U.S. stocks open down after strikingly strong jobs report
NEW YORK, May 7 (Reuters) - U.S. stocks opened sharply lower on Friday, after a report showing strikingly strong jobs growth in April stoked fears of an earlier than expected interest rate hike by the Federal Reserve.
Here we have some seemingly very positive economic news: businesses are hiring more than expected and so surely must be doing more business than expected, higher profits, etc, ... . But, stocks go down, and it is reported that the drop is because of fears that interest rates will go up sooner as a result of growth.
Good news is bad news, bad news is good news. This has always puzzled me. How can it be so? It struck me this morning that maybe this reaction/interpretation is an outgrowth of a misguided belief in the correctness of the Fed Model. Interest rates go up, future earnings are discounted at a higher rate, so the value of the market goes down, per that model. But, the very thing that makes people fear higher interest rates is in fact a quickening of business growth, which itself means higher profits in the future.
Higher discount rate, higher profits: the two are offsetting, and the price shouldn't change. It appears the market is incorrectly linking real interest rates and nominal interest rates: increases in nominal interest rates on bonds are driving up the real interest rates available through stocks.
So, does this mean we have to wait for higher interest rates/inflation to drive stock prices back down to a higher return? Well, nominal interest rates are surely not the only factor affecting the stock markets real interest rate. And, predicting changes in nominal interest rates is a tough task (to say the least). But, it sure seems like some factors are lined up to push inflation: massive federal debt being a big factor in my eyes. I mean, geez, I have to admit I am basically in the dark here. But, just the simple facts that rates are sooo low, that business does seem to be picking up, and oil prices seem likely going to stay high/go higher given the unrest in the MidEast ... all these things make me think higher inflation and higher interest rates are in the pipeline.
So has widespread belief in the Fed Model (an incorrect application of the discounted dividends model of stock valuation) opened up an exploitable inefficiency in stock market pricing? If we 'know' that the intermediate future (say 1-10 years) will bring higher interest rates and lower stock valuations, then how do we exploit it? Will the increase in real interest rates available from stocks be paralleled by an increase in real interest rates available from TIPS (meaning their price will drop)? Are short term bonds/money market accounts a place where money can be stashed without loss of real capital? Do precious metals funds offer an asset class that might see growth in such an environment?
Well, I don't know the answers, but I have my strong hunches. And I have put my money behind them to some extent, with far more in short term/stable value type instruments than I would have if I didn't think a return toward mean in stock valuations was coming. Identifying the good is bad/bad is good conundrum and a possible explanation for it makes me feel a little more grounded in my strategy. So, does this make much sense? Any thoughts and comments are appreciated.
(editted for spelling)