Slow Economy Rewrites Stock Market Rules
Aug 11 9:53am ET
By Chelsea Emery
NEW YORK (Reuters) - Gone are the days when announcements of job cuts sent stock holders jumping for joy and share prices soaring.
"When equity markets were doing well, investors saw layoffs as positive," said Dan Rivera, chief investment officer of American Express Asset Management Group's large-cap growth division. "They thought cuts could make companies more efficient, expand profit margins, and make them able to produce at a lower cost."
These days, layoffs push stocks under water as investors see the cuts as a last-ditch attempt to pump up corporate profits amid a global economic slowdown. It's the latest sign that the lagging U.S. economy has rewritten the rules of the stock market.
Investors now see drastic layoffs, such as telecom equipment maker Lucent Technologies Inc.'s announcement it will lay off 15,000 to 20,000 employees, as a sign things are getting worse.
"There's a whole new round of recession-type strategies being employed by Lucent and American Express," said Ned Riley, chief investment strategist for State Street Global Advisors, which oversees $720 billion. "There's a feeling that the unemployment rate will go up even more, hurting stock values and eroding the wealth that people had been relying on."
In an unscientific survey of 17 technology and blue-chip companies reporting job cuts recently, shares fell in all but 3 instances the day the announcement hit markets. The stocks fell an average of 12 percent.
While stocks are not benefiting from layoffs in the short term, past evidence shows that the long-term picture is bleak, too. A 1999 research study of 377 companies by consultancy Bain & Co. found layoffs did not improve long-term stock-price performance.
Companies that cut more than 15 percent of their work force over three years performed below average and those announcing repeated layoffs did even worse, the study said.
STOCKS TUMBLE AFTER JOB CUTS
Lucent shares plunged 19 percent on July 24 after it announced the job cuts and a wider-than-expected quarterly loss. The company also said it would take a charge related to the job cuts and asset write-offs.
Shares of American Express Co. , dropped 3 percent the day the financial services firm said it would slash as many as 5,000 staff, on top of a previously announced 1,600 job cuts, and said it would take as much as $1.2 billion in charges because of fallout from the weak economy.
Compare this with the early 1990s, when shareholders cheered layoffs as sign of management's discipline and conviction to raise profitability by any means necessary.
Shares of copier maker Xerox Corp. climbed almost 6 percent when the company said it would slash 10,000 employees, or about 10 percent of its work force, back in December 1994.
And shares of Scott Paper Co. rose about 4 percent on Jan. 26, 1994, when the paper products maker said it would cut a quarter of its work force, or 8,300 employees, to reduce costs.
Indeed, a 1999 study of layoffs at Fortune 100 companies between 1977 and 1993 found job cuts in combination with a restructuring resulted in better short-term and long-term stock performance.
But job cuts as a penny-pinching measure resulted in flat to slightly lower share prices, according to the study's authors, Rice University professor Geoffrey Love and Harvard Business School professor Nitin Nohria.
And many of the cuts these days are just that, measures to rein in costs, said Ed Rankin, chief executive at outsourcing firm PeopleSolutions.
"There is a market cleansing happening right now. Most companies are not repositioning, they are scaling back," Rankin said.
MARKET SHIFT
The shift in the market's response to job cuts stems from the slumping economy. Job losses are accelerating as gains in gross domestic product slow. GDP is a key measure of economic health and recently showed a mere 0.7 percent annual rate gain. That's the slowest growth rate since 1991, when the United States was mired in a recession.
Slowing economic growth hinders sales of products, which forces companies to cut back on production. Thus, fewer workers are needed.
And, as layoffs continue -- 770,000 job cuts have been announced by U.S. companies in the past six months, according to outplacement firm, Challenger, Gray & Christmas -- consumers become worried they, too, may lose their jobs. They then cut back on spending, cutting into product demand even more.
"Now the market isn't reacting well to layoffs," said Rivera. "Investors wonder if consumers can keep buying enough to keep the economy out of recession."
In addition, layoffs now signal the economy may be getting worse, leading investors to pull out of stocks.
"It's a short-term cost-cutting move," said Louis Navellier, who helps oversee $6 billion for Navellier and Associates in Reno, Nevada. "But all you're doing now is going from negative to less negative. (The layoffs) really don't help."
To be sure, stocks do not drop solely because the company has fired workers. Instead, investors see companies forced to fire employees are also facing slumping sales, and have said profits are likely to miss forecasts.
Still, the shift in the market's reaction(THE SHIFT,this is what needs be watched--sentiment,in general shifting,as i have said it is very hard to shift sentiment,but once it does shift it is very hard to reverse the shift-max) to job cuts illustrates how the economic decline has rearranged the definitions of so-called "good" news and "bad" news, investors say.
"Generally, layoffs raise stock prices because they are considered a sign of discipline by management -- that it will be responsive to financial realities," said James Walsh, author of "Rightful Termination," which examines hiring and firing strategies. "But during concern about a general economic slowdown, the effect is reversed. Layoffs signal a struggling economy and show that even responsive management can't avoid the problem." |
