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When bad news is bad news Commentary: Market's reaction to jobs report suggests U.S. is in a recession By Mark Hulbert, MarketWatch Last Update: 12:01 AM ET Sep 12, 2007 ANNANDALE, Va. (MarketWatch) -- Making sense of the stock market's reactions is never easy. But it appears to be especially inscrutable in the face of unexpectedly weak news on the employment front. Sometimes it will rally in the face of such news. Yet, at other times, such as Friday, it will plunge. Believe it or not, the market's behavior may not be so mysterious after all. Let me start by reviewing what happened Friday. The Labor Department reported before the market open that nonfarm payrolls had dropped by about 4,000, far worse than the 115,000 increase that was the consensus expectation of a group of economists that MarketWatch had polled. See Economic Report The stock market plunged on the news. The Dow Jones Industrial Average ($INDU:Dow Jones Industrial Average dropped some 160 points at the open, on its way to losing 250 points for the session. To make sense of the market's varied reactions to seemingly bad news, I turned to an academic study from several years ago that examined the reaction to unemployment news., "The Stock Market's Reaction to Unemployment News: Why Bad News is Usually Good News for Stocks," was conducted by finance professor John Boyd of the University of Minnesota, Jian Hu of Moody's Investors Service, and finance professor Ravi Jagannathan of Northwestern University. See study The researchers found that when the economy was in recession - as later determined by the National Bureau of Economic Research, the unofficial arbiter of when recessions begin and end - the stock market typically fell when the unemployment news was unexpectedly bad. But when the economy was in an NBER-declared expansion, more often than not the market rallied. The reason the market reacts differently during recessions than during expansions, according to the researchers: When the economy is growing, the positive effect of a strong jobs report is more than outweighed by the negative effect of the interest-rate increases that such a report makes more probable. Just the reverse is the case following a weaker-than-expected jobs report. Now the bad news of the jobs report is more than outweighed by the good news that the Fed will have less pressure on it to raise rates. During recessions, in contrast, interest rate hikes are less of a threat. So a strong jobs report is taken at face value as good news, and a weaker-than-expected report is considered to be bad news. The researchers' findings are summarized in the accompanying table. Economy expanding Economy contracting Job news unexpectedly good Stock market likely to fall Stock market likely to rise Job news unexpectedly bad Stock market likely to rise Stock market likely to fall Based on the patterns the researchers found in their study, we can use the stock market's behavior as a barometer of whether the economy is more likely to be expanding or contracting. Why, you might ask, do we even need such a barometer? Don't we already know if we're in a recession? Unfortunately, not. Recessions typically aren't declared to have started by the NBER until months later. In some cases, in fact, the recession is over before the NBER confirms that it had even started. So such a barometer could be helpful. What does all this mean for today? The market's plunge Friday in the face of unexpectedly bad job news is yet another straw in the wind that the economy may be a lot weaker than previously had been thought. As with all conclusions based on a statistical analysis of the historical precedents, this one comes with no guarantees. But I for one would be more confident in the economy's health if the stock market had risen Friday rather than fallen. Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.