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It never pays to bet against the American consumer, market bulls love to remind pundits these days. Bears counter by saying that bidding up stocks on the premise that oil prices will keep heading lower has long been a fool's game.

Both sides are offering sage advice, according to the lessons of recent history, but as usual, neither is heeding that of the other.

Market pessimists are closely watching the sharp deterioration of the U.S housing market, predicting that a decline in homes' values will eventually hit consumers wallets and cause a malaise throughout the economy.

Optimists are looking at declining oil prices, which closed at a 10-month low Friday, believing the red-hot energy market is finally returning from the stratosphere, easing the strains of inflationary pressures and consumer spending.

Despite the housing dropoff, persistent twin deficits and the usual rumblings on the geopolitical front, bulls had the upper hand early in the week.

Some traders went so far as to price in a rate cut before Wednesday's

Federal Open Markets Committee

meeting, but the central bank held rates steady, as was more widely expected. That, along with earnings blowouts from the likes of


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Morgan Stanley

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, inspired yet another stock rally that put the

Dow Jones Industrial Average

within 110 points of its all-time high from way back in January of 2000.

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But along came the Federal Reserve Bank of Philadelphia Thursday with the September results of its manufacturing index, which gauges the business climate in the mid-Atlantic region. The index took an unexpected dive into negative territory for the first time since April of 2003, after a previous reading of 18.5.

"An eight, nine or even 12-point move on the Philly Fed index from month to month is not uncommon," says Joel Naroff, chief economist with Naroff Economic Advisors. "A 19-point move is uncommon. This move was so large, you have to say that it's a warning sign to some extent."

Wall Street agreed with that sentiment and stocks finished down for the week -- a reminder of just how fragile a market rally is amid a minefield of threats to economic growth facing investors. The Dow gave back 53 points for the week, or 0.4%; the


is shed 5 points, or 0.4%, and the


lost 17 points, or 0.7%.

Despite the alarms sounded by a sour economic report from the mid-Atlantic states, Naroff says the results shouldn't be construed as a symptom of the housing market's slowdown. He says the housing market in that region, while softer, is not experiencing the sharp dropoff that's taking place in markets like Miami, Las Vegas, Texas or California. Also, the mid-Atlantic manufacturing sector is more directly connected to sectors like pharmaceuticals, medical technology and chemicals.

"The slowdown in housing will translate to manufacturing over time if it causes consumers to cut back their spending, and then manufacturers will feel that cold wind," says Naroff. "We haven't seen that yet."

Inflation Inspection

Despite the drop in the index, the Philly survey showed that manufacturers are still hiring, bringing in the inflation question -- an issue that remains prominent for the Fed, despite its two-month pause in its rate-tightening campaign.

"Readings on core inflation have been elevated, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures," said the Fed in its policy statement. It went on to say the "extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

Subodh Kumar, chief investment strategist with CIBC World Markets, interpreted the statement to mean that rate cuts aren't going to be arriving anytime soon.

"The Fed paused in rates but continues to be vigilant on inflation," says Kumar. "If oil prices or inflation picks up and long bonds move higher, then our equity risk premiums are too narrow, and stock prices would have to pull back due to risk reasons."

Perhaps the most glaring reminder that inflation remains a threat came from the second-consecutive dissent on Fed policy from Jeffrey Lacker, president of the Federal Reserve Bank of Richmond.

Lacker cast his first vote against new Fed chairman Ben Bernanke in August because "he believed that further tightening was needed to bring inflation down more rapidly than would be the case if the policy rate were kept unchanged," according to the minutes from the August Fed meeting. "The inflation outlook had deteriorated in the inter-meeting period; the recent surge in core inflation had persisted and appeared to be broad-based, while the revision of the national income and product accounts indicated a recent upswing in compensation and unit-labor costs."

Investors have been quick to dismiss Lacker's stance on inflation as meaningless, but his position reflects comments made by Bernanke himself last spring that sent the markets into a tailspin. Given the political pressure that is inherent to Bernanke's position as a fledgling Fed chairman with mid-term national elections around the corner, he may have felt an incentive to reverse his stance and leave Lacker as the lone voice of caution.

"I suspect there are others on the board who agree with Lacker's position," says Naroff. "If everyone is aware that one person is going to go against the chairman, it makes it really difficult for others to follow. They have to be willing to, in essence, cast a no-confidence vote against the chairman. One should not presume that there aren't others who might want to see rates go higher but are not willing to take that step."

In its September statement, the Fed once again singled out an expectation for lower energy prices as a force for moderation on the inflation front. Like Wall Street's bulls, the Fed appears to be betting on lower oil prices to keep the inflation genie in its bottle.

Since crude futures trading on the Nymex hit their intraday peak at $78.40 on July 14, prices have plummeted to a closing price on Friday of $60.55.

Oil prices have fallen from lofty levels before in recent years, only to spike back up again as the violence raging in the Middle East has posed additional risks to that region's supply.

"Energy prices may well go lower, but that's not what they should hang their hats on," says Naroff. "Lacker is hanging his hat on the simple fact that unit labor costs are rising, wage costs are rising, commodity prices are still high and the unemployment rate is still low. The biggest complaint from businesses is they can't find suitable labor, which accounts for 65% to 75% of costs for most businesses. Energy is one-tenth of that, so which should we be worrying about? That's why Lacker is making sense."