Why tech stocks rally when companies cut jobs

Google’s parent, Alphabet Inc., GOOG-NE on Friday announced it will eliminate 12,000 positions, marking the tech giant’s deepest cuts ever and adding to concerns that the swell of layoffs by technology companies over the past several months is signaling gloomy days ahead.

So why are Google shares rallying? Evidence suggests that job cuts can be good news for share prices, and today’s environment may be no exception.

Consider that November was the worst single month for tech job losses in 2022, at 52,000. Yet the tech-heavy Nasdaq Composite Index has risen about 5 percent since then. January has been even worse for job losses, but the index is up 5.3 per cent so far in 2023.

“Investors want to see these companies get ahead of a softer economy. They were spending for hypergrowth that was unsustainable,” Dan Ives, managing director of equity research at Wedbush Securities, said in an interview.

Layoffs can be upsetting for employees, of course. But in the upside-down world of investing, in which bad news is sometimes good news, widespread job cuts are often embraced as an upbeat development.

Tech companies laid off more than 150,000 employees last year from the likes of Meta Platforms Inc. META-Q (Facebook’s parent), Amazon.com Inc. AMZN-Q, Shopify Inc. SHOP-T and Salesforce Inc. CRM-N, according to figures from website Layoffs.fyi.

In the first three weeks of 2023, companies have announced an additional 55,000 cuts, including Microsoft Corp.’s announcement MSFT-Q this week that it will eliminate 10,000 positions, and a raft of layoffs by Canadian tech companies.

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The layoffs have occurred after a rough patch for tech stocks: The Nasdaq has fallen more than 30 percent from its record high in November, 2021.

The continuing slide over the past 14 months has come amid surging inflation, rising interest rates and concerns about a looming recession, which have skewered tech stock valuations. But recent headline-grabbing layoffs have coincided with a more stable stock market – so far, at least.

The market’s reaction to specific companies underscores the trend particularly well.

Shopify’s share price has risen 27 percent since last July, when it announced it would cut 10 percent of its staff. Meta’s share price has risen 35 percent since the company announced 11,000 job cuts in November. Amazon’s share price has risen 13 percent since Jan. 5, when the giant said it would cut 18,000 employees.

Microsoft has essentially tracked the Nasdaq since Wednesday, when the company announced job cuts, making the stock a bit of an outlier so far. Alphabet’s shares jumped on Friday after its announcement, and closed up 5.7 percent.

The connection between job cuts and share price performance has appealed to many academics, analysts and investors, who have noticed that companies trimming their payrolls often perform well. Some research even suggests that the connection has grown stronger over time.

In a 2020 research paper titled The Market Loves a Layoff, Christopher Mace, a professor at the University of Texas at Dallas, found that share prices respond positively to proposed layoffs in the near term.

There are longer-term benefits as well. Despite concerns that layoffs can erode trust in a company and push remaining employees to look for opportunities elsewhere, Prof. Mace found that stocks outperformed over the three years after layoffs, more than offsetting any negative side effects. Larger layoffs generate the greatest returns.

The reason why job cuts can be good news for stocks? Prof. Mace tracked operating profitability, cost of goods sold, capital expenditures and administrative expenses before and after layoffs, and found that layoffs increase profits and decrease expenditures.

“Overall, my results consistently indicate that layoffs most often create firm value,” he said in his paper.

The current round of cuts in the tech sector follows a period when payrolls expanded rapidly at many companies. From June, 2021, to June, 2022, for example, Microsoft added 40,000 employees, representing growth of 22 percent in just one year.

mr. Ives argued that head count cuts – which he estimates are 5 per cent to 10 per cent across tech companies so far – are the first major step towards stabilizing stocks and setting the groundwork for the next growth cycle for the sector, as companies continue to spend aggressively on strategic next-generation fast-growing areas, while cutting back elsewhere.

“I view this as a rip-off-the-Band-Aid moment in terms of cutting costs,” Mr. Ives said. That is, it looks painful, but it delivers benefits.