One of my commuting pleasures as I drive from client to client is listening to podcasts from the Planet Money team at National Public Radio (www.npr.org/money). Each week, the intrepid reporters do an outstanding job of exploring and explaining, in laymen’s term, a wide range of economic topics.
While listening to a recent Planet Money podcast (available through iTunes), I heard the first explanation that really made sense for me about why the stock market seems to improve early in a recovery cycle, while unemployment only comes down much later. Here’s what I learned…
During an economic downturn, as business turns soft, companies lay off workers to reduce their labor costs. They don’t need as many people to produce the lower amount of goods and services demanded during the recession.
When the turnaround begins, demand for products and services starts increasing. Now remember that employers have just laid off millions of workers, and those unemployed people are not around to start producing the additional products and services demanded. Instead, the people who weren’t laid off have to work harder to meet the increasing demand, and they’re willing to do so because they don’t want to be laid off. Thus, at the start of the recovery, productivity increases.
Economists tell us that increasing productivity is good for the economy, and it’s also good for company profits. Companies’ profitability improves because revenues are going up faster than labor costs (remember, all the still-working hamsters are spinning their wheels faster to keep up and keep employed). And what are stock prices based largely on? Profits and revenue growth (remember your P-E ratios). The result: stock prices climb.
Finally, the recovery gets to the point where most companies believe it will continue, and there’s a realization that the hamsters are getting tired. That’s when companies begin hiring again.
That’s true of our current recession and recovery, and has been true for many cycles in the past.
I highly recommend the Planet Money podcast. It’s free, and I think you’ll enjoy it.