Nothing is more reliable than a failed signal. The stock market collapse of Friday, April 14, 2000, was significant not only for its magnitude, but for what did not happen. The Hound of the Baskervilles, fresh from treating your portfolio like a fire hydrant, neither barked nor induced a bond-market rally.

Because markets are motivated by fear and greed, and because we are programmed biologically to run away from scary things, it is only natural for us to flee market calamities and seek solace in a safe haven. The term "flight to quality" moved into common financial parlance in the aftermath of the October 1987 crash.

That day's festivities lopped close to 23% off the value of the

S&P 500

. Since the crash followed months of disturbing economic talk about how there would be hell to pay for our twin deficits -- budget and trade -- it was only natural to assume that there would be at least some macroeconomic consequences from this crash.

In fact, the

Brady Commission

report ordered by

President Reagan

and released in January 1988 was fixated on comparisons between 1987 and 1929.

Several factors made 1987's flight to quality intense. First, the 1987 bond market was terrible -- yields had been rising steadily since March -- and the yawning gap between bond yields and stock valuations received much of the subsequent blame for the crash. The high point for bond yields in 1987 occurred on the morning of Oct. 19, and that provided a huge impetus for short covering over the next three days.

Second, the

Fed

, under the skillful leadership of a promising rookie named

Alan Greenspan

, was determined to provide sufficient liquidity to prevent a catastrophic implosion of credit -- something that very nearly occurred anyway on the morning of Oct. 20, 1987

Short-term interest rates fell by almost 250 basis points from Oct. 19 to Oct. 20. Third, the dollar had been weakening throughout 1987, and it didn't take much of a push to make foreign holders of U.S. assets sell. Finally, the connection between the stock market crash and a looming recession or worse seemed plausible.

In retrospect, the lack of macroeconomic fallout from 1987 was nothing short of a defining moment in our culture. Investors have internalized the timeless investment advice of

Alfred E. Neuman

: What, me worry? Not only do we buy the dips, we have sworn off fleeing stocks for various havens.

Flight to Quality: An Urban Legend

Since the 1987 crash, there have been 17 daily declines of 3.5% or more in the S&P 500, even though it feels as if there have been many more. If we examine the behavior of five potential safe haven markets on the day of each of these downturns -- and on the two subsequent days -- we are left with one and only one important conclusion: There has been only one flight to quality response, and that was 1987's.

A second conclusion emerges. Of the five safe havens examined -- eurodollars, 10-year notes, Treasury bonds, Japanese yen, and gold -- the market with the highest average gain following a downturn in the S&P 500 has been gold. Gold has been in a bear market since the waning days of the

Carter

administration. It has failed to rally during times of international distress; central banks and mining companies have driven the price down so far that they've had to publicly renounce further sales, and yet the yellow metal still manages to shine during stock market selloffs. Go figure.

The charts below depict the percentage moves of these following markets during and immediately after the stock market downturns.

Flight To Quality: Same Day

Source: Bridge/CRB Infotech CD-ROM

Flight To Quality: Next Day

Source: Bridge/CRB Infotech CD-ROM

Flight To Quality: Two Days Later

Source: Bridge/CRB Infotech CD-ROM

Alarmed By the Lack of Fear?

The failure of a flight to quality to materialize during the week of April 10-14, 2000, may, in fact, underscore a deeper problem with the market as a whole.

The proximate cause of Friday's debacle was a high CPI number, one that raised concerns of still more interest-rate increases to come. If you believe higher interest rates are on the way, courtesy of a stronger economy and an unleashing of price pressures suppressed for 2 1/2 years by various international crises, then a move into fixed-income instruments is irrational. You would have to believe that lower interest rates, a slowing or contracting economy, and a sudden disappearance of inflationary pressures are imminent.

This page has held inflation to be in check (see "Put the Pedal to the Metals in Inflation Hunt," Nov. 3, 1999, "Inflation Isn't Lurking in the Fields," Dec. 8, 1999, or "Metals Still Carry Weight and May Even Point to Bond Rally," Feb. 16, 2000). However, the essence of great trading and investing is knowing when you are wrong.

Should the CPI number be confirmed, then neither stocks nor bonds will be very rewarding for a prolonged period. After all, the stock market remained in a trading range between 1966 and 1982 during our last inflationary cycle, and that's an ugly thought to contemplate.

Howard L. Simons is a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of The Dynamic Option Selection System (John Wiley & Sons, 1999). Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he invites your feedback at

HSimons@aol.com.