Tame inflation and lower oil prices helped Wall Street set aside jitters about hedge funds and housing, and saw the major indices put in their best performance since November.

For the week, the

Dow Jones Industrial Average

rose 3.2% and the

S&P 500

added 3%. The

Nasdaq Composite

posted the biggest advance, adding 3.5%, and returning firmly above the key 2000 level.

On Friday,

Fed

Chairman Alan Greenspan -- as he patted himself on the back for accurately predicting the recent fall of oil prices -- summed up pretty nicely the factors supporting the market's rally over the past week.

"The effect of the current surge in oil prices, though noticeable, is likely to prove less consequential to economic growth and inflation than in the 1970s," Greenspan said in prepared remarks in New York.

Of course, that leaves a lot of room between two extreme scenarios -- the oil shock-induced stagflation of the 1970s and the so-called Goldilocks scenario of strong growth with no inflation. But for the moment, the market clearly prefers to believe in the latter scenario.

Greenspan equally quelled fears over the red-hot housing market. Although he conceded there was regional evidence of real estate speculation, he said he didn't expect housing prices would fall nationally.

In spite of the words of assurance by the Fed chairman, the market put in a mixed performance Friday, amid options expirations and profit-taking after the prior day's strong gains. The Dow finished down 21.28 points, or 0.2%, at 10,471.91. The S&P 500 fell 1.80 points, or 0.15%, to 1189.28. Meanwhile, the Nasdaq continued trending higher, rising 3.84 points, or 0.19%, to 2046.42.

Tame inflation news and the continued slide in oil prices provided the perfect fuel for the impressive rally.

On Monday, traders were still basking in the glow of the previous week's strong economic data -- April retail sales and a narrower trade deficit -- which eased concerns over the extent of an economic slowdown. Yet the data had reinforced concerns that the Federal Reserve might raise rates more aggressively to stay on top of inflation.

But on Wednesday, news that core consumer price inflation remained mercifully tame in April provided the perfect antidote to those concerns. If food and energy prices were added back in the picture, the consumer price index actually rose 0.5%, above expectations. But soaring gasoline prices appear to be a thing of the past, if the downward trend in crude oil prices continues. Over the past week, crude oil sank another 1.9% to $46.80 per barrel.

Under the spell of inflation relief, the market ignored a batch of weak economic indicators. A drop in industrial production, weak economic activity in the key Philadelphia and New York regions, and a drop in the Conference Board's leading indicators, were collectively viewed as more fodder to keep the Fed's hawks at bay.

Understandably, some in the market were caught daydreaming again that the Fed may not only pause but even halt its tightening campaign sooner than previously thought. Interest rate-sensitive financial shares made a comeback this week, during which the Amex Broker/Dealer Index rose 5%. Furthermore, traders focused on strong earnings from companies such as

Lowe's

(LOW) - Get Report

and

Hewlett-Packard

(HPQ) - Get Report

, as well as corporate developments such as

Motorola's

(MOT)

buyback announcement and

Maytag's

(MYG)

buyout agreement with private equity firm

Ripplewood Holdings

.

Meanwhile, the Treasury market continued its impressive performance. As its price continued to climb, the yield of the benchmark 10-year Treasury fell to three-month lows, ending the week at 4.12%. Safe-haven flows amid continued concerns in the corporate credit arena were partly responsible. The tame inflation and weak U.S. economic data this week provided an added bid for Treasuries.

Given that the yield of the 10-year note is used to set mortgage rates, the lower trend pleased those still bullish on housing stocks, which remains a bright (white hot) spot in the economy. The Philadelphia Housing Sector Index rose another 6.5% this week. But don't be too worried about froth and speculation in housing, Greenspan says -- although by using those terms the chairman is arguably trying to jawbone the residential real estate market. (Of course, he never acknowledged the Internet bubble until after it burst -- and then only grudgingly so.)

Wall of Worry

If all the circumstances of tame inflation and decent economic growth persist, the market's bounce from its April lows seems well supported. Both the DJIA and the S&P 500 have risen 4.5% from their respective April 20 lows. The Nasdaq, meanwhile, has gained an impressive 7.4% since its low on April 28.

But of course, there are risks to the rally: the Fed feels the need to raise rates regardless to return them to neutrality; commodity prices may make a comeback; and there are still mixed growth signals.

The Fed will continue raising interest rates, especially as the effects of the prior 200 basis-point hikes have failed to appear convincingly. Most observers -- presumably Alan Greenspan included -- would have thought the yield of the 10-year Treasury would be closer to 5% vs. 4% by now; how quickly it gets there (if it ever does) may surprise a few home owners and speculators.

And, if as Greenspan believes, economic growth has not been badly dented as first thought, commodity prices may make a comeback. Next week's revised first-quarter growth estimates could provide support to energy prices, according to some analysts. The global picture has similarly shifted from recent reports of waning growth to more bullish signals from the likes of China and Japan. Chinese oil imports, for starters, surged by 22.5% in April.

Perhaps in response to these factors, the Amex Oil Index finished the week up 1.2%.

Where it gets interesting, according to Morgan Stanley chief U.S. economist Richard Berner, is when one brings the dollar back in the picture. Dollar strength in recent weeks has played a significant role in the decline of commodity prices. The greenback, meanwhile, has itself been supported by firm expectations that U.S. growth remains on track and that interest rates will keep rising.

"The irony here is that while signals are still mixed, lower energy prices and consequent signs of emergence from the soft patch are bullish for both the dollar and growth, and thus for commodity demand," Berner wrote to clients. "In this context, growth may improve before commodity prices rebound."

Conclusion: No one really knows if it's definitely time to dump the stocks of energy and commodity-producing companies for good, or if commodity prices will make a comeback and threaten growth again.

For the contrarians out there, it seems retail investors already have caught up to the scenario of declining commodity prices, according to the latest weekly mutual fund data from Merrill Lynch. Energy funds had outflows of $785 million, which was the second-worst week on record, coming two weeks after the worst week as recorded by Merrill.

At the same time, mutual funds are starting to catch up with the strong uptick in technology shares. Tech funds, while still seeing money flow out of them, had the lowest level of outflow since late last year, Merrill said. That's much better than the overall performance of equity funds, which saw their strongest outflows since January -- a sign that the proverbial wall of worry remains very much intact despite this week's solid performance.

To view Gregg Greenberg's video take on today's market, click here

.

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

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