Why the Bears Are Smiling

Halfway through 2005, the stock market has nothing to show for itself. And if you're waiting for the Federal Reserve to stop raising interest rates before you buy equities, don't hold your breath.

Last week, the Fed logged its ninth straight quarter-point rate hike and repeated its "measured pace" mantra, leaving no end in sight to a tightening campaign that began more than a year ago. Stocks tumbled, and the spread between short- and long-term interest rates continued to narrow, exacerbating the "conundrum" first mentioned by Fed Chairman Alan Greenspan.

Conventional wisdom dictates that when the monetary gatekeepers raise short-term rates, long-term rates should follow. This time around, they've fallen, a phenomenon that recurred on Thursday after the Fed's announcement.

Unfortunately for investors, the simplest explanation of the market's thirst for low-risk investments like 10-year Treasury notes is that people don't see good investment opportunities anywhere else.

Well, almost. The real estate market remains red hot, leaving pundits to busy themselves with bubble babble. Commodities are also producing, with crude futures making headlines at $60 a barrel. Hedge funds and private equity are in fashion, having jumped headlong into the mergers-and-acquisitions craze. And the dollar is on the mend.

Meanwhile, aside from their lack of progress in the first half of 2005, stocks remain at the tail end of a bull run. The S&P 500 has gained 31% since July 2002, when the economy was battling a recession. The Dow Jones Industrial Average has added 18% over that period, while the Nasdaq is up 55%. Still, none of the indices have climbed back to where they were five years ago, in the days of irrational exuberance.

So, can stocks break out of their range-bound ways in the back half of 2005? Or is a flattening yield curve signaling that the U.S. economy is headed for another slowdown? An informed guess might lean bearish: With all of the pitfalls facing economic growth, stocks might very well remain too high.