The great stock market paradox as rising unemployment boosts share prices:

A cooling jobs market and fears of rising unemployment are troubling America, so what do US share prices do? They boom. Both the Dow Jones Industrial Average and the S&P 500 hit all-time highs last week.

Here, the economy is shrinking thanks to the ineptitude of our Chancellor. Meanwhile, the FTSE 100 index did have a bit of a wobble, but it is still up 17 per cent on the year. So what’s up?

Well, there is a counter-intuitive relationship that is sometimes forgotten. Rising unemployment, in the short term at least, is good for share prices.

That’s because a softer jobs market leads to cheaper money. Central banks try to offset rising unemployment by cutting interest rates. That is what the Federal Reserve did last week and in all probability the Bank of England will do this Thursday.

Lower rates mean more money sloshing around, some of which goes into shares. And insofar as that extra money leads to higher inflation, stocks – unlike bonds – offer some protection.

But that is only part of the story. Why have share prices been so strong, given all that has been thrown at the world economy, especially the disruption from Donald Trump’s tariff war against the US’s established trading partners?

What’s up?: The FTSE 100 index had  a bit of a wobble, but it is still up 17 per cent on the year

One answer is to say markets are deluded, that this is a bubble, and it’s going to pop. A lot of people in Britain believed the scare stories and have been net sellers of shares right through 2025.

It’s true that all bull markets must come to an end, but very often the best returns come in their final months. People who sold too soon will have missed out on those extra profits, while the ‘buy-on-the-dip’ crowd will have done very well.

There are two other elements that help explain what has happened, which taken together give some pointers to the future.

One is the extraordinary extent to which the potential of artificial intelligence has mesmerised investors. The other is the resilience of the rest of the world economy against all the stuff that has been thrown at it.

The basic point about AI is that the investment requirements are so huge, and the valuations so extreme, that at some stage investors will baulk at pumping more funds into the industry.

We had a glimpse of those concerns last week when the quarterly results from software developer Oracle failed to ease worries that it had become too dependent on one customer – OpenAI. Its shares are now nearly 40 per cent down on their September peak, when the firm’s co-founder Larry Ellison briefly passed Elon Musk to become the world’s richest man. Other AI-related stocks have weakened too, though far less dramatically.

The message for investors is: ‘Yes, of course AI will change the world and we have made shed-loads of money, but let’s trim our commitment and stick some of our profits in other, more boring but less volatile enterprises.’

The process is called rotation, as investors move out of high-growth stocks into basic sectors such as banking, energy, defence and consumer goods.

That leads to the second part of the explanation for what is happening. While the world economy is still growing, these basic industries can make juicy profits.

We know a serious recession will come at some point because there is such a thing as the global economic cycle and we don’t seem to be able to do anything about it. But meanwhile there are sound investments to be made.

That is where UK stocks come in. The FTSE 100 companies get three-quarters of their sales from overseas, either from foreign subsidiaries or from exporting.

And some 65 per cent of those firms are owned by overseas investors, maybe more because the figures are out of date.

So for those foreign investors what happens to the UK economy is not that important, nor is the fact that we here are being clobbered with higher taxes.

The Footsie is a sterling-denominated bet on the world economy and as such looks still to be pretty decent value. If more money comes out of AI-related US businesses, expect quite a few billions to be invested in UK-based firms.

DIY INVESTING PLATFORMS

AJ Bell

AJ Bell

Easy investing and ready-made portfolios

Hargreaves Lansdown

Hargreaves Lansdown

Free fund dealing and investment ideas

interactive investor

interactive investor

Flat-fee investing from £4.99 per month

Freetrade

Freetrade

Investing Isa now free on basic plan

Trading 212

Trading 212

Free share dealing and no account fee

Affiliate links: If you take out a product This is Money may earn a commission. These deals are chosen by our editorial team, as we think they are worth highlighting. This does…