Why Didn’t Stock Markets Move Higher?

The stock market tends to be a leading economic indicator.

Last week offered some insight to economics and stock market behavior. The U.S. unemployment rate reached its lowest level since 1969 and wages moved higher, yet major U.S. stock indices lost value.

Why didn’t stock markets move higher?

The answer is stock prices tend to be leading indicators. They reflect investors’ expectations for the future. Last week, investors may have been thinking like this:

When unemployment is low, companies cannot always hire enough workers…

To hire more workers, companies raise wages…

Higher wages give workers more spendable income…

More spendable income produces higher demand for goods and services…

Higher demand for goods and services leads to higher prices…

Higher prices (inflation) cause the Federal Reserve to increase the Fed funds rate…

An increase in the Fed funds rate pushes interest rates higher…

Higher interest rates make borrowing more expensive…

Higher borrowing costs may slow business spending…

Slower business spending may cause profits to fall…

Falling profits may cause investors to sell shares…

When investors sell shares, stock prices may drop.

In general, “…while it usually takes at least 12 months for any increase or decrease in interest rates to be felt in a widespread economic way, the market's response to a change (or news of a potential change) is often more immediate,” explained Mary Hall on Investopedia.com.

At the end of last week, 10-year Treasuries yielded 3.2 percent. Daniel Kruger of The Wall Street Journal reported, “U.S. government bond yields rose to their highest level in years Friday as investors reconsidered the strength of the U.S. economy while selling off stocks that could be hurt by higher borrowing costs.”

One of the best ways to manage stock market volatility is to have a well-allocated and diversified portfolio.

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