Stock Market’s Dirty Little Secret

It’s a taboo subject to discuss in public, but corporate executives would prefer to buy back their own stock than hire more people this year. Meanwhile, investors want unemployment to stay at elevated levels so that the Federal Reserve stays accommodative.

"While unemployment is a terrible circumstance for individuals and families, I am sure some companies believe they are better off with fewer people and are hiding behind a supposedly weak economy to keep their ranks thin, focusing instead on greater productivity from their current employees and ensuing higher margins," said Stephen Weiss of Short Hills Capital.

Goldman Sachs estimates that companies in the S&P 500 will increase spending on buybacks by 25 percent this year, far and away the biggest increase among possible capital deployments. A distant second are cash acquisitions, which should jump by 15 percent, according to Goldman. The latter could actually lead to higher unemployment as merged companies fire employees with duplicative jobs.

Capital expenditures will increase by 12 percent. Not to shabby, but Goldman doesn’t breakout how much of that are new machines and plants and how much of it is new hires. Dividends and research and development will rise by 11 percent and 10 percent respectively. Goldman’s equity strategist David Kostin, among the most bullish on Wall Street, believes this strategy will cause the S&P 500 to return 19 percent this year.

"What really evolved out of the great recession is a structural shift to focusing on increasing productivity," said Joe Terranova, Chief Market Strategist for Virtus Investment Partners and a ‘Fast Money’ trader. "It’s why technology has done well. You need fewer humans to expand margins."

Fed Chairman Bernanke basically said as much yesterday to Congress in his testimony on the economy before the House Budget Committee.

"While indicators of spending and production have been encouraging on balance, the job market has improved only slowly," said Bernanke, whose mandate as Fed Chairman is to promote price stability and maximum employment. He gave no hints that the $600 billion purchase program of Treasuries – QE2 – would be reduced.

"The power cord for the stock market runs right to the Federal Reserve, and it is their response to unemployment that motivates actions like quantitative easing," said Nicholas Colas, Chief Market Strategist at BNY ConvergEx. "Persistently high joblessness will keep them from pulling liquidity from the system. It could even push them to QE3 if things don’t improve by mid-year."

The S&P 500 has gone up pretty much in a straight line since Bernanke first hinted at a second quantitative easing program at the end of August, climbing more than 25 percent.

Just 36,000 jobs were added to the non-farm payrolls in January, far less than the 140,000 increase economists were expecting, according to the Labor Department a week ago. The jobless rate came in at 9 percent. Yet the market keeps going up.

"The stock market can do fine in the face of weak employment because that’s the very thing that insures continued Fed accommodation," said James Iuorio, managing director of TJM Institutional Services. "As counterintuitive as it seems, weakness in the labor market and in the housing market are providing fuel for the stock market rally."

At some point, companies will end up biting the hand that feeds them, investors said, as consumer spending is dented by elevated unemployment. But we are a long way from that point, they said.

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John Melloy is the Executive Producer of Fast Money. Before joining CNBC, he was an editor for Bloomberg News, overseeing the U.S. Stock Market coverage team.