Stock Rally, Though Tentative, Offers Hope for Economy

The stock market is rallying, and that is raising hopes it might take the economy along for the ride.

Major market indexes have been swept higher over the last two weeks as the war in Iraq has wound down and more investors have adopted an upbeat view of stocks’ potential.

The Nasdaq composite index, dominated by big technology shares, rose Wednesday to its highest level since Dec. 2 and is up 9.8% since Jan. 1.

Among blue-chip issues, the list of stocks that have posted double-digit percentage gains this year includes IBM, Citigroup, General Electric and Wal-Mart. Surprisingly strong first-quarter corporate earnings from many companies have helped to stoke the latest rally.

“People are starting to feel that all the bad news is finally out,” said Marc Pado, U.S. strategist for New York-based brokerage Cantor Fitzgerald. He believes that the long bear market ended in October with share prices at five-year lows. Since then, the Dow Jones industrial average, which added 30.67 points to 8,515.66 on Wednesday, has risen nearly 17%.

And as the market advances after three straight years of heavy losses, the effect is more significant than to enrich a relative handful of Wall Street traders. Indeed, some experts say a continuing rebound in share prices may be the best tonic for the struggling economy -- because of the confidence it could engender in corporate executives and everyday consumers alike.

“The market is a huge wild card for the economy,” said Bill Dudley, economist at brokerage Goldman Sachs & Co. in New York. “There’s no question that a higher market could be very helpful” in spurring growth.

“If you could tell me that the Standard & Poor’s 500 index will finish this year up 10%, chances are we’ll be very satisfied with the economic recovery,” said John Lonski, economist at Moody’s Investors Service in New York. The S&P; is up 4.5% so far this year.

For executives, a sustained rise in their companies’ share prices could provide the brighter sentiment necessary to justify long-delayed capital spending decisions, Lonski said. That, in turn, could give the economy what it has been missing most for the last three years: higher outlays on technology equipment, machinery and other goods that ultimately improve businesses’ long-term efficiency.

As a company’s stock price gains, the value of the business rises, which gives the firm greater financial flexibility in borrowing, for example. What’s more, a rising market can boost the worth of executives’ personal portfolios, including their often substantial unexercised stock options, naturally bolstering their optimism about the future.

“The stock market’s level is very much an issue for business confidence,” Lonski said.

In the late 1990s the relationship between the market and the economy was viewed as a “virtuous circle,” as improvement in one begat improvement in the other, and the cycle repeated. A more modest version of that circle could be developing again, some analysts say.

As with companies, a higher stock market could have a beneficial effect on Americans who own shares -- which is estimated to be half of U.S. households.

Many families have been hurt by stocks’ slump since 2000, but surging home values have offset some of their losses. Now, there is concern that the housing market could slow. If that happens, consumers’ willingness to spend could become more dependent on whether their stock portfolios, including shares held in retirement savings accounts, begin to grow again.

Some of the most popular stock mutual funds have posted solid gains this year. The Fidelity Magellan fund, for example, is up 5.6%. The American Century Ultra fund is up 6.1%, and the Janus Fund has surged 9%.

Meanwhile, investors are earning paltry returns on safe “cash” accounts. The average annualized yield on money market funds dipped this week to a record low 0.71%, according to fund tracker ImoneyNet Inc.

In Upland, financial planner Nancy Langdon Jones will play host to up to 40 clients over breakfast Saturday. Compared with recent years, she said, the discussion is likely to be much more fun because of the market’s recent gains. Jones already is hearing from clients who want to put new money into stocks.

“They’re starting to invest again,” she said. “But they’re going in easy.”

To be sure, there is no certainty that the bear market has ended. Many analysts view the rebound in stocks this year as nothing more than a temporary bounce, like several others in recent years.

Just as a rising market could help the economy, if this rally fizzles it could dash confidence and threaten to depress corporate and consumer spending, making a recovery much more difficult.

That risk is more pronounced now because the Federal Reserve has little room left to cut interest rates, having already reduced its key short-term rate to 1.25%, a 40-year low.

At Schaeffer’s Investment Research in Cincinnati, analyst Tom Reynolds said, the firm still is telling clients to expect the Dow to fall as low as 5,600 in the years ahead, which would represent a drop of 34% from its current level. That view is based partly on expectations that corporate America will continue to struggle and that investors will continue to lose interest in the market.

David Wyss, economist at credit-rating firm Standard & Poor’s in New York, is among many who remain cautious about the idea of a sustained market turnaround.

“I still think a lot of this is a ‘relief’ rally,” with the conflict in Iraq largely concluded, he said. “I figured we could see a 20% bounce. We’re not even there yet.”

The Dow has gained 13% from its March low of 7,524 shortly before the war began. The Nasdaq index has risen 15.3% from its March low.

By contrast, the Dow rallied between 20% and 25% in three separate periods since March 2001, only to fall back.

The widespread opinion on Wall Street is that the market at best remains stuck in a “trading range,” with indexes charting a pattern not unlike a heartbeat -- rallies, followed by sell-offs, with little net progress over a period of years.

Market bulls, however, say there are key reasons the current rally could last much longer than those of recent years.

One is that many people are deeply distrustful of any rebound after being burned so badly since 2000. In the often upside-down world of Wall Street, a high level of suspicion can make it more likely that a rally will continue, because the market frequently confounds the majority view.

“Sentiment is so negative that higher stock prices seem to make people nervous instead of happy. This is the classic ‘climbing a wall of worry’ rally environment,” said Scott Grannis, economist at money management firm Western Asset Management in Pasadena.

Another difference compared, say, with 2001 is that corporate earnings overall are recovering. This week, companies including defense giant Lockheed Martin, biotech firm Amgen, Internet auction site EBay and wireless technology leader Qualcomm have reported better-than-expected first-quarter earnings and have raised their estimates of full-year results.

Blue-chip companies on average are expected to show a first-quarter profit gain of about 11% from a year earlier, according to earnings tracker Thomson First Call in Boston.

Market bears say the improvement in profit isn’t enough to justify stock prices that remain historically high relative to underlying earnings per share.

To Cantor Fitzgerald’s Pado, investors’ doubts are “the fuel for the fire.” If indexes such as the S&P; 500 break through their recent trading ranges, he said, psychology on Wall Street could quickly turn much more bullish.

Although professional and amateur investors have good reason to be cautious after enduring the worst bear market in a generation, human nature doesn’t change, said Tobias Levkovich, market strategist at brokerage Smith Barney in New York: If people suspect better times are at hand, he said, their caution “caves in to the pressure of wanting to make money.”