A fight every now and then makes a relationship stronger. Arguments clear out the cobwebs and help air issues that may have been swept under the rug. But most important, the making-up can be rejuvenating.

Friday morning's payrolls report seemed like the kiss-and-make-up moment after a brief two-week spat between investors and the "Goldilocks" ecomony -- the ideal of moderate growth and low inflation.

After a volatile couple of weeks, stocks rallied and U.S. Treasury bond yields soared Friday morning. But by Friday afternoon, the relationship seemed back on slightly shaky ground.


Dow Jones Industrial Average

ended the day up only 0.1% but recaptured 1.3% on the week to close at 12,276.32. The Dow is still 4% off its Feb. 20 all-time high of 12,786.64 but is up 1.9% from its recent low of 12,050.41 March 5.


S&P 500

finished the day up 0.1%, and up 1.1% for the week to close at 1402.85. The large-cap benchmark is down 3.9% from its high of the year but up 2.1% from its Monday low. The

Nasdaq Composite

ended the day down a fraction to close at 2387.55 but finished the week up 0.8%. The tech-heavy index is still down 5.4% from its Feb. 22 high of 2524.94 but is up 2% from its Monday low.

Stock and bond markets stabilized at lower prices and yields this week amid some mounting evidence that the economy is weakening. So, as Friday's payrolls report approached, investors seemed more on recession watch than inflation watch.

Traders reported expecting a payrolls print much lower than the consensus estimate for 95,000 new jobs. Some strategists were even preparing clients for the possibility of no new jobs in the month.

When the 97,000 new jobs in February and the 55,000 new jobs in upward revisions hit the tape, the news righted the ship. The report seemed to restore inflation to its rightful, more prominent place in the ladder of worries.

"This was an above-consensus report in many ways," says Michael Darda, chief economist of MKM Partners. The service sector created 168,000 new jobs in February, just off the 12-month moving average of 172,000. The 62,000 decrease in construction jobs is partially explained away by weather factors. "There's really no slowdown in the service sector, which comprises 86% of total employment," says Darda.

When traders noticed the higher-than-expected 0.4% increase in hourly wages, they remembered that on Monday, unit labor costs also were revised higher in the fourth-quarter productivity report. Wage inflation roared again. And suddenly,

Federal Reserve

officials' and U.S. Treasury Secretary Henry Paulson's hawkish comments on inflation and the economy this week seemed more in touch with reality.

In the middle of the week, calm words about the economic outlook or concerns about inflation seemed off base. With eurodollar futures traders pricing in 75 basis points of easing in the next year, the markets were wondering when the Fed would signal a move to a neutral policy stance.

On Wednesday, Chicago Federal Reserve President Michael Moskow said that "it is much too early to say that inflation is no longer a concern." Paulson, on a trip in Asia, repeatedly said the economy is in "solid" condition.

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And the Federal Reserve's beige book acknowledged some weaker growth but mostly revealed a Fed that remains relatively sanguine about future economic growth. The Fed is certainly not on board with Alan Greenspan and his recession fears.

After the payrolls report, the yield on the 10-year Treasury note rose to 4.9%, up from 4.51% last week. After a volatile week, oil fell 2.6% on the week to close at $60.05 per barrel.

Despite the surface anxiety in stocks, some of the most cyclical parts of the market, or what many call the old leadership, climbed back.

As overseas markets stabilized, the iShares MSCI Emerging Markets Index gained 4% this week, as did the

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exchange-traded fund. The Dow Jones Transportation Average gained 1% this week, while the Morgan Stanley Cyclical Index gained 1.9%. The small cap Russell 2000 Index gained 1.25% while the S&P Retail Index finished up 1.1%.

But many traders still spent much of the week emphasizing the subprime mortgage market or the yen carry trade unwinding. Adding to economic angst was a weaker-than-expected report of nonmanufacturing activity from the Institute for Supply Management. Factory orders were weak, and same-store sales reports were disappointing.

On the flip side, the strong jobs report reminded traders of some of the signs of strength that emerged this week. The Fed reported Thursday that household net worth increased by $1.4 trillion in the fourth quarter. The trade deficit also shrank in January to $59.1 billion, while workers' wages rose.

"The trade data may spur some upward revisions to first-quarter GDP growth," says James Paulsen, chief investment strategist at Wells Capital Management. "Everyone thought it was a fourth-quarter phenomenon, but it could be a contributor all year long."

But the relationship with Goldilocks is still not "back to normal" yet.

As if on cue to keep the animal spirits quelled, Susan Bies, a Federal Reserve governor and bank regulation expert, said Friday afternoon at a conference in Washington, D.C., that regulators are concerned about "payment shock" from rising mortgage payments on adjustable rate loans. She also said the subprime market "is not at the end of a wave, but at the beginning."

To make things more confusing, Bies also said that the economy is strong and that the job market should continue to boost consumer spending.

The stock market turned down Friday on her words but clawed its way back upward by the finish. Indeed, traders seem to be taking some of the most recent subprime headlines in stride. Thursday's news of

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possible bankruptcy filing did not dramatically hamper the stock market's rebound. New Century slid another 17.1% on the day.

In sum, the market's correction, or the most heated part of the market's fight with Goldilocks, may have died down this week. But next week brings February's report of retail sales, and the producer and consumer price indices. If both are high, the rate-cut expectations could spin 180 degrees into inflation fears. What seemed Friday morning to be just a two-week spat could well become a bigger but different argument.

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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