The U.S. economy just got a terrible-looking number.
The September non-farm payroll report showed an addition of just 29,000 jobs during the month, well below expectations for a gain of 90,000. On top of that, both July and August numbers were revised lower. July was actually revised down to a 10,000 job contraction, the fourth month in the past 12 that job growth was negative.
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But investors responded to that bad news by buying stocks. On Oct. 2, the S&P 500 (SNPINDEX: ^GSPC) closed up 0.7% while the Nasdaq-100 added 1%. While the number was bad from an economic standpoint, it was good from a market standpoint because it lowered expectations that the Fed would hike rates again in October.
Why is this “bad news is good news” dynamic working?
High interest rates have become one of the market’s biggest boogeymen. While the short-term impact can be minimal, over time they can increase borrowing costs, slow economic growth, and become a drag on corporate earnings.
But those things occurring while economic growth is still healthy and earnings growth is strong might not be the worst thing in the world.
In the current situation, slower job growth could lead to lower rates, but at the same time, potentially not slow the economy enough that a recession becomes a risk. If the economy can strike an equilibrium where inflation and interest rates fall but GDP growth and earnings growth remain positive, it can produce the ideal environment for stock prices to keep pushing higher.
If the situation deteriorates to the point where the Fed needs to lower rates sharply in order to try to avoid a recession, stocks are more likely to fall. Recession becomes the much larger risk.
What S&P 500 investors should watch now
This is a situation where you need to look at the complete picture: rates, inflation, geopolitics, GDP, corporate earnings, etc.
If rates remain elevated for several more quarters, they may be able to cool inflation without running the risk of recession. That’s likely the justification for why stock prices rose following the release of the non-farm payroll report.
If the economy slows significantly and the Fed needs to slash rates before the situation becomes worse, then you’re probably looking at a potential S&P 500 correction.
