Can Wall Street's Bush Bounce Last?

The surprisingly strong post-election rally has already stirred lots of bullish feeling. Investors, however, still have reason for caution

By Amey Stone

Election 2004's aftermath has thus far been a bonanza for investors. Not only did stocks surge on Nov. 3 when it became clear that George W. Bush had been reelected but they rocketed upward again on Nov. 4 during Bush's first press conference as he talked up his plans to reform Social Security and the tax code.

The President was speaking Wall Street's language when he promised to spend some of the "capital" he gained during the campaign on pushing pro-business initiatives (see BW Online, 11/5/04, "Corporations Come Collecting from Bush"). "It was a near perfect-pitch performance by the President," wrote David Gitlitz, chief economist for research boutique TrendMacrolytics in a Nov. 5 note to investors.

All those good vibes carried over to Friday, Nov. 5, when the October jobs report came in far stronger than anticipated, with 337,000 new positions added. That was the best growth seen in the past seven months. In the last three days of the week alone the S&P 500-stock index rose more than 3%, to give it a 5% year-to-date return. Not bad.


  Suddenly, surprisingly, a virtuous cycle may be in the making for the economy and the markets. Improving employment numbers could lead to stronger consumer confidence, which would mean a better holiday shopping period. Ultimately, it could generate the kind of stronger demand for goods and services that sustains a growing economy.

Faster payroll growth would certainly help make up for higher energy costs, which have eaten into personal income, notes Moodys Investors Service. If the price of oil falls further -- it's still near $50 a barrel, even though it has dropped from the recent highs in the mid-$50s -- that could be another boost for the economy and the stock market.

This rally has legs, believes Jason Trennert, chief investment strategist at International Strategy & Investment in New York. "The stock market has some catching up to do with the level of earnings and the low level of interest rates," he says. "I also think there has been a fair amount of skepticism and bearishness this year, which means there is some pent up demand for stocks."


  Brief as it has been so far, the fact that the market's surge lasted for three days after the election -- and not just one -- has already surprised some strategists and traders. Many thought the initial "relief rally" would be confined to Nov. 3 as investors went back to focusing on fundamentals and saw declining earnings growth and flagging consumer spending (see BW Online, 11/4/04, "A GOP-Inspired Relief Rally").

Many traders also thought the market would sell off due to profit-taking after the initial post-election run-up. "It didn't follow the usual script," says Michael Panzner, head trader at Rabo Securities and author of The New Laws of the Stock Market Jungle. "Maybe Mr. Market is proving everyone wrong. He has to do that once in a while to keep everyone honest."

Still, as rosy as the recent market rise looks now, investors have reasons to be cautious about the future strength of the economy and the stock market. More than one-third of October's payroll jump was likely due to hurricane-related rebuilding efforts (see BW Online, 11/5/04, "A Better Wind for October Jobs"). "We think October was an exception and not the harbinger of surging employment," wrote Leo Kamp, economist at TIAA-CREF, which manages pension funds for teachers, in a Nov. 5 report.

And technology stocks have trailed during the surge, especially semiconductor stocks, notes Arnie Berman, senior tech strategist at CreditSights. He believes this is an indication that investors think fundamentals could be weak in the last quarter of 2004 and first quarter of 2005.


  But the biggest red flag is the falling dollar. On Nov. 5, the greenback fell to an all-time low against the euro, now $1.30. That's a sign currency traders think the deficit could worsen under Bush. "Four more years with additional Republican strength in Congress may encourage Bush to carry on with policies that haven't been good for U.S. financial imbalances," says Panzner.

Most investors aren't too worried yet about the dollar. Moodys notes that, as long as a weak dollar doesn't trigger sharply rising interest rates, it could actually be good for U.S. corporate earnings and the economy. Robert Smith, president of Smith Affiliated Capital, a fixed-income investment firm in New York, doesn't think foreign buyers will demand higher interest rates to buy what they see as riskier U.S. Treasuries, simply because they rely on U.S. consumers to buy the goods they produce and have good reason not to push up U.S. interest rates.

Smith's forecast is for more slow growth in the U.S., figuring the upbeat flow of economic news could easily shift back to his more moderate assessment. The second week of November brings a meeting of the Federal Open Market Committee (which is expected to raise short-term interest rates another quarter-point) and earnings reports from Cisco (CSCO ) and Dell (DELL ) as well as reports from more than a dozen retailers. They'll be worth watching.

So will the price of oil, which Smith thinks will rise to $70 before it falls to $40. All the excitement following the election and the strong jobs report "doesn't change a muddle-through economy," he says. While potential for a market rally with decent staying power has emerged after the election, it's still hardly a shoo-in.

Stone is a senior writer for BusinessWeek Online in New York

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