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Dow Jones Finishes Week on Rise, Awakes from Summer Slumber

By Brett D. Fromson and Steven Pearlstein
The Washington Post

The stock market has awakened from its summer slumber and pushed the Dow Jones industrial average up 126 points this week.

Many investment strategists are saying the economy is growing nicely with little inflation, and that should translate into a long period of good corporate profits.

Friday's 51-point rally in the Dow - on top of a 70-point gain on Wednesday - was sparked by another report indicating that the economic recovery is slowing to a more sustainable pace-one that is less likely to trigger inflation.

The Commerce Department report said the gross national product, the broadest measure of the economy's growth, increased at a 3.8 percent annual rate for the second quarter of the year, a number that was revised from the original estimate of 3.7 percent.

Investors had forecast an even higher rate. In the logic of the stock market, what seems to be good news-a roaring economy-actually can depress investments because of the inflation that can accompany fast growth. Inflation eats away at the future stream of profits, dividends and interest income to owners of capital.

So when the GDP figure came in at 3.8 percent Friday rather than a widely expected 4.1 percent, investors celebrated by buying. The Dow closed at 3881.05.

It was just such a mild deceleration in economic growth that the Federal Reserve had in mind last week, when it raised short-term interest rates by half a percentage point. When the Fed nudges short-term rates higher, the move tends to reassure investors that inflation will be forestalled in the long run and encourages them to lower the long-term rates they set each day on the Wall Street bond market.

"I think the Fed should be pretty happy right now," said David Wyss, an economist at DRI-McGraw Hill Inc. "We are seeing an economic slowdown that is very similar to soft landings in the past."

Some analysts, however, forecast a new downturn in the market before a pickup next year.

Thomas McManus, stock strategist at Morgan Stanley & Co., fears the recent interest rate hikes by the Fed will slow consumer demand in the short run. He looks for a better buying opportunity down the road.

Charles I. Clough Jr., chief investment strategist at Merrill Lynch & Co., shares McManus' concern that higher rates might nip consumer spending. But he says that slack demand should hit only some companies, not all.

Clough and other analysts now expect the economy's path will now permit the Fed to follow its political instincts and put off any further change in interest rates until after the November congressional elections.