It's hard to characterize the last couple of months in the stock market as anything but disastrous.

The strong first quarter unraveled completely, and more than $2 trillion in stock market capitalization went away. Heading into Memorial Day -- the unofficial start of Wall Street's summer season -- the

S&P 500

was down 6.2%. That's its worst performance since 1984.

"This is not simply a valuation shift," said Hugh Johnson, chief investment officer at

First Albany

. "It's not simply that investors are selling overvalued tech stocks and buying undervalued stocks. This is a very defensive market."

Many portfolio managers, Johnson included, have not just shifted to what they see as safer stocks, but have raised cash as well.

It's all about the

Federal Reserve, of course. With spring came the realization that the economy was running too fast for the central bank to continue with the gradualist, quarter-point-hike-at-a-time course that it had been following. The Fed would have to clamp down harder on the economy, and that is exactly what happened two weeks ago, when it raised the fed funds target rate by a half-point, to 6.5%. That's frightening, because with the Fed's battle to tame the economy more pitched, the chances that it will overshoot have grown. "This is classic end-of-cycle stuff," said Johnson. "The market is saying there is a big danger the Fed will be seduced into raising interest rates too high."

It's generally believed that the Fed has more to do, but the extent of the further hikes is unclear. A number of economists have suggested that the

Federal Open Market Committee may cool its heels at its June 27-28 meeting, allowing it to see how much bite the hikes so far have had. Whether or not that happens, however, depends a lot on what the next round of big economic reports looks like. Two of them are due out in the coming week.

The

National Association of Purchasing Management's

May

Purchasing Managers' Index comes out Thursday and the May

Employment Report comes Friday. Though the NAPM will give some indication as to what kind of pricing pressure companies are seeing, the jobs report will be the thing to watch most closely.

"Right now, your major inflation threats are related to tight labor markets, not so much to tight goods markets," explained Mike Cloherty, senior market economist at

Credit Suisse First Boston

.

Predictions for the payrolls numbers are all over the place. There are some factors -- changes in methodology and Census workers -- that make it very hard to come in with a very good forecast. So it will probably be the unemployment rate that the market looks at most carefully. The consensus sees it coming in at around 3.9%, though a handful of economists see it coming in lower than that. Economists at

Morgan Stanley Dean Witter

think it will come in at 3.7%.

Yet they are also among those who think the Fed will hold off on bumping up rates at the next meeting, and then crank them up another half-point in August.

"My view is we're in a transition period from a white-hot economy to one that is just cherry red," said Richard Berner, Morgan's chief U.S. economist. He doesn't buy the idea that a real economic slowdown is upon us -- despite the protests of a number of his firm's equity analysts, who say they're seeing slowing in the industries they follow. But neither does he believe that the Fed will have to aggressively ratchet up rates from here.

"Some people had thought the Fed would have to tighten by 150 basis points, or more," he said. But recently, "the market's outlook has shifted to the position that the Fed doesn't have to be as aggressive." As a result, the yield on the two-year Treasury note has fallen by better than 0.2 percentage points over the past couple of weeks.

Clearly, the stock market is not as confident that the Fed will safely guide the economy lower, one reason it has fallen even as the two-year has done better. And despite economists' frequent scoffing about how bad the stock market is as an economic forecaster, First Albany's Johnson says he'll pay more attention to stocks than the dismal scientists to figure out where things are headed.

"You better know it's 1994 and not a 1981," he said. "The only way you can tell is by watching the stock market carefully."