Actual Higher Than Forecast: Good or Bad for Stocks?

A hypothetical company earns $5.00 a share and the market pays 20 times that, so the stock sits at $100. A strong economic report lands, analysts lift the earnings outlook by 2% to $5.10, and by the close the stock is at $96.90. Better earnings, lower price. Nothing in that sequence is a mistake, and the explanation sits on the rate side of the sum, which the green number on the calendar row tells you nothing about.

Does green on the calendar mean good news?

Many calendars color the Actual cell green when it comes in above the forecast and red when it comes in below. That is a comparison of two numbers. It says nothing about whether the economy is doing better.

For several rows, a higher number is worse. The unemployment rate is one. Weekly initial jobless claims is another, since more claims mean more people losing work. The inflation readings make up the rest, the consumer price index, the producer price index and the PCE price index, where a higher actual means prices rose faster than expected and the money in your account buys a little less.

Some calendars flip the color on those rows, so a higher unemployment rate shows red. Others color by direction alone. Both approaches are in use, and the same report can look cheerful on one screen and alarming on another.

How can a strong report push stocks lower?

Through rates. Price is the product of expected earnings and a multiple, the amount investors hand over per dollar of profit, and the multiple depends in part on interest rates, because bond yields set the return investors can get without owning stocks and because a higher rate shrinks what profits many years away are worth today. The lesson on valuation multiples covers what each multiple assumes.

A strong jobs or inflation number can raise the rates the market expects. Yields climb. The multiple slips. If it slips by more than the earnings outlook improves, the stock falls on good news.

Hold the multiple at 20 and the same earnings give $102, a 2% gain. Losing one point of multiple, a 5% cut from 20, more than wipes that out. The 19 is invented for the example, since nobody can say in advance how far a multiple will move, but the shape of the sum holds: one point off a multiple of 20 is worth 5% of the price, more than twice the earnings gain in the example. The lesson on interest rates and stock valuations goes further into why.

Which wins, the stronger economy or the higher rate?

Whichever the market is worried about. That is a pattern, and nobody can say in advance when the worry will switch.

When inflation is the worry, strong data gets read through rates. A hot jobs number means a tight labor market, which means wage pressure, which means a central bank less inclined to cut and possibly inclined to raise, and so a reading that would be welcome in calmer times knocks stocks lower on the day it lands.

When recession is the worry, the same strong number is relief. It says the economy is holding up and earnings with it. Stocks rise.

Between those two, the reaction can look random. It usually isn’t. The market is trading the worry, and the worry can change from one month to the next.

You can see which worry is in charge on your own screen. Look back at the last few big releases and note how stocks and bond yields moved in the hour after each one: if strong data sent yields up and stocks down together, rates are the lens the market is using, and if strong data lifted stocks while yields rose only a little, growth is. Do it before the next release.

Why does one number lift one sector and sink another?

Sectors differ in when their earnings arrive and in how much they borrow. A company whose value rests on profits expected far in the future loses more of that value when rates rise than a company paying out most of its earnings now, and a business that funds itself with debt feels higher rates twice, once in its multiple and again in its interest bill.

So a strong report that lifts rate expectations can push the index one way while individual groups scatter. The lesson on stock market sectors sets out what drives each group and which ones lean hardest on borrowing costs.

Why can inflation fall when this month’s change went up?

Base effects. Calendars often list inflation twice, as the change from last month and as the change from a year earlier. The annual rate is roughly the sum of the last 12 monthly changes. Each new month adds one change and drops the one from a year ago.

The figure is an approximation, because monthly changes compound and the exact annual rate comes out slightly different from the simple sum. The direction holds. A positive month can bring the annual rate down when it replaces a bigger one.

Now suppose the monthly forecast had been 0.3%. The same rough sum puts the annual forecast near 2.9%. The annual actual of about 3.0% is then lower than Previous and higher than Forecast, both at once. Which comparison counts? The forecast. The market had already expected a drop, and it got a smaller one. So the row reads as hot inflation, under a headline that says the rate fell, and a trader who reads only the headline and a trader who reads only the monthly row can walk away from the same release with opposite stories about it.

What do people get wrong on these rows?

The usual slip is comparing Actual with Previous. The market priced the forecast, and a reading can be above last month and still a miss. Another is reading the color without reading the row. Then there is the revision to Previous, easy to skip, which the walkthrough on how to read an economic calendar shows can add a lot to a modest headline miss.

Before each high-importance release, run through the row:

• Which direction is good for the economy?
• Which direction raises rate expectations?
• Which of the two is the market worried about now?
• What happened to Previous, and was it revised?

The economy question and the rates question often get different answers, and that is the reason to ask them separately. A strong payrolls figure is good for the economy and bad for rate expectations in the same minute, and the question about the market’s worry decides which of those answers the price follows.

Then size the gap. A higher actual that sits well inside the usual miss for that release barely registers, while one several times the usual size can reset rate expectations, which is the arithmetic worked through in actual vs forecast and how big a surprise matters.