academic study, such a rally most likely would not have taken place had the economy been in a recession.
This "bad news can be good news" story puts into an entirely different context the comments of some Federal Reserve governors who continue to entertain the prospect of an interest-rate hike in the remaining three months of this year. Though their insistence has struck many as totally inscrutable, if not downright crazy, this study suggests their response might actually make sense.
The study, "The Stock Market's Reaction to Unemployment News: Why Bad News Is Usually Good For Stocks," appeared a decade ago in the prestigious Journal of Finance. Its authors are two finance professors, John Boyd of the University of Minnesota and Ravi Jagannathan of Northwestern, along with Jian Hu, a managing director at Moody's Investor Services.
The researchers found that, during economic expansions, the stock market's average reaction to unemployment news is just the opposite of what it is during recessions. During expansions, weaker-than-expected unemployment news is considered a good thing; just the opposite is typically the case during recessions. (See chart above.)
This is why Friday's triple-digit rally was so significant. Not only was September's job creation total unexpectedly low, but the previous estimates for July and August were also revised lower. Commentators' immediate reaction ranged from "ugly" to "couldn't have gone much worse."
Had we been in a recession, the academic study suggests, such dismal news would have been taken as unambiguous evidence that the U.S. economy was weaker than previously thought — and the stock market would have fallen. As fate would have it, of course, the Dow rallied 200 points, or 1.2%. The S&P 500 was even stronger, gaining 1.4%.
You might object to this analysis since the stock market's initial reaction to the unemployment report was to plunge. At Friday's open, for example, the Dow plunged more than 230 points. But Professor Jagannathan, in an interview, said that the full day's reaction to unemployment news is very likely a more reliable signal than the immediate reaction. That was what he and his fellow researchers focused on in their study, which analyzed data back to 1962.
Just because the U.S. economy may not be in a recession doesn't mean that happy days are here again, of course. But the stock market's continued strength on Monday of this week — when the Dow rallied another 300 points — increases our confidence that the positive interpretation of Friday's unemployment report is on target.
Posted by: sarah_oz@yahoo.com
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