Job cuts should be bad for stocks… so why aren’t they?
Layoffs are usually associated with worsening economic conditions. After all, if the economy is booming and demand is increasing, surely companies would need more – not fewer – workers. But why then do stock prices increase on layoff announcements?
Salesforce is an example. Salesforce announced that it would layoff around 10% of its workforce. But, the stock price increased 4% on the day.
Conversely, the market sometimes takes a ‘bad news is good news’ approach to employment data. For example, the market has fallen on better than expected jobs data. This looks odd: strong jobs data should be good for the economy and signal greater buying power.
The question is then why the market reacts in a seemingly idiosyncratic way to layoff, employment, and jobs data. The answer is that it depends on (a) what the market had already priced in, and (b) what new information is contained in the data release.
How then might the market react to layoffs?
When a company announces layoffs, the announcement may contain several pieces of information. (1) it might signal the firm had overhired and is now right-sizing its labor force. Perhaps the company had over-estimated its growth prospects or engaged in labor hording. (2) Layoffs can signal poor economic prospects. (3) Layoffs can signal that the firm is taking steps to mitigate those worsening prospects.
The market’s reaction will depend on what information it has already priced in and the nature of the new information. For example, if the market already knew that the firm’s growth prospects had decreased, but is surprised by the decision to mitigate those declines, then the stock price could increase.
What about economic data?
The market’s reaction to economic data is not always straightforward. Good economic data – such as strong employment – can signal that the economy is surging. However, it also implies information about what central banks, policy makers, or legislators might do.
Suppose that an economy is struggling with inflation. And, a strong labor market supports and exacerbates that inflation. Then, consistently strong jobs data can signal that the central bank will need to hike rates. This can be bad for stocks. The net impact on stock prices will depend on whether the bad news (rate hikes) offset the good news (consumer spending power).
Overall implications
The overall implication then is that investors must analyze news in a nuanced manner. Myriad announcements can signal multiple pieces of information. This includes layoffs, equity offerings, and takeovers.