The theme this week was what didn't happen. Most notably, the Federal Reserve did not ease Tuesday and a huge number of companies did not restate results while meeting Wednesday's deadline for certification of financials.

The stock market sold off following the Fed's announcement Tuesday afternoon , and the central bank did downgrade its assessment of the economy. But the selling didn't continue, and in fact, equities rallied solidly in the days thereafter, before finishing mixed Friday in soporific trading.

Big gains Wednesday and Thursday helped the Dow Jones Industrial Average rise 0.3% for the week, while the S&P 500 gained 2.2% and the Nasdaq Composite rose 4.2%.

Neither did stocks suffer negative reactions to another round of sluggish economic news, particularly Thursday's Philadelphia Fed survey and industrial production/capacity utilization data as well as Friday's weaker-than-expected housing starts and University of Michigan consumer confidence reports. (Monday's in-line retail sales data and Friday's tame CPI report were offsetting factors.)

Nor were equities rattled much by events such as a spike in oil prices (which helped the Philadelphia Stock Exchange Oil Service Index rise 8.8% this week), the ongoing financial crisis in South America, Standard & Poor's credit watch listing of several key Wall Street firms or the potential financial fallout of the floods in Europe.

Similarly, the bankruptcy filing by US Airways ( U) last Sunday, followed by Wednesday's warning United Airlines' parent UAL Airways ( UAL) may follow suit (and big layoffs at American Airlines) had little spill-over effect on the broader market, although shares of airlines and their suppliers did suffer. The Amex Airline Index fell more than 13% this week.

In fact, the overall action and results from firms such as Target ( TGT) and Dell ( DELL) encouraged optimism.

"The stock market most likely hit the year's low on July 24," Ed Yardeni, chief investment strategist at Prudential Securities, commented Thursday. Yardeni raised his recommend allocation in equities to 50% from 40% for "moderate" investors (leaving cash at 10% and reducing bonds to 40% from 50%) and to 70% from 65% for "moderately aggressive" accounts (cutting bonds to 30% from 35% and leaving cash at zero).

The strategist, who expressed caution amid some "bottoming" talk back in mid-July, has year-end targets of 10,500 for the Dow and 1100 for the S&P 500.

How Safe Is Your Haven?

For all the focus on stocks, the greatest drama this week occurred in the bond market. Early Wednesday, yields on the benchmark 10-year Treasury note dipped briefly below 4%, its lowest level since September 1963. Other maturities hit similarly historic levels, as did mortgage rates.

The big question is whether Wednesday marked the culmination of a long-running rally in fixed income that accelerated dramatically beginning mid-May, i.e., the top in Treasury prices and the bottom in yields. Treasuries reversed course midday Wednesday and finished the week in arrears as equities recovered.

On Friday, the price of the 10-year note fell a full point to 100 18/32, its yield rising to 4.30%.

"It's highly likely, especially from a technical point of view that we've seen a top" in bond prices, said James Padinha, economic strategist at Arnhold & S. Bleichroeder. "It is a very strong possibility."

Padhina remains optimistic about the economy's path and believes the recent rally in Treasuries was due mainly to the stock market's poor performance. "What we might be seeing now is bonds returning to the lead position and the fixed-income market saying 'this is getting ridiculous, we're priced for a really horrible economic scenario which seems unlikely to happen.'"

Bonds perform best in periods of economic weakness because inflation, often associated with faster growth, erodes the value of future interest payments. So bonds benefited from signs of economic weakness and worries the recent swoon in equities would slow growth further.

Many market participants believe Treasuries overreacted to those fears, more especially now that the Fed has indicated it's likely to cut rates at any indications of further weakness.

"I think the bond market is anticipatory and saying either the data starts to print more strongly and erases doubts about a double dip or the Fed comes in and you get the same result," Padhina said. "It's feeling more and more like Wednesday marked the trough" in yields.

Given the still predominant view on Wall Street that the economy won't slip back into recession, many investors concluded this week that equities had become attractive relative to Treasuries, which had become overpriced. That was starkly expressed by reports of big asset-allocation trades out of bonds and into equities by pension funds and other institutions.

As the stock market recovered from its late July swoon, one broker/dealer reported seeing "$50 billion in asset allocation into stocks , mostly from pension funds," Tony Crescenzi, chief bond strategist at Miller Tabak and contributor, recalled Friday. That dealer, which Crescenzi didn't name, had another $50 billion to allocate by the end of the quarter.

"For each dip there's buyers," he said, recalling the rapid rally in equities after weakness early last week. "This asset allocation stuff is for real."

Given that, and reports optimistic sentiment among bond fund managers reached levels this week unseen since September 1998, "the odds might favor" Wednesday proving to be a peak in bond prices and nadir in yields, Crescenzi said.

The bond strategist added some caveats, noting bond prices could rally again if the asset allocation trade fades, the economy weakens further or some crisis -- financial, geopolitical or otherwise -- sparks renewed interest in their perceived safety. "Bonds could recover from this ... there is no big justification to short the Treasuries," he said.

Through June, investors had put $58.5 billion into bond funds (both taxable and tax-exempt) this year, on top of $35.6 billion in 2001, according to the Investment Company Institute.

Given what's transpired in equities, that "flight to safety" is understandable, even laudable. Still, prudence dictates an examination of what a potential top in the bond market means, something we'll discuss further next week.
Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.