Traders may not believe in Santa Claus or the Easter Bunny, but they sure put their faith in Goldilocks this week as major averages rallied sharply amid stronger-than-expected corporate earnings and benign inflation data.

The

Dow Jones Industrial Average

rose 2.8% for the week, punctuated by Friday's gain of 153 points, or 1.2%, to 12,961.98. Friday marked the Dow's third-straight record close and 15th advance in the past 16 trading days. The day's rally followed stronger-than-expected earnings from components

Caterpillar

(CAT) - Get Report

,

Honeywell

(HON) - Get Report

and

American Express

(AXP) - Get Report

.

With approximately 25% of

S&P 500

companies reporting thus far, 66% of first-quarter earnings have been better than expected.

"People were anticipating

earnings would not be so good,"

New York Stock Exchange

floor trader Doreen Mogavero, president & CEO of Mogavero Lee & Co., said Friday in an

interview on TheStreet.com TV. "So it was a good surprise and made people very enthusiastic."

Indeed, the Dow was joined in record territory this week by the Russell 2000, Dow Transportation Average, Dow Utilities and S&P MidCap 400.

As for the other so-called major averages, the S&P 500 hit a six-and-a-half year high, gaining 2.2% this week and rising 0.9% to 1484.35 on Friday. Beyond financials and industrials, the S&P's rally was led by resurgent biotech and health care stocks such as

Johnson & Johnson

(JNJ) - Get Report

,

Merck

(MRK) - Get Report

,

MedImmue

(MEDI)

and

Amgen

(AMGN) - Get Report

.

The

Nasdaq Composite

rose 1.4% this week and 0.8% on Friday to 2526.39, its highest level since February 2001, as

Google's

(GOOG) - Get Report

advance helped overcome the sting of

Yahoo!'s

(YHOO)

midweek tumble.

Mixed results from tech bellwethers such as

eBay

(EBAY) - Get Report

,

IBM

(IBM) - Get Report

and

Intel

(INTC) - Get Report

received the most media attention, but the key to this week's rally was the financials, as discussed on

Wednesday's "Real Story" podcast.

The decline in late February came, in part, because some experts feared that a "subprime spillover" would lead to "systemic risk" in the financial sector. Then, in early March, the big brokers revealed limited exposure to subprime and said they saw opportunity to buy distressed assets. That helped kick-start the market's recovery.

Fast forward to this week, when financial giants American Express,

Citigroup

(C) - Get Report

,

Bank of America

(BAC) - Get Report

,

Merrill Lynch

(MER)

and

JPMorgan Chase

(JPM) - Get Report

posted better-than-expected earnings and limited exposure to the subprime space.

Even

Washington Mutual

(WM) - Get Report

, which cited "difficult market conditions" in its home lending business, rallied sharply midweek as its overall results beat expectations and its subprime exposure was not as bad as feared.

"For mega-caps broadly, it's been a very good reporting season," Smart Financial Partners's Joe Capone, a

RealMoney.com

contributor, said in an

interview for TheStreet.com TV Friday. "It was a rough February-March for banks, so people were afraid of financials," and expectations were low ahead of earnings.That said,

Capital One Financial

(COF) - Get Report

was punished this week for posting disappointing results.

Awash in Liquidity

Beyond earnings,

Freddie Mac

(FRE)

announced Wednesday it will buy $20 billion worth of subprime loans, while

H&R Block

(HRB) - Get Report

on Friday announced the sale of its subprime mortgage business, Option One Mortgage, to private-equity giant Cerberus Capital Management.

Freddie and Cerberus joined a string of firms investing in the subprime space, belying the "liquidity crunch" fears heard in late February and early March. The ability of H&R Block,

Accredited Home Lenders

(LEND) - Get Report

and others to obtain capital and/or find buyers for their mortgage portfolios -- even at a steep discount -- is a key reason for the market's quick, sharp rebound from the February selloff.

Outside the mortgage industry, ample liquidity presented itself in the $20 billion private equity buyout of

Sallie Mae

(SLM) - Get Report

, as well as aggressive buyback announcements from JPMorgan and

Linear Technology

(LLTC)

.

All the capital in private equity, in hedge funds and on corporate balance sheets should impede a

Federal Reserve

rate cut. Odds that the Fed will lower rates anytime between now and August fell to 25% this week even as the year-over-year rate of core CPI fell to 2.5% from 2.7%. While retail sales and housing starts proved better than expected, other data this week were tilted to the weak side, leading some to call for rate cuts despite ongoing strength in commodities and sharp dollar weakness.

Still, records for myriad equity averages this week suggests that the stock market does not need rate cuts.

If the bulls were right for the wrong reasons, the bears were just plain wrong -- about both the direction of the stock market and the implications of a falling dollar. The Dow's strength this week proves that the falling dollar actually has some positive implications, including making the exports of U.S. multinationals more competitive.

"The dollar may trend lower still -- but the optimistic

view is it would encourage foreign investment in this country," says Mogavero. "That may help the housing market."

Hand-wringing about the dollar -- which approached a record low versus the euro this week -- was one sign of skepticism about the rally's sustainability. Others include record short interest on the NYSE and punk results from discount brokers

TD Ameritrade

(AMTD) - Get Report

and

E*TRADE Financial

(ETFC) - Get Report

.

Additionally, some cycle watchers were forecasting a downturn this week, as reported

here, while more -traditional technical analysts say the market has become extremely overbought. Undaunted as the advance continues, some bears espoused the classic "sell in May and go away" theory Friday, a reference to the market's historical struggles in the May-to-October timetable.

Contrarians say a high level of disbelief is bullish because investors betting against stocks are forced to cover positions and those previously on the sidelines feel compelled to invest as the market goes higher, helping extend the gains. Although the Dow rose just 4 points and the S&P and Nasdaq dipped modestly, Thursday's session was particularly significant because the major averages overcame early negativity that followed a steep overnight selloff in China. The inability of the bears to capitalize on the Shanghai Composite's 4.5% decline was another sign that the bulls are firmly in charge, paving the way for Friday's ascent.

Looking forward, it's easy to say that the market is due -- even overdue -- for a setback and that Friday's rally was goosed by options expiration. But the market continues to defy the naysayers, and, as John Maynard Keynes famously said, "The market can stay irrational longer than you can stay solvent."

That said, it's interesting to note that "Goldilocks" is a fairytale that doesn't have a happy ending.

Aaron L. Task is editor at large of TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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