Commentary; Posted: 10/13/04

Politics, the economy and the stock market

Dave Purdy
Guest Columnist

With the Democratic and Republican conventions behind us, political campaigning now goes into high gear for the next two months.

The focus is, of course, on the Presidential race, but with polls currently showing George Bush and John Kerry even, attention is also turning to elections in the Senate and the House.

There used to be wide agreement that the Republicans would retain a majority in the Senate; now there is some doubt. As to the House, there is very little chance of a shift.

The Republicans are highly likely to retain control with very few competitive races this year. Consequently, while many issues are in doubt depending on the election outcomes, I think that a major change in tax policy is unlikely given the power wielded by the House in this area.

Turning to the economy, recently the widely watched Employment Report for August was released. It showed another drop in the unemployment rate to 5.4 percent and a gain in payroll employment of 144,000.

The employment gains in June and July were both revised upward from a total of 110,000 to 169,000 and so far this year payroll employment has risen 1,440,000. That is a nice solid gain, but somewhat below whatís typical in the third year of a recovery.

I think the slower pace of employment gains reflects continued efforts by companies to control costs and rebuild earnings.

Companies have certainly delivered on earnings. As you know I have been quite bullish on earnings for more than a year and expected a big second quarter.

Now that the full set of earnings reports on the S&P 500 companies is in, the gains exceed even my optimistic expectations. Operating earnings per share were up 31.4 percent over that last four quarters and total reported earnings per share were up 36.9 percent.

With the S&P 500 up only 8.9 percent over the last year, Price/Earnings ratios have fallen sharply. I remain optimistic on earnings going forward.

I expect three big positive continuing factors for many companies:

1.) the combination of cost control and pricing power will continue to strengthen reported earnings,

2.) I have never seen higher earnings quality, and

3.) balance sheets have improved dramatically with the ratio of liabilities to financial assets at all-time record lows (liabilities are less than assets for the first time).

I think the first two factors have reduced earnings risk considerably and the third factor reduces balance sheet risk (lower leverage). These positive factors are like a coiling spring ñ at some point I think they will outweigh the negative worries over terrorism, oil and Iraq.

Meanwhile we can focus on the election campaigns and may the best candidates win.

Writer David Purdy is president of Wealth Management Midwest, Forest Lake, and offers securities through Linsco/Private Ledger, Member NASD/SIPC and an investment advisor.

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