Why stocks are surging as jobs disappear

By U.S. News & World Report

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 60%, one of the most awesome rallies in market history. The Dow Jones Industrial Average ($INDU) 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.

While the Dow has been racing upward, however, the unemployment rate has also skyrocketed, from 8.5% in March to 9.8% now. The economy has lost 7.2 million jobs since the recession began at the end of 2007, and the trend is still going the wrong way. The unemployment rate will almost certainly hit 10% and hover near there before gradually declining.

So are job losses good for the stock market? Actually, yes. At least for a while.

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 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 (JNJ, news, msgs) said third-quarter revenue declined 5.3% percent but net earnings rose 1.1%.

Domino's Pizza (DPZ, news, msgs) said revenue declined 6% in the third quarter while net earnings soared 77%.

Abbott Laboratories (ABT, news, msgs) reported that its third-quarter revenue rose 3.5% but net earnings shot up 36.5%.

PepsiCo (PEP, news, msgs) revenue slipped 1.5% in the third quarter but its net earnings climbed 9.5%.

Alcoa (AA, news, msgs) said its third-quarter revenue rose 9% and it swung to a narrow profit of $124 million, compared with a $459 million loss in the previous quarter.

Each of these companies laid off workers over the last two years, probably necessary to keep the companies 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 both the stock and job markets.

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.

Some companies will be able to coast for a while. 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 domestic 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.

This article was reported by Rick Newman for U.S. News & World Report.