Why Wall Street Loves High Unemployment

09/08/2009 3:30 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

You’d think that last week’s jump in the August unemployment rate to 9.7%—the consensus among economists was for just 9.5%—would have sent stocks tumbling. After all, if more people are out of work, consumers will buy less. And it’s not exactly a vote of confidence in the economy that companies still aren’t hiring.

But when Wall Street’s in a bullish mood, it manages to find a way to turn bad news into good—at least for the short run.

The current story on why high unemployment is good for stocks runs like this:

Because companies are still cutting payrolls—another 216,000 jobs lost in August—while the economy is stabilizing, corporate profits will be higher than expected in the third quarter.

Fewer workers on the payroll results in lower costs. And that means a higher percentage of revenues reach the bottom line as profits—especially since companies aren’t paying more overtime to those who are working. The average work week for August came in at 33.1 hours, just six minutes a week above the 33 hours recorded in June. And June’s number was the lowest since the US Department of Labor started tracking this figure in 1964.

As I understand the argument, Wall Street figures that since unemployment is a lagging indicator on the economy—that is, unemployment doesn’t go down until well after the economy has entered recovery—corporate profits could therefore come in higher than expected in the third quarter.

In the short term, that might be true. The second quarter showed a huge 6.6% jump in calculated worker productivity as fewer workers did more to meet demand that was up from the dismal levels of the first quarter. Some economists are predicting an even bigger jump for the third quarter.

But in the longer run? Like way out in 2010—the distant future, from Wall Street’s perspective?

It’s hard to see a sustained pick up in demand and economic growth with unemployment still rising and with the real unemployment rate—the rate that includes all those who are unemployed, underemployed (working part time but looking for full time work), and so discouraged that they’ve stopped looking for work—at a shocking 16.8%.

And Wall Street’s rosy interpretation of the data ignores the possibility that the signs of economic recovery we’ve seen represent nothing more than companies rebuilding inventories they sold down during the worst of the recession. If that’s the case, demand will weaken again as companies finish rebuilding their inventories and they don’t reorder because consumers, worried that so many are out of work, don’t return to buying.

In my opinion, the jury is still out of this one. In my post today on JubaksPicks.com,  “The recovery isn’t yet a sure thing,” I note that some companies are behaving as if what they’re seeing is inventory rebuilding and not a return of end demand.  

Related Articles on MARKETS