When a strong economy is bad news

Sometimes, you can have too much of a good thing. Like single-handedly eating a gallon of ice cream (don't ask). Or binge-watching your favorite TV show to the point of exhaustion.

Something similar is in play in the U.S. economy, in two forms. One is the way the U.S. is outperforming its global peers. The other is the way the U.S. job market is rapidly tightening. Both are clearly good things. But if they continue, it could become bad news for investors.

In the first case, I'm talking about the disconnect between what's happening here at home (strong job growth, rising currency, relatively buoyant markets) and what's happening overseas (threat of recession, weaker currencies, stumbling markets).

The situation is so dire abroad that Germany and Japan -- two of the world's largest economies -- are on the verge of falling back into recession. Japan's economy contracted last quarter. German factory activity is dropping on a scale not seen since early 2009. China is weak, too, with electricity production -- a proxy for industrial activity -- slumping in a way it hasn't done also since 2009.

But the U.S. has been chugging along, with the largest number of job postings since 2001 and the best pace of job gains since the 1990s. Moreover, GDP growth has totaled 3.5 percent or more in three of the last four quarters, with two above 4.5 percent. That's why the U.S. dollar has been on a tear lately.

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The greenback recently rose for 12 weeks in a row and for 19 of the last 22 weeks, taking it back to levels not reached since 2010. While that's good news for consumers because it lowers the price of fuel and the cost of imported goods, it represents a danger for the U.S. economy.

That was the takeaway from the minutes of the Federal Reserve's September meeting, which when released on Wednesday, ignited the strongest stock market turnaround in years. But some Fed officials expressed concern that the dollar's strength could pinch the U.S. economy by making U.S. exports more expensive at the same time economies abroad are limping. And on Thursday, those global growth worries again swept Wall Street, sending all three major indexes down around 2 percent and more than wiping out Wednesday's big rally.

No surprise then that the dollar has since rolled over like road kill, with the PowerShares US Dollar Bullish Fund (UUP) testing its 20-day moving average to the downside -- a measure of trend -- for the first time since June (chart above).

Now, for the second facet.

The team at Capital Economics is worried that while a stronger labor market is obviously great news for job-seeking Americans, it could be trouble for the stock market. That's because one primary fuel for rising stock prices over the last few years has been a big increase in corporate profitability (also helped in large part by the fact wages have been so stagnant in recent years).

Already, the unemployment rate has fallen to 5.9 percent. Not only has it dropped to this point faster than the Fed's forecast of hitting that level by year-end but it's only two-tenths away from the Congressional Budget Office's estimate of full employment. This is also known as the "natural unemployment rate," or the point at which the job market is at full potential.

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Further declines in the jobless rate below this level could result in wage inflation, crimping corporate profit margins in a way that hasn't been felt since the last economic expansion. While that won't necessarily slam the brakes on the overall economy, or result in a dramatic stock market decline, it does mean stock price gains could be more muted in coming years.

So be careful what you wish for. Sometimes, getting what you want can cause unexpected problems.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.