By Nick Godt
Markets Reporter
10/28/2005 4:06 PM EDT

A report showing the U.S. economy was powering ahead with limited inflation before Hurricanes Katrina and Rita hit was just what the doctor ordered for a frazzled stock market. The third-quarter report on gross domestic product easily trumped the day's other news -- an indictment in the Bush administration.

Stocks, which have struggled for three sessions, rallied. The Dow Jones Industrial Average closed up 171 points, or 1.7%, to 10,401. In a sign of newfound optimism, even Microsoft (MSFT:Nasdaq - news - research - Cramer's Take), whose revenue guidance disappointed overnight, gained 2.8%.

The S&P 500 rose 19 points, or 1.6%, to 1198. Energy shares were also strong, even as crude oil prices dropped, after Chevron (CVX:NYSE - news - research - Cramer's Take) became the latest supermajor to report double-digit earnings growth.

The Nasdaq Composite surged 26 points, or 1.3%, to 2090. Gateway (GTW:Nasdaq - news - research - Cramer's Take) shot up 5.5% after posting better-than-expected revenue in the third quarter.

The various run-ups came even as a special prosecutor was unsealing a five-count indictment charging Vice President Dick Cheney's chief of staff, Lewis Libby, with lying to the federal grand jury probing the Valerie Plame affair. While Bush aide Karl Rove wasn't named, he reportedly remains under investigation. The charges capped a tough week for the president, coming a day after Harriet Miers withdrew her nomination to the Supreme Court.

Some observers said all the bad political news for Bush contributed to nervousness that drove the Nasdaq down 1.7% on Thursday. According to Marc Pado, a Cantor Fitzgerald market strategist, traders are worried that Bush will be prevented from making his current tax cuts permanent. "With even Republicans breaking ranks with him in Congress, Bush has gone from 'lame duck' to 'dead duck' in the space of a week," Pado says.

Whatever the fate of those, the market took heart in a catchphrase of Bush's predecessor Friday: "It's the economy, stupid." On that front, the news was good.

The Commerce Department's preliminary estimate of the third-quarter GDP pegged growth at 3.8%, above the 3.5% on average expected by Wall Street economists. The report's inflation gauge -- the personal consumption expenditure deflator -- rose 3.1%, above forecasts of a 2.9% increase, but excepting energy, core PCE prices rose just 1.3%.

While the numbers lifted stocks, they weren't enough to stem a weeklong tumble in the bond market, where 10-year Treasury notes fell 5/32 to yield 4.57%. Economists noted that the impact of the hurricanes on growth, energy prices and consumer spending will likely be felt in the fourth quarter.

For Joel Naroff, president of Naroff Economic Advisors, the fact that the economy was sturdy ahead of the hurricanes minimizes the risks of a recession next year. But he's concerned that markets are viewing the core rate of inflation numbers as representing the "real inflation."

"The core simply is the best forecaster of future top line inflation. And right now, that is high and is creating real uncertainty for both households and businesses," Naroff wrote in a research note.

On a shorter-term basis, the stock market has been trying to find catalysts for a traditional end-of-year rally, and that's so far been mired in uncertainty about the economy and profits in the fourth quarter.

For Marc Pado, if the market can get good indications about retail sales ahead of the key holiday shopping season, then "we could leave all the October negativity behind and rally in November."