Coming Week: Hazier Horizon

If anything can change the Fed's mindset, it's the Feb. 21 consumer price index report -- specifically the core data, he says. The Fed has consistently said core inflation is above its "comfort zone," but it expects further moderation going forward, Bianco notes. "If inflation numbers are bad, we're going to move back toward tightening."

But last week's FOMC statement -- particularly the line "readings on core inflation have improved modestly in recent months" -- led many traders to believe that a rate hike has been taken off the table. After the statement, the stock market rallied on the hopes of a potential rate cut by springtime.

Jim Cramer expressed this view in our Wall Street Confidential video on Friday, noting strength in rate-sensitive cyclical stocks, weakness in January sales by U.S. automakers and continued concerns about housing, despite the homebuilders' rally Friday following Standard Pacific's (SPF Quote) upbeat 2007 guidance.

Bianco counters with a statistic: The S&P 500 has gone more than 200 days without a 2% correction, something that has only occurred once before (in 1995) in the past 53 years.

"The stock market for the last seven months has gone in one direction and has not wavered" despite big swings in expectations for monetary policy, he says. "I don't think the stock market is paying attention at all" to the Fed save for "hour by hour" movements following Fed meetings and such.

Rather than the Fed, he believes what's driving the stock market higher is the shrinking supply of stock, as shown in the accompanying chart.

As a result of private equity takeovers, mergers and Sarbanes-Oxley regulation curtailing U.S.-based IPOs, the supply of stock has been shrinking dramatically, a trend that is accelerating in recent quarters. This shrinkage "has the same effect as a 'liquidity surge,'" Bianco says, and is a more important dynamic in the stock market than Fed policy or perceptions thereof.

Stock Supply Drying Up M&A, buybacks and fewer IPOs shrink equity volume

Click here for larger image.

Source: Bianco Research; Fed flow of funds data