Last Friday the employment report for the month of February was released, and it was quite good. 295,000 jobs were added for the month and the national unemployment rate dropped from 5.7 to 5.5 percent. It should be noted that the unemployment rate, which can bounce around from month to month, declined in part from a decrease in the labor force.
A separate report showed the unemployment rate in California dropping to 6.9 percent in January from 7.1 percent in December. The reported state figures are typically one month behind the national figures. While the unemployment rate in California remains well above the national average, it is still a major improvement compared to the 12 percent rate we had coming out of the prior recession.
The job gains nationally were fairly broad based across a wide variety sectors. Job gains have now been consistently increasing at over 200,000 per month for the past 12 months. This is a significant increase compared to the amounts we saw in recent years. What was a little surprising was seeing a strong number, when much of the country experienced one of the coldest February’s on record.
When there is good economic news the bond market typically sells off. That is interest rates rise. On the day of the report the 10-year Treasury increased from 2.12 percent to 2.25 percent. This would imply that home mortgage rates would rise by a similar amount.
While the increase in interest rates was not surprising, the stock market declining over 1 percent on that day was. During the past 15 years, much of the time the stock and bond markets have moved in opposite directions. Part of the reason is that over the past 15 years, we have not experienced normal economic times.
During much of the second half of the second century stocks and bonds tended to move in tandem. That is when interest rates rose stocks fell, and when rates fell stocks rose. That is consistent with finance theory in that a future stream of earnings is worth more when interest rates are lower.
In recent history that relationship broke down for basically two reasons. During periods of economic stress there is greater uncertainty about future earnings, so a decline in interest rates will not help stock valuations, if earnings are falling. In addition interest rates had become so low that further declines were of little benefit.
The concern for investors becomes whether what we saw this past Friday represents a change, or was just an aberration from the trend of recent years. My sense is that the stock market sold off because the market is now expecting the Fed to begin raising interest rates sooner than previously expected.
We have had short-term rates near 0 for so long that there is some element of concern on how the economy will perform with the eventual increase in rates. Because interest rates are so low, a modest rise in rates should not have a material impact on the economy.
I think for the near term what happened on Friday with the stock market declining along with the bond market was a one-time event. At some point in the future, when interest rates are at higher levels, the stock and bond markets may move together more than they have recently.
If the employment report had been weak, with longer-term interest rates declining, the stock market probably would still have sold off. This is in part due to the stock market being near an all time high, and any news that doesn’t meet expectations will be perceived negatively.
Obviously for the economy overall it is a positive to see more people working. Despite improved employment data wage gains remain fairly mediocre. If the unemployment rate continues to fall, eventually we should see stronger salary increases.
Despite what happened this past Friday, with the stock market declining on good economic news, a better economy should be positive for stocks over time. With the stock market near its all time highs, it is not reasonable to expect the type of gains we had in recent years. However, I doubt that the market action of last Friday was the start of a new trend between stocks and bonds.s