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In the Markets Now - The "Good News is Bad News" Economy Thumbnail

In the Markets Now - The "Good News is Bad News" Economy

(Baird’s Ross Mayfield wrote the following piece in August 2022)

WHY THE MARKET MIGHTFALL IF THE ECONOMY IS STRONG


We’ve explored many times before why the stock market and economy don’t track each other perfectly (in short, the stock market looks forward while economic data looks backward). But it is an entirely different prospect for the stock market and economy to seemingly oppose one another. Yet that is partly where we find ourselves today – a market that can react negatively if economic news is too positive. A world where good news on one hand can be bad news on another. 

But why might this occur? Let’s break it down. Inflation is the key problem facing the global economy, and central banks around the world are raising interest rates to combat it. At its core, inflation is a mismatch of supply and demand—too much demand, too little supply, or both. The Fed can’t do much about supply (e.g., pumping oil), but they can raise interest rates to try to lower demand throughout the economy.



On its face, lower demand is a negative. Consumer and corporate demand drive our country’s economic growth. But inflation is too large a problem to ignore. The worse inflation is and the longer it lingers, the higher interest rates go, the lower demand is, and the bigger the hole the economy enters. It’s hard to rein in inflation if the economy is too hot.

And so here we are: a world where a strong economy could be a bad thing for stocks if the Fed thinks it might further stoke inflation. One place in particular where this is true is the labor market. Every month, there’s a report that details the state of the labor market: unemployment rate, jobs added, wages, hours worked, etc. Julys blew through expectations. But in a world where a strong job market leads to robust wage growth and, ultimately, to price inflation (a classic wage-price spiral), the Fed will look on with caution rather than joy. Following the blowout July jobs report (528k added vs. 250k expected), expectations for interest rates rose—and stocks fell. 

We are living through a very confusing economic moment. Thanks to the millions of aftershock effects of the Covid-19 pandemic and Russia-Ukraine war, it can feel like up is down and bad is good. But this framework does seem to be the way of the world in the near-term: the Fed’s fight against inflation is THE market story, and everything else a byproduct. So, there will be days where the market reacts negatively to good news – like a blowout jobs report – or vice versa. Inflation still reigns supreme in the minds of investors, and whether the stock market has officially bottomed or not, the path forward will be determined by inflation and the reaction of the Fed. So, the next time the market sells off on seemingly good news and it feels a bit bizarre, just remember this framework.

As always, we are here to listen to and address any concerns you have about the markets or your financial plan.


Disclosures
This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.

This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should not consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report.

For investment advice specific to your situation, or for additional information, please contact your Baird Financial Advisor and/or your tax or legal advisor.

Fixed income yield and equity multiples do not correlate and while they can be used as a general comparison, the investments carry material differences in how they are structured and how they are valued. Both carry unique risks that the other may not.

Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.

Copyright 2022 Robert W. Baird & Co. Incorporated.