Economic Update | “Bad News”, and Stock Markets Surge

submitted by
Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast

Markets started the year anticipating six interest rate reductions by the Fed, while the Fed was proclaiming three. Continued moderation of the Consumer Price Index (CPI) along with Fed speak gave the markets confidence that 2024 would be the year of rate cuts.  Stock markets surged as a result.

A few columns ago, I offered that the narrative of “stagflation” would begin to enter the national scene. Stagflation is the combination of slower growth and inflation, or elevated prices.  This was reinforced with the first quarter GDP report showing quarter-over-quarter growth of 1.6%, along with CPI reports showing that inflation was greater than expected. Interest in the term “stagflation” surged on Google Trends, peaking during late April. The market went from pricing six rate reductions down to possibly two.   

All this changed with the national employment report released on May 3^rd. Jobs added came in at 175,000.   While this would normally be considered a solid month, it was significantly under the market-expected level of 240,000 plus. A few weeks ago we talked about equity markets in search of “bad news”, and it hit the jackpot on May 3^rd!   The average workweek declined to 34.3 hours, along with average hourly earnings. Along with the slowdown in payrolls, the unemployment rate increased to 3.9%, from 3.8% the prior month. Inferences from the national employment report were supported by a prior report on job openings, showing additional declines. The S&P surged more than 1% on this “bad news”. The weaker payroll growth put rate cuts by the Fed back on the table. Last week, new claims for unemployment ticked up to the highest level since August. The CME Fed Watch Tool is now showing the odds of the first Fed rate reduction in September, and another one in December, although with less than convincing current probabilities. 

There has been other “bad news” over the past couple of weeks. The ISM Services Index, a measure of service-side activity of the economy, unexpectedly declined to 49.2, signaling contraction in the largest part of the economy. During the pandemic, the service side of the economy had cooled considerably, as consumers flocked to goods spending. Since then, goods spending moderated, and services fueled economic growth. The ISM Services Index has been under 50 in only three different periods since 2009:  April and May of 2020, December 2022, and the last reading. The index happened to be released on the same day as the employment report, and this was additional “bad news” for the positive stock market response. 

Survey data have also cooled over the past few weeks.  The Small Business Optimism Index has been declining since December and is now at the lowest level since late 2012. Respondents point to inflation as the top business problem. Measures of consumer optimism have also waned.  The Conference Board consumer confidence measure, which leans more on employment and job security,  declined to 97, less than the market consensus and lower than the prior month of 103.1 The University of Michigan consumer sentiment measure, which is aligned more with consumer finances, plunged to 67.4, under the expectation of 76.5 and lower than the prior month of 77.2.

Locally, employment across the five Louisville Metro Southern Indiana counties (Clark, Floyd, Harrison, Scott, and Washington) is down from last year. This measure of employment is not necessarily country-specific. That is, the place of employment could be outside the five counties, in Kentucky, for example. So, negative changes in employment in the five counties do not necessarily imply that jobs are shrinking in these specific counties. But here is an interesting observation of negative year-over-year changes in Southern Indiana employment. In the last 30 years, a negative change in employment is usually associated with a recession, either a year or so before or during. A negative year-over-year change in employment occurring without a recession happened only once, and that was in 2004.

How fast conditions can change!  Since as recent as the third week of April, the Dow, S&P, and NASDAQ are all up around 5%, reversing losses of the prior month. The market is getting the bad news it was seeking, and now interest rate cuts will need to materialize to sustain gains. The problem with cuts is that a weaker economy is usually the cause.