Election, Job Data Lift Mood on Wall St.

Wall Street got both the president and the employment report it wanted last week. Now it could be on the verge of getting the holiday present it craves: a second straight winning year for stocks.

Those odds seemed shaky a week ago, when two of the three main U.S. market indexes were in the red, the election looked too close to call and economists were still using the phrase “jobless recovery.”

But with President Bush emerging with a clean victory in Tuesday’s election and the Labor Department reporting Friday that employers added 337,000 nonfarm workers to their payrolls in October, the political and economic pictures have come into sharper focus. And for the most part, equity investors like what they see.

“If you wrote a headline to summarize the past week,” said David Kelly, an economic advisor at Putnam Investments in Boston, “it would be ‘Uncertainty Plunges.’ ”

Wall Street savored not only the election’s result but also an absence of the legal disputes seen when the 2000 election results in Florida were contested -- a preelection fear stoked by news reports of the two main political parties lining up armies of lawyers.

Friday’s payroll report gave the stock market a final lift, sealing a week that left the blue-chip Standard & Poor’s 500 index up 4.9% year to date and the technology-heavy Nasdaq composite up 1.8%. The Dow Jones industrial average rose a cumulative 351 points from Wednesday through Friday, although it remained down 0.6% for 2004.

“It’s clear that the economy has kicked into a self-sustaining mode,” Kelly said, “in which demand creates jobs, those jobs create income and that income creates more demand.”

The Bush victory is considered especially bullish for stocks in industry sectors seen as benefiting from his policies, such as manufacturing, defense and energy. Investors have quickly bid up several names in those sectors.

Steel maker Nucor Corp., for example, has risen 5.3% since the election, to $47.35; military contractor General Dynamics Corp. has gained 6.3%, to a 52-week high of $106.85; and oil giant Exxon Mobil Corp. is up 4% to $50.39, also a 52-week high.

For bond investors, the flip side of the economic good news is likely to be continued upward pressure on interest rates and bond yields, which move in the direction opposite from prices.

On Friday, after the jobs report, the yield on the benchmark 10-year Treasury note leaped to 4.17%, from 4.07% on Thursday.

“Bonds really like a divided government and don’t like a unified government,” said James Bianco, president of Bianco Research in Barrington, Ill.

Government gridlock is considered good for Treasury investors because less legislation tends to mean less federal spending and lower budget deficits.

But with Republicans retaining the White House and strengthening their control of both the House and the Senate, the Bush administration has a chance of pushing through an ambitious legislative program that would extend tax cuts, reform the tax structure and create individually managed Social Security accounts.

Record budget and trade deficits add to the pressure on bonds, as does the likelihood that the Federal Reserve will continue its money-tightening campaign by ticking up interest rates.

Higher interest rates hurt Treasury investors because they cause bond prices to fall. The dollar amount of interest paid annually by the bonds remains fixed, but the underlying value of the securities rises and falls to correspond with changing market interest rates. So with bond prices falling, investors end up with securities that have less value.

The Fed is almost universally expected to raise its key short-term interest rate to 2% from 1.75% at its policy meeting Wednesday. Until Friday, Wall Street was about evenly divided on whether the Fed would tighten again at its Dec. 14 meeting. But the jobs report swung opinion sharply, and now bond traders think there’s an 80% chance that the Fed will push rates to 2.25% in December, Bianco said.

John Lonski, chief economist for Moody’s Investors Service in New York, estimated that about 75,000 of the 337,000 jobs added in October were related to the cleanup and reconstruction after the destructive hurricanes that hit the Southeast in late summer.

Still, he said, a “real” 262,000 gain is still fairly strong. Lonski believes that hiring is starting to catch up with other signs of stronger economic growth and that the job gains will be sustained in the coming months.

That’s good news for workers and good news for stocks, but again, bad news for bonds, he said.

If the economy adds 300,000 more jobs in November, Lonski says, bond traders would quickly push yields on the 10-year note to 4.75%, approaching the 4.87% high reached in mid-June.

Other interest rates move up along with those of Treasuries, so consumers would start feeling the effects in the form of higher mortgage and loan rates.

Higher mortgage rates would make it tougher for consumers to refinance and tap the equity in their homes for spending cash. The drag on consumer spending could be offset by wage gains that might come along with increased hiring and a tighter job market, Lonski said.

The currency market also has reacted strongly to Bush’s reelection and the surprising jobs number.

The dollar on Friday hit a record low of $1.296 against the euro, which seemed on the way toward breaking through $1.30, according to CS First Boston currency strategist Lara Rhame.

“Bush never had a strong-dollar policy,” Rhame said. She added that his reelection made it likely that several factors seen as negatives for the dollar would remain in place: a high trade deficit, geopolitical tensions and high oil prices.

A falling dollar erodes the value of dollar-denominated assets such as U.S. bonds. Analysts worry that at some point overseas investors will start dumping their Treasuries, driving up yields and causing high interest rates to ripple through the U.S. economy, slowing growth.

Although conditions look sunniest for stocks, some analysts caution that the market rally could be short-lived.

Russ Koesterich, domestic equity strategist at State Street Global Markets in Boston, noted that historically, the first year of a new presidential term has tended to be weak for stocks, which doesn’t bode well for 2005.

Further, Koesterich said, corporate profits appear to be softening. For the S&P; 500, profits grew by more than 20% in the first half of 2004 from the previous year, but that growth has slowed to the mid-teens for the third quarter and is expected to slide into the high single digits next year.

In addition, Koesterich said, investors are less likely to bid up stocks when interest rates rise.

“Enjoy the next two or three months,” he said, “but realize that 2005 has the potential to be very rocky for equities.”

Still, bullish analysts put a positive spin even on projections for slower profit growth.

“For Wall Street, it’s a lot better that expectations are low,” said Zachary Karabell, senior economic analyst for Fred Alger Management. “We think it’s more likely that a lot of companies can surprise on the upside.”

*

Mulligan reported from New York and Friedman from Los Angeles.