Stocks Sail Past Worries

Iran's release of British sailors and marines buoys a choppy market.
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The stock market drifted higher Wednesday, defying the old Wall Street saying that markets can only drift lower.

An upward move amid such thin trading and persistent economic uncertainty is bullish, say traders. The gain came even as inflation snapped higher in a slightly weaker-than-expected report on the services sector. Also, the ADP national employment report points to a possibly lower-than-estimated rise in nonfarm payrolls report Friday.

But Iran's freeing 15 British sailors and marines, and another drop in the price of oil were enough to maintain the bulls' advantage. And while rate-cut odds increased slightly Wednesday, the

Federal Reserve's

favorite combination of slowing economic growth and high inflation keeps the central bank in its familiar box -- on pause.

"It is encouraging that the market is coming back the way it has been," says Michael Driscoll, director of listed trading at Bear Stearns. "You still have to give the stock market the benefit of the doubt."

The

Dow Jones Industrial Average

gained 0.2% to close at 12,530, while the

S&P 500

gained 0.1% to close at 1439. The

Nasdaq Composite

added 0.3% on the day to finish at 2458. The price of a barrel of light sweet crude oil fell 0.4% to close at $64.38. The defensive Dow Jones Utilities Index marked another new all-time high intraday Wednesday, but closed down a fraction on the day.

Tuesday's retail rebound proved unsustainable Wednesday despite a strong earnings report from

Best Buy

(BBY) - Get Report

. The company beat expectations and reiterated guidance, but the stock was battered down 2.3%.

Investors may have lumped Best Buy in with

Circuit City

(CC) - Get Report

, which reported that it swung to a loss amid weaker-than-expected sales. But it fell only 0.3% on the day.

Wal-Mart

(WMT) - Get Report

fell 0.1% Wednesday.

Perhaps the Best Buy-Circuit City paradox foreshadows the tone of trading during the upcoming earnings season. As Bank of America's chief equities strategist Thomas McManus

said Tuesday, the chorus of voices complaining of challenging times may move stocks more than the lone standout superstar. And, certainly in the realm of retailers, there is no shortage of concern about weakness in a softening economy.

The broad indices were resilient in the face of a 52.4 reading of the Institute for Supply Management's measure of production growth in the services sector in March. Analysts had expected a 55.5 reading, as the service sector is what has held up economic growth while manufacturing obviously wavers.

Factory orders in February rose 1%, which was lower than the 1.9% rise that analysts expected. The level of employment and new orders measured by the ISM services index also were lower, but the biggest surprise in the report points to stubborn inflation.

The prices paid component in the ISM index jumped to 63.3 in March from 53.8 in February -- the second-largest single-month increase in 10 years.

Revealing that traders are more focused on growth than inflation, the bond market staged a modest rally, and the fed funds futures market slightly increased odds of a rate cut. The 10-year Treasury bond added 4/32 to yield 4.65%. The fed funds futures market puts odds of a cut at 8% in May, up from 6% on Tuesday, according to Miller Tabak. The market puts 24% odds of a cut in the June meeting and 58% on August. For the year, the market prices in 100% odds of one rate cut, and puts 80% odds on two cuts.

But the Fed seems unlikely right now to bend its ear to calls for rate cuts, though it's what many market participants have been calling for since last spring.

"The Fed is likely to read the ISM non-manufacturing survey as a reason to stand pat and let the volatility that lies ahead work to its advantage to unwind some of the risk taking that characterized the final months of 2006," writes Joe Brusuelas, chief economist at IDEAglobal. "The Fed will not bail out the market."

As to whether traders are worried about inflation, Driscoll says, "We're always worried about inflation." He adds with a bit of frustration, "We've been listening and worrying about inflation for three years now as energy prices have crept higher over the last three years. I'm surprised there hasn't been more inflation."

Energy prices aren't necessarily tamed just because the Britons were released. Demand for gasoline is taking the baton to threaten higher energy costs. Gas prices are at their highest levels since September as demand for gasoline soars.

Gas inventories fell by 5 million barrels in the week, vs. expectations for a 400,000-barrel drop, according to a report Wednesday. Due to fires, the capacity to refine oil into gasoline is also running at low levels, which just pushes gas and oil prices even higher. And the next round of inspections in Iran happens in about two weeks.

Investors also paid attention to the ADP report this week, as nonfarm payrolls come on Good Friday when the stock market is closed. The ADP report showed a 106,000-job rise in the private sector in March, slightly lower than the 135,000 analysts expected, but not low enough to suggest any massive subprime or housing-market blow to the strong labor market. Analysts expect 133,000 new jobs from Friday's nonfarm payrolls report.

Indeed, with still-low risk premiums on corporate and emerging market bonds, high commodity prices, strong global equities markets and strong labor markets, "recession fears remain overblown," writes Michael Darda, chief economist at MKM Partners.

So the growth story remains in focus for stock and bond traders. And even with some mild disappointments, the soft-landing or at least no-recession forecast still holds water, allowing stocks to drift higher even if rate cut fantasies aren't panning out.

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

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