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The market resumed its rally Monday, as investors again piled into technology issues amid continued expectations that the

Federal Reserve

may soon be done tightening, while growth remains decent.

Still under the recent spell of strong economic data and indications of tame inflation, investors happily bought into reports of a deal between two tech giants --






-- and an upgrade of the software sector.

Even higher crude oil prices -- July contracts closed up 51 cents at $49.16 on Nymex -- were ignored after Sanford Bernstein upgraded several oil majors, including

Exxon Mobil










Dow Jones Industrial Average

rose 51.65 points, or 0.5%, to 10,523.56. The

S&P 500

added 4.58 points, or 0.4%, to 1193.86. The

Nasdaq Composite

added 10.23 points, or 0.5%, to 2056.65.

Breadth was positive, with advancers beating decliners by nearly 2 to 1 on the


, and 17 to 14 on the Nasdaq. Yet volume remained light, with approximately 1.7 billion issues exchanged on both the Big Board and Nasdaq.

Bonds rallied ahead of Tuesday's release of the minutes of the May 3 meeting of the

Federal Open Market Committee

. The benchmark 10-year Treasury note added 15/32 while its yield fell to 4.06%.

All the optimism again benefited technology issues, as has been the case over the past several weeks. A report that Intel is in talks with Apple to provide chips for Macintosh computers spurred early interest in technology issues. Then Goldman Sachs' Rick Sherlund upgraded the software sector -- including the likes of









-- which, he says, should benefit from the expansion of Web services standards.

This may be another "well-timed" research call by Goldman Sachs, coming right in the strength of the tech rally of the past few weeks, which has led the overall market's bounce from its April lows. Maybe this call will have the same effect as Goldman's "super-spike" note in late March, which predicted that crude oil prices could eventually rise above $100. Voluntarily or not, that call seemed to signal the end (even temporarily) of the latest run-up in oil prices, which have steadily declined after trading above $57 in early April.

The parallel may be far-fetched. But it's notable amid all the recent sell-side bullishness (including Merrill Lynch last week and Bear Stearns on Intel on Monday) that the profit outlook for the tech sector has not changed much since the beginning of this year. In other words, the recent rally could just be a rebound from the prior beating and not necessarily an indication of greater health in the sector.

From January through April, prices took a beating on expectations that a decelerating economy and rising interest rates were not fundamentally good for the tech industry and other growth stocks. As concerns mounted over a significant economic slowdown -- combined with rising inflation and higher interest rates -- tech stocks sold off even more. Then as fears on both the growth and inflation fronts abated in recent weeks, the tech sector has made a nice comeback. The Nasdaq Composite is now up nearly 8% from its low of 1904 on April 28.

Room to Grow or Time to Prune?

As mentioned

here Friday (and by


over the weekend), there are contrarian signs suggesting that there's still room for this rally to grow. According to Merrill Lynch's weekly tally of mutual fund flows, outflows from equity funds in the latest week were the strongest since January. This usually signals to contrarian investors that investor disbelief is still strong enough to support a "wall of worry" that bulls can climb.

However, the same report from Merrill also signals that retail investors may be catching up to the trend in tech, as money flowed out of tech funds at the slowest pace since late last year.

And there are some signs that it may be time to at least become cautious on tech, according to Banc of America market strategist Tom McManus. Although he regrets staying out of the recent rally, McManus is wary of adding to existing tech stock positions "while the economy is apparently decelerating."

The strategist dismissed evidence of investor disbelief, pointing out that the Merrill data track both open-ended funds and exchange traded fund (ETF) flows. Removing ETF flows, McManus says that retail investors were not heavy sellers after all.

"To our eyes, investors are quickly becoming more confident -- as one might expect -- given the strength of the rally," he wrote to clients. A clear symptom of this newfound confidence is that investors are less fearful of risks in the tech sector than they've been in the recent past.

This was evident on Friday when an index measuring volatility based on Nasdaq 100 options, aka the VXN ("the Vixen"), fell below 16% for the first time in 10 years. And the spread between the VXN and its equivalent index for the S&P 500, aka "the VIX," has narrowed to 2.75%, close to an all-time low, McManus notes.

Yet the bulk of the rally -- for techs and for the market at large -- may still be far from over. After all, the Nasdaq and the other major indices are still far from their March highs.

"It's not late in the game

for techs and the market because we're not even up for the year, which means there's still some room," says Barry Hyman, market strategist at Ehrenkrantz King Nussbaum. "But then, this Nasdaq-led rally took hold on presumption that the Fed will be over sooner rather than later, of which we can't be certain."

And that's the catch. The Fed is unlikely to end its tightening campaign, even if it may afford a pause. Inflation is creeping higher, which by itself should encourage the Fed to continue nudging rates back to at least a neutral level. And as the fed funds rate remains historically low, signs of excess, be it the housing bubble or hedge funds taking too much risks, provide more reason for Fed Chairman Alan Greenspan to make sure he ends his term on top.

To view Aaron Task's video take on today's market, click here


In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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