Why stocks go up when things are bad

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Tuesday, Nov. 1, 2022

Today’s newsletter is by Sam Ro, the author of TKer.co. Follow him on Twitter at @SamRo. Read this and more market news on the go with Yahoo Finance App.

If stock prices only went up after you got confirmation of good news, then investing would be pretty easy.

Unfortunately, that’s not quite how it works.

In theory, a stock reflects the present value of all the future cash flows a company is expected to make. And as time goes on and those expectations evolve, a stock will fluctuate. More or less.

Simply put, stock prices mostly reflect expectations for the future, and not so much what’s happening now or what’s happened in the past.

This is relevant today as the S&P 500 has rallied sharply from its Oct. 12 low, and yet corporate earnings are deteriorating, economic growth is slowing, and unemployment is expected to rise. Meanwhile, the Federal Reserve is expected to hike interest rates again this week, which should put even more pressure on the economy.

The apparent divergence between the stock market and the economy does not necessarily reflect irrational behavior. Rather, the stock market may just be anticipating a bullish turn in the economy in the weeks and months to come.

Michael Cembalest, chairman of market and investment strategy for JPMorgan Asset Management, explored these relationships in an Oct. 19 research note with some illuminating charts. (Via Michael Batnick)

“There is a remarkable consistency to the patterns shown below: equities tend to bottom several months (at least) before the rest of the victims of a recession,” he wrote.

As you can see, stock prices (dotted blue line) tend to inflect upwards before we see improvements in earnings (red line), GDP (yellow line), and employment (purple line).

Cembalest notes that the dotcom bubble of the early 2000s was an outlier in the pattern with earnings inflecting ahead of a market bottom. However, the market rally did begin before the labor market turned around.

“As for the latest bear market, it appears on the right,” he argued. “I see no reason why this cycle will not end up looking like most of the other ones. If so, the bottom in equities will occur even as news on profits, GDP and payrolls continues to get worse.”

It’s certainly possible that the S&P will fall below its October low before inflecting higher. And it’s certainly possible that would signal further deterioration in the economic data. Investing isn’t easy and perfectly timing market bottoms is nearly impossible.

The bottom line: Don’t be surprised to see stock prices move higher even as economic conditions deteriorate. It just might be the case that the economic data will soon turn, in which case the market bottom would’ve happened long ago.

What to Watch Today

Economy

9:45 a.m. ET: S&P Global U.S. Manufacturing PMI, October final (49.9 expected, 49.9 during prior month)
10:00 a.m. ET: JOLTS Job Openings, September (9.750 million expected, 10.053 million during prior month)
10:00 a.m. ET: Construction Spending, month-over-month, September (-0.6% expected, -0.7% during prior month)
10:00 a.m. ET: ISM Manufacturing, October (50.0 expected, 50.9 during prior month)
10:00 a.m. ET: ISM Prices Paid, October (53.0 expected, 51.7 prior month)
10:00 a.m. ET: ISM New Orders, October (47.1 during prior month)
10:00 a.m. ET: ISM Employment, October (48.7 during prior month)
WARDS Total Vehicle Sales, October (14.50 million expected, 13.49 million prior month)

Earnings

Eli Lilly and Company (LLY), Pfizer (PFE), BP (BP), Advanced Micro Devices (AMD), Sony Group (SONY), Mondelez International (MDLZ), Airbnb (ABNB), Eaton Corporation (ETN), Marathon Petroleum (MPC), McKesson (MCK), Uber Technologies (UBER), Thomson Reuters (TRI), Devon Energy (DVN), Phillips 66 (PSX), American International Group (AIG), Sysco (SYY), KKR & Co. (KKR), Prudential Financial (PRU), Sirius XM (SIRI), ZoomInfo Technologies (ZI), Clorox Company (CLX), Match Group (MTCH), H&R Block (HRB), Western Union Company (WU), SoFi Technologies (SOFI)