Economic data brought back the possibility of the "worst of all possible worlds" this week -- slowing growth amid rising inflation.

Whether the economy's landing is bumpy or smooth remains unclear, as does the future of

Federal Reserve

policy. Economists are engaged in heated debate while most investors' stomachs are still lurching from the week's wild ride.

The

Dow Jones Industrial Average

ended Friday down for the sixth consecutive day, down 0.3% at 11,966.04. The

S&P 500

dropped 0.22% Friday to 1364.30 while the

Nasdaq Composite

fell 0.14% to 2330.79. For the week, the Dow and S&P fell 0.9% each while the Comp shed 0.8%.

The 30-year Treasury bond fell 1 13/32 in price Friday to yield 4.81%, just one basis point higher than it was at the end of last week; but the long bond had rallied mid-week to yield only 4.68%. The 10-year Treasury note fell 30/32 Friday to yield 4.71% after having touched 4.56% midweek.

In terms of slowing growth, which is what the Fed wants to happen,

Wal-Mart

(WMT) - Get Report

kicked off the week's roller coaster by warning that its October sales would fall short of expectations. The announcement sparked a nervous reaction in the markets, as investors suddenly questioned the U.S. consumer's health.

The red flag was a big one, as American consumption has been the linchpin of the soft-landing argument. Spending behavior has thus far been mostly untouched by the severe slowdown in residential real estate. The bulk of U.S. retailers pulled the rug out further Thursday with a set of disappointing same-store sales results for October. The retail sales figures sent shares of Wal-Mart and its competitors down sharply. Wal-Mart fell 1.57% Friday, and 6.3% on the week. The S&P Retail Index lost 0.89% Friday and 2.57% on the week.

In the middle of the week, the Institute for Supply Management printed a lower-than-expected reading of manufacturing activity, and the Labor Department reported that productivity was flat. Investors shuddered at the notion of the hard landing as bond bulls patted themselves on the back. Bond yields fell dramatically and the stock market rally faltered.

But on Friday, the Bureau of Labor Statistics revived hopes for a healthy consumer and a lucrative Christmas season, with a lower-than-expected 4.4% unemployment print and another massive upward revision to jobs. The BLS said 92,000 jobs were added in October, fewer than the 125,000 forecast by economists. But that soft reading was overshadowed by the revision to September's report, bringing 51,000 jobs in the month to 148,000. The BLS also revised upward August payrolls.

While news of a strong labor market may mean the slowdown doesn't get ugly for consumers, it does mean that inflation pressures are sticking around.

Friday's data showed a greater-than-expected increase in average hourly earnings, supporting Thursday's third-quarter productivity report, which showed a 3.8% gain in unit labor costs. Unit labor costs are growing at a 5.3% year-over-year pace -- the fastest since 1982.

"For a bond market intoxicated with weak growth and benign inflation expectations, this is a real problem," says Michael Darda, chief economist at MKM Partners.

The bond market tumbled Friday, while stocks got stuck in anxiety mode. As for the Fed's next move, blink and it's a cut. Blink again and it's a hike.

After reaching 56% odds of a rate cut at the March FOMC meeting, the fed funds futures market ended the week pricing in only 16% odds of a cut in March, according to Miller Tabak. Similarly, after pricing in 16% odds of a cut in January as of Thursday, now the market prices in 2% odds of a hike at the Fed's first meeting of 2007.

While the data are providing some drama, the markets are remarkably stable. Bonds are trading around the middle of their 4.5%-5% range. Stocks are down, but not by any large percentage, and not amid huge selling pressure.

"I think this is pre-election anxiety," says Margie Patel, portfolio manager at Pioneer Investment Management. "The debates focus on problems in the economy and the world."

Earnings season remained quite strong this week, and on Friday

JDS Uniphase

( JDSUD) and

Electronic Arts

( ERTS) surprised investors to the upside. Their shares gained 16.11% and 11.77%, respectively.

But there were some grand disappointments in the mix, too. Friday's greatest declines came from

Whole Foods Market

( WFMI), which fell 23%, after warning investors that 2007 could bring weaker results.

Red Robin Gourmet

(RRGB) - Get Report

also disappointed investors with its results and guidance, sending its shares down 26.1%.

The trend remains positive, "and so do we," says Justin Walters, analyst at Birinyi Associates, adding that investors seem shaken because the indices had previously been going up without much of a breather. "It seems as if people have forgotten what it is like to have a down day, and for good reason," he says. The S&P 500 has gone 79 days without a 1% decline, something that hasn't happened since 1995.

If the S&P 500 is up at least 10% going into the last two months of the year, it continues to climb in the last two months 84% of the time, he says. The S&P 500 returned 10.2% through the end of October.

The bond market likewise just "got a little steamy," says William Hornbarger, fixed-income analyst at A.G. Edwards. "This is what you get when the economy is in transition. Some days you get data that shows slowing and some days you get data that shows strength."

The floundering is likely to continue at least at the start of the week as Wall Street turns its eye to a trio of Fed speakers Monday and, of course, Tuesday's mid-term elections.

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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