Last Thursday U.S. stocks had their worst day in two months, when the Commerce Department released data showing U.S. GDP grew 2.8% in the third quarter, which was much stronger than expected. The next day the BLS released its closely watched employment report, which showed a much stronger than expected 204,000 increase in new jobs for October. Initially, the stock market moved lower in response to this positive surprise.
As long as monetary policy is the focus of the stock market, bad economic news counter intuitively leads to stronger equity prices as investors anticipate a continuation of the Fed’s aggressively easy monetary policy. This dynamic began to fade earlier in the year, but re-emerged in September when the Fed surprised the market by not tapering QE.
The influence of the Federal Reserve over the stock market over the past five years has grown to a historic extreme. We believe that corporate earnings will eventually re-emerge as a primary driver of the stock market. We may seeing some initial signs of that dynamic as stocks were able to rally into Friday’s close and reverse all of Thursday’s losses in spite of the better than expected economic data.