In the great "deflation vs. reflation" battle, reflation scored a minor victory Tuesday, providing a boost to commodities while undermining Treasuries and housing stocks.

With major equity averages digesting Monday's big gains, the big story Tuesday was the May consumer price index. CPI was unchanged vs. expectations for a 0.1% decline while the core rate, which excludes food and energy, rose 0.3%. That was its largest gain since August; expectations were for a rise of 0.1%.

On a year-over-year basis, headline CPI is up a modest 2.1% and the core rate by just 1.6%, vs. a 37-year low of 1.5% in April. Still, deflation concerns are so heightened that the stronger-than-expected monthly results moved markets, even if most economists believe the deflation dragon remains unslain.

Following the CPI report, expectations for a 50-basis-point rate cut next week by the Federal Reserve fell to under 40% from 62% on Monday. In conjunction, the price of the benchmark 10-year Treasury note fell 23/32 to 103 3/32, its yield rising to 3.26% vs. its recent low of 3.11%. Meanwhile, the S&P Homebuilding Index, a proxy for the acutely rate-sensitive group, fell 1.3% despite a stronger-than-expected report on housing starts/permits.

In other economic news, industrial production rose 0.1%, the first increase since February, but capacity utilization remained at a 20-year low of 74.3%.

A second-straight day of losses for Treasuries had some wondering if the long-awaited, much-anticipated top in bonds has finally arrived.

"We have no idea if this is the end of the bond bull run but we do know historical odds certainly do not favor an increased commitment to bonds at these levels," wrote Steve Galbraith, chief domestic strategist at Morgan Stanley. "As with the parabolic move in the Nasdaq three years ago, our sense is everyone understands there is something strange going on in bond land."

Galbraith cut his recommended bond allocation to 20% from 25% Tuesday, while also reducing his shares allocation to 65% from 70%. (More on that below.)

Top Talk

By his own admission, comparing the Treasury market to the Nasdaq circa 2000 may be "overstating it." But the strategist observed that 10-year annualized returns on Treasuries, at nearly 10%, are running at almost twice their long-term average. "As with Nasdaq, however, everyone seems equally loath to call the top."

Actually, it strikes me that many more people are trying to "call the top" in Treasuries than those lonely few attempting to call the peak in tech in late 1999/early 2000. Moreover, many market watchers believe the "bubble" description is a gross misnomer when it comes to Treasuries.

First, there's a risk-free return to maturity in Treasuries, something stocks never did (or can) provide. Second, there are huge differences in sentiment among current Treasury market participants vs. their bubble-era equity counterparts.

"It's a facile comparison," said one fixed-income money manager. "At the top of the Nasdaq bubble, people loved stocks. People hate Treasuries at these levels and are begrudgingly buying." (Until this week, that is.)

Unlike in 2000 when "everyone was overweight tech," most fixed-income managers today aren't overweight duration, he said. "So when { Treasuries start to sell off, guys aren't in as much of a hurry to unload." (Duration measures sensitivity to interest-rate changes; the longer the duration, the more risky the bond, or portfolio.)

Just something to think about for those eagerly awaiting an implosion in Treasury prices. They may weaken further, but replicating what occurred in tech stocks after their March 2000 peak seems unlikely.

It's Different This Time

As for Galbraith's reduced equity allocation, the strategist noted the S&P hit his year-end target of 1000 -- established about three months ago -- and is now 20% overvalued.

"Although we are leery of coming across as too tactical in this shift, we think valuation continues to matter and we simply see significantly less value in the market than at the start of the year," he wrote. "While we see some good news on the fundamentals and believe that second-quarter earnings can actually surprise on the upside, much of this appears to be discounted in the market."

Galbraith stressed he's "not bearish on equities," an acknowledgement of Wall Street's growing confidence in shares/fear of being left out if they keep rallying. But if this really were "1999 all over again," as some contend, Galbraith would have found some convoluted reasons to raise his equity allocation and/or S&P target. Instead, he advised clients to "take some money off the table," something nearly unheard of during the boom.

In the microcosm, that says something about the state of sentiment. The again, how about those huge percent gains in Asian Internet stocks such as ( CHINA) and Internet Initiative Japan ( IIJI)?

Still Digging Gold

Gold futures gained 1.2% to $363.30 Tuesday thanks in part to the stronger-than-expected CPI data.

The basic theme for many pro-gold investors is that because the government is doing everything to fight deflation, including devaluating the dollar, a "reflation" cycle will emerge. (The dollar gained against the euro and yen Tuesday, but had surrendered much of its intraday advance by late New York trading.)

"Do we believe the cycle is over? Absolutely not," Frank Holmes, chairman and CEO of U.S. Global Advisors in San Antonio, declared in a conference call early Tuesday. "The causes, effects and ramifications for higher gold haven't changed."

Unlike many gold proponents, Holmes, whose firm runs about $1.1 billion, is also bullish on shares in general.

"The market is refueling for the election cycle, which is historically bullish for stocks," he said. "But reflation is also bullish for gold. Gold stocks with growth in cash flow and earnings can show spectacular performance in a rising stock market."

Gold stocks were among the better-performing sectors Tuesday as major averages posted marginal gains. The Amex Gold Bugs Index rose 3.5% while the Dow Jones Industrial Average rose fractionally to 9323.02, the S&P 500 climbed 0.1% to 1011.69 and the Comp rose 0.1% to 1668.56.

Among names U.S. Global is long, Newmont Mining ( NEM) rose 4.4% to a 52-week high of $33.84 after trading as high as $34.15 intraday. In the process, Newmont broke out of the ascending triangle pattern cited here last week.

Other names Holmes shined favor upon were Goldcorp ( GG), up 5.1%, and Randgold ( GOLD), which rose 3.1%.

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.

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