President Bush’s bounce from the capture of Saddam Hussein has faded. His State of the Union message had clear vision but it lacked enough rhetorical punch to deliver another bounce. And now the president is taking political hits from all angles, temporarily slowing the stock market advance.
Sen. John Kerry, on the other hand, is getting a large bounce from his primary victories, with Bush-bashing on the Democratic campaign trail nearing a fever pitch. Heavy coverage by the print and broadcast media is only fuelling the charge of the anti-Bush forces.
Missing WMDs haven’t helped Bush either. Nor has lower-than-expected job growth — although continuing gains in the Labor Department’s household survey, showing more self-employed and private-contract workers, is still the dirty little secret. (Just watch: Significant job gains are coming.) Big budget deficits are also grabbing the headlines, even though they are vastly overrated in both numerical and economic terms.
What all this says is that the stock market rally has come under some political pressure. Bush is the pro-investor candidate, but his fortunes have momentarily slumped. Kerry is the enemy of the investor class, and the new Democratic class-warfare hero, but his veneer has only temporarily brightened. Stocks, of course, respond to all these factors, passing though they may be.
Time for investors to worry? Not at all. Liberal Yale economist Ray Fair has a better idea. His economic model projecting the presidential popular vote is strongly favoring Bush (although the rigorously honest Prof. Fair would have it otherwise). With a 2004 growth economy near 4 percent, low inflation, and a rising jobs number, Fair’s model predicts a Bush landslide with 58 percent of the popular vote.
Additional uncertainty is coming from both the G-7 finance ministers and Federal Reserve chairman Alan Greenspan — who is to give congressional testimony today. But there’s still no reason for market skittishness.
The G-7 ministers, a.k.a. the currency mavens, have changed their tune of late. Last September in Doha, Dubai, they called for “more flexibility” in currency exchange rates. Over the weekend in Boca Raton, Florida, they criticized “excess volatility and disorderly movements.”
No one knows exactly what this means, but chances are Europe will be buying dollars and selling euros. They will also reduce their policy interest-rate target and create faster money-supply growth to lower the euro currency value.
Which brings us to Greenspan before Congress. He is likely to hint today that a slight rise in the fed funds policy interest rate is in the offing, especially because of strong economic growth and a more solid labor market than payroll job reports have indicated.
The combination of a firmer dollar and a minor Fed rate hike suggests that U.S. monetary policy will become ever-so-slightly less accommodative.
For quite some time, interest-rate futures markets have been predicting a Fed hike of one-quarter of one percent in either June or August of this year. Currency futures markets suggest a slightly lower euro.
Forward-looking stock market sectors are beginning to discount these mild changes in the economic outlook. That translates to a little less emphasis on growth-leveraged sectors (tech, telecom, materials, industrials, and consumer cyclicals) and a bit more emphasis on slower-growing value sectors (consumer staples, healthcare, and energy).
But a minor rise in U.S. interest rates and a steadier dollar that would slow down gold prices would be a good thing, not a bad one, and would certainly not reduce the bullish outlook for stock markets or the economy. Economist Arthur Laffer is now emphasizing the steeply upward-sloping Treasury yield curve as well as upward revisions to IRS-based corporate-profits measures as two incredibly bullish signals for rising stocks and the economy.
After-tax corporate profits have risen to 8 percent of gross domestic product. According to Laffer, that’s the highest ratio since all the way back in 1960. Even if these profits are capitalized with a 4½ or 5 percent 10-year Treasury, the stock market is still cheap.
A 5 percent 10-year Treasury yield inverts to the equivalent of a 20-times price-to-earnings (P/E) ratio. At 17½ times 2004 earnings, the S&P 500 would therefore be 15 percent undervalued. This gets us to over 1,300 on the S&P and above 12,000 on the Dow.
Obviously a lower Treasury rate translates to even higher prices on the major stock indexes. If the bond bears are too bearish, then the stock bulls can be even more bullish.
So have no fear. President Bush is taking some hits. But the stock market advance is far from over. Very far from over.
— Larry Kudlow, NRO’s Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC’s Kudlow & Cramer.