Why Stocks Are Surging as Jobs Disappear

Companies are earning more because they have fewer workers. But it can’t go on forever.

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Stocks are up. Jobs are down. So if you're an investor you're enjoying a vibrant recovery and if you're a worker it still feels like a grinding recession.

Since bottoming out in March, the stock market has soared by about 65 percent, one of the most awesome rallies in market history. The Dow Jones Industrial Average cracking 10,000 may not be strategically significant, but it's a psychological breakthrough that's worth cheering after the demoralizing crash that preceded it.

[See 5 myths about the economic "recovery."]

While the Dow has been racing upward, however, the unemployment rate has also skyrocketed, from 8.5 percent in March to double digits now. The economy has lost nearly 8 million jobs since the recession began at the end of 2007, and the trend is still going the wrong way. It seems likely that the unemployment rate will hover above 10 percent well into 2010—while peaking close to 11 percent—and only decline gradually once it finally turns around.

So are job losses good for the stock market? Actually, yes. At least for awhile. Stocks are rising because many companies are earning more money than analysts have expected. But earnings aren't up because companies are selling more stuff; most companies are still selling less stuff and grappling with falling revenue. Instead, earnings are rising because companies have cut their costs more than revenues have fallen. And "costs" are often the same as "jobs." Consider these snippets from some recent earnings reports:

Johnson & Johnson. Third-quarter revenue was down 5.3 percent but net earnings rose 1.1 percent.

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Domino's Pizza. Third-quarter revenue down 6 percent; net earnings up 77 percent.

Abbott Labs. Third-quarter revenue up 3.5 percent; net earnings up 36.5 percent.

Pepsi. Third-quarter revenue down 1.5 percent; net earnings up 9.5 percent.

Alcoa. Third-quarter revenue up 9 percent, compared with the second quarter; net earnings swung from a $459 million loss to a $124 million profit.

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All of those companies have laid off workers over the last two years, probably necessary to keep the company healthy. And it's worth keeping in mind that when earnings outperform revenue, it's a sign that the company is well-run (assuming there's no Enron-style hocus-pocus). But CEOs also know that you can't grow a company or keep juicing the stock price by cutting costs and slashing jobs. Real growth only comes from new customers, new business, and increased revenue. And on that measure, the outlook is murky for the stock and job markets both.

The same workers who have been getting laid off, improving the cost profile for many companies, are also consumers running out of money to spend. Some are going bankrupt, defaulting on bank loans, and losing their homes. That's a major risk to corporate profits—and stock prices—down the road.

[See 10 retailers gaining strength from the recession.]

Some companies will be able to coast for awhile. The weak dollar and relatively strong economies in Asia and parts of Europe and South America, for example, are good news for U.S. exporters, since it helps them offset weak U.S. sales with stronger business overseas. And more-efficient companies can withstand lean times longer. But most American companies still rely on American consumers to keep business humming. Sooner or later, the U.S. job and stock markets need to go in the same direction.

The question is whether the job market will hitch onto the coattails of the stock market, with companies starting to hire as their fortunes improve—or stocks will turn south as the ranks of the unemployed swell. Good thing workers and investors both have become familiar with uncertainty.

Updated on 12/07/09: This story has been updated to include the latest economic data.