Solid gains Monday and Friday surrounding three days of declines left major averages marginally changed for the week, but with a slightly positive bias.

For the week, the Dow Jones Industrial Average rose 0.9% and the S&P 500 gained 0.7%, while the Nasdaq Composite added 0.1%.

Those results might surprise some readers, given this week's headlines were dominated by rising concerns about war with Iraq and the unrest in Venezuela. On the political front, Sen. Trent Lott stepped down as Senate GOP leader. Such developments helped propel gold to near six-year highs, while oil spiked to a three-month peak, and the dollar tumbled to three-year lows vs. the euro and one-month lows vs. the yen.

Given that, along with profit warnings and/or disappointing results from corporations, such as McDonald's ( MCD), Micron Technology ( MU) and Best Buy ( BBY), among others, the performance of major stock proxies could be described as impressive.

Yet, that's probably not the term most market participants would use. "Disappointing" or "lackluster" might more readily come to mind, especially given the trend of sluggish volume. A streak of 11 straight sessions of below-average Big Board volume was snapped Friday, when nearly 1.8 billion shares were exchanged, no doubt thanks to the triple-witching expiration of stock index options and futures (actually it was a "quadruple witch" when the expiration of recently unveiled single-stock futures are also included.)

Bifurcation between actual results and the mood on Wall Street perhaps reflects the attitude of Federal Reserve Chairman Alan Greenspan. On the eve of the government's reporting third-quarter U.S. gross domestic product expanded by a 4% annual rate, the chairman told the Economic Club of New York:
The limited evidence since the November easing has supported our view that the U.S. economy has been working its way through a soft patch. And the patch has certainly been soft. The labor market has remained subdued, as businesses apparently have been reluctant to add to payrolls. The manufacturing sector remains especially damped, and nonresidential construction has trended lower. By all reports, state and local governments continue to struggle with deterioration in their fiscal conditions. Oil prices have recently risen and, not least, the economies of most of our major trading partners have shown little vigor.

Inflation, Deflation -- Let's Call the Whole Thing Off

Of course, the chairman had a lot of other things to say. He again defended the Fed's actions (or lack thereof) during the 1990's bubble; downplayed concerns about U.S. consumer indebtedness, suggesting the "servicing requirement for that mortgage debt relative to homeowners' income is roughly in line with the historical average;" and reiterated faith in the "remarkable resilience" of the U.S. economy and markets.

Continuing a recent trend among Fed officials, Greenspan also spoke extensively about the risk of deflation, suggesting the U.S. is "nowhere close to sliding into a pernicious deflation," while stressing that "options for an aggressive monetary policy response are available" if such a scenario were to emerge.

Along with Lott's announcement and a $1.4 billion conflict-of-interest settlement by Wall Street firms, Greenspan's comments were attributed by some as spurring the market's rally Friday. The Dow rose 1.8% to 8512.01, the S&P 500 gained 1.3% to 895.82 and the Comp rose 0.7% to 1363.60.

"On the margins, his commentary was somewhat positive for equities," said William Sullivan, senior economist at Morgan Stanley. "He suggested deflation in the U.S. is very unlikely and reminded listeners the Fed has tremendous resources to combat deflation, which makes it less likely."

The chairman also attributed the economy's current "soft spot" to geopolitical concerns, suggesting "once they abate, there's enough stimulus to support a rigorous recovery," Sullivan said.

Still, the economist cautioned against reading too much into the impact of Greenspan's speech on the financial markets. In addition to the aforementioned triple witching, he noted Friday also witnessed the rebalancing of the Nasdaq 100 and that there may have been some "profit-taking" in Treasuries ahead of the weekend and two weeks of holiday-influenced trading.

On Friday, the price of the 10-year Treasury note fell 3/32 to 100 13/32, its yield ticking up to 3.95%. Still, the benchmark note's yield fell 12 basis points for the week.

Conflicting Signals, Mixed Messages

The performance of Treasuries -- which are highly sensitive to inflation prospects -- was seemingly out of step with the rise in a number of commodities this week, most notably oil, natural gas and gold. Each rallied sharply, with oil closing Friday above $30 per barrel, natural gas at $5.18 per million btu and gold at $341 per ounce after eclipsing $353 intraday on Thursday. For the week, the Bridge/CRB Index rose 0.8% and is now up more than 23% year to date.

Gold's performance this week certainly generated a considerable amount of attention. A number of market participants still view gold as the classic inflation hedge, even though Bridgewater Associates says the link has been shaky for about 20 years, as reported here .

In sum, it seemed as if gold was rising because people are worried about inflation -- or at least "reflation," due to aggressive fiscal and monetary policies. But almost all economists agree inflation currently isn't a problem, and maybe gold isn't a very good indicator of inflation anyway.

"Gold is tough to define," said Morgan's Sullivan. "The upturn in gold does reflect the prospect of war and geopolitical tensions, but could also be a response to potential deflation." (Yes, deflation.)

Much of the demand for gold lately has come from Japanese investors, who are "reallocating more funds into precious metals to get out from yen-denominated securities and avoid deflation risk," the economist observed. "Too often we interpret market events in terms of what U.S. investors are doing, but you have seen some buying in the bullion market spurred by deflationary concerns" vs. inflation.

So maybe gold retreated Friday because Greenspan said, correctly or not, the risk of deflation is minimal. That, at least, would make rational sense in terms of how the financial markets performed.

On another note, a longtime gold investor once suggested to me that gold is a proxy for sentiment about central bankers. In that light, gold's recent rally and the dollar's descent make (almost) perfect sense given Greenspan's ham-handed defense of the Fed's role during the bubble and his recent struggles to accurately forecast the economy's path.

One thing for certain, 2003 isn't going to be boring.

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