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Economic optimism driving stocks

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Maybe this time will be the charm. Driven by optimism that an economic upturn may at last be at hand, the stock market is deep into rally mode, and investors can only hope they will not be disappointed again, as they repeatedly have been over the past two years.

Nobody is expecting a new boom anytime soon, and next week’s crucial employment report could well show the economy lost jobs for a fourth straight month, a result never before seen outside a recession. But after a dismal performance in April, there are faint signs the economy began heading in the right direction in May, and most economists are expecting robust, sustainable growth to resume by the end of this year or early 2004.

Stock investors, who try to stay ahead of the economic curve, have been jumping on the bandwagon since shortly before the Iraq war began in March, at least partly because the conflict cleared a cloud of uncertainty that had been hanging over financial markets for months.

Stock prices rallied again Friday on positive economic news, pushing the S&P 500 to its highest close in nearly a year. Since March 11 the broad index has surged more than 20 percent, while the technology-oriented Nasdaq composite index is up more than 25 percent over that 12-week span.

“We (economists) find it funny why a three-month change would make that big a difference to valuation,” said Rajeev Dhawan, director of the economic forecasting center at Georgia State University. “The economy is still in a stage where it’s one step forward and two steps sideways.”

Dhawan said investors appear to be taking heart from the fact that with the Iraq war now largely over and won, consumers and businesses will be making purchase and investment decisions that may have been delayed by uncertainty over the conflict.

“People now have to bet one way or another — it’s no longer in a holding pattern,” he said. “Most people are betting on the side of it’s going to be a recovery. The issue is when.”

Jay Bryson, global economist for Wachovia Securities, agreed that stock market investors appear to be betting that consumer spending will stay strong and business investment will accelerate. “There is a lot of stimulus in the pipeline right now,” he noted.

Oil prices have fallen sharply in recent months, record-low mortgage rates are supporting a new wave of refinancing and millions of Americans can expect $400 and $800 tax rebate checks just in time for the back-to-school shopping season.

Consumer sentiment is at its highest level in nearly a year, according to a report out Friday, and a report on manufacturing in the Chicago area hinted at an upturn in the battered sector.

Still, there is another possible explanation for the stock market’s latest surge that has been embraced by the more skeptical market watchers.

“My thought is we are going through another one of these bear-market rallies,” said Sung Won Sohn, chief economist for Wells Fargo Securities. He pointed out that in the long bear market of 1974-1982 there were six major rallies averaging 33 percent each.

The current bear market that began in March 2000 has had its own share of false bottoms and bear-market rallies, including a steady three-month climb that began shortly after the 9/11 terrorist attacks and was followed by a long, dispiriting slide last year.

Sohn predicted the latest rally also will be extinguished by traders locking in short-term profits. “Institutional fund managers I have talked to don’t have conviction in the sustainability of the economy’s growth or the stock market rally,” he said.

By no means is Sohn looking for an economic disaster or even a double-dip recession, a prospect that largely has been ruled out by most mainstream economists. But this year’s corporate profit growth has been driven mostly by cost-cutting and productivity gains, he said. Without strong growth in business and consumer demand, profits cannot grow fast enough to justify current market valuations, he said.

As for the much-heralded $350 billion fiscal stimulus packaged signed into law this week by President Bush, Sohn figures the impact made its way into financial markets long ago.

“Certainly it’s a plus, but I’m not sure it’s a major positive,” he said. He estimated the impact at $100 billion to $150 billion a year over the next two years, which he called “basically peanuts” in an $11 trillion economy.

Of course, the market rally has not necessarily run its course just yet. In addition to next Friday’s important data on employment, traders anxiously are awaiting Monday’s report on manufacturing from the Institute on Supply Management. After four straight months of declines, a strong report surely will be interpreted as a sign that the tide at last is turning in the nation’s factories. Based on Friday’s report from the Chicago area, analysts have raised their expectations.