Stocks rose modestly this week, but the gains seemed much more impressive considering the drubbing that opened the holiday-shortened week.

Indeed, the proverbial wheels felt like they were coming off the bus Tuesday after an announcement Monday -- when U.S. markets were closed -- by South Korea's central bank that it would seek to diversify its foreign reserve holdings.

In response, and also in reaction to oil's surge (which a weak dollar exacerbates), the Dow Jones Industrial Average suffered its worst point loss since May 2003 and the S&P 500 its worst in six months. Meanwhile, the dollar sustained its biggest decline since August and gold futures soared to a 2005 high.

South Korea's announcement seemed to be a fulfillment of the "sum of all fears" scenario whereby foreigners refuse to own or buy more of the dollar and dollar-denominated assets, sparking a self-replicating cycle of dollar selling by foreigners leading to tumbling financial assets, leading to more dollar selling and, ultimately, sharply higher interest rates. That, in turn, would crush the housing market, consumer spending and the economy in general.

But as is often the case, the time to buy was when the situation looked worst.

Mounting a very successful three-day recovery from Tuesday's widespread losses, blue-chip proxies ended the week at their highest levels of 2005. The Dow ended the week up 0.5% to 10,842.57, the S&P 500 rose 0.8% to 1211.41 and the Nasdaq gained 0.3% to 2065.38.

Stocks rose modestly Wednesday after the consumer price index report quelled inflation fears -- for now -- but Thursday afternoon was key to the comeback as stocks rallied solidly after oil had a modest intraday reversal. The pattern repeated Friday as stocks gained momentum in the afternoon following an upward revision to fourth-quarter GDP and further evidence of robust housing activity, despite a slight drop in existing home sales.

The bad news (for those long) regarding the week's economic data is that if above-trend growth continues, it will absorb slack in the economy and boost inflation risks. If that happens, "the Fed may begin to consider tightening beyond neutrality to outright restraint," as Morgan Stanley economist Richard Berner observed. "That's almost certainly not in the price in bond, equity or currency markets."

The minutes of the Fed's February meeting -- released Wednesday -- showed no urgency to tighten among Federal Open Market Committee members, and traders were unafraid of the Fed on Friday, when the Dow rose 0.9%, the S&P gained 0.9% and the Comp rose 0.6%. The rally was broad-based and volume solid, but down from Tuesday's action, the busiest volume day of 2005.

ExxonMobil ( XOM) was a big winner Friday after an upgrade by Prudential Securities and amid talk of a "bubble" in energy stocks. For the week, the Amex Oil & Gas Index rose 4.4%, while the Philadelphia Stock Exchange Oil Service Index gained 2.6% as crude prices hit a four-month closing high of $51.49 Friday, up 6.5% for the week. (Elsewhere this week, the euro rose 1.3% vs. the dollar, gold rose 2.2% and the 10-year's yield was essentially unchanged at 4.27%.)

Old Mo vs. New

Bubble or not, steel and other basic materials stocks are certainly in fashion. Still, there remains an intense focus on tech stocks and a hope that the group will return to its former glory. Various indicators, including upbeat guidance this week from Ingram Micro ( IM), suggest another period of outperformance may be at hand, akin to the fourth quarter of 2004 or most of 2003. (No sane observer expects a return to the halcyon days of the 1990s.)

The Comp rallied Thursday -- and again Friday -- despite a high profile downgrade of Internet bellwethers Google ( GOOG) and Yahoo! ( YHOO). Coupled with FindWhat.com's ( FWHT) implosion after warning of weaker-than-expected first-quarter sales, Thursday was a tough day for Internet stocks, which fell 1.3% for the week, based on TheStreet.com's Internet Index.

Meanwhile, the Philadelphia Semiconductor Index, or SOX, rose 3.7% to 443.70 for the week, evidence (perhaps) of the rotation out of Internets and into semiconductors that RealMoney.com contributor Helene Meisler observed . The SOX also secured a weekly close above its 200-day moving average of 442.56, an accomplishment fellow contributor Richard Suttmeier says is key to tech resuming leadership, which he maintains is crucial to a successful 2005.

In a similar vein, Tobias Levkovich, U.S. strategist at Citigroup's Smith Barney unit, also made a positive call on semis this week, adding Intel ( INTC) to a recommended list already inhabited by Applied Materials ( AMAT).

Levkovich's full-blown semi bullishness was part of a recommendation to "add beta" (or volatility) to portfolios, given a belief "the stock market appears poised to generate a strong upside move." This is based partially on his view that sentiment is more negative than commonly cited indicators such as the CBOE Market Volatility Index might otherwise suggest.

Citing widespread concern about valuations, the outlook for consumer spending, the "supposedly weak capex recovery, and the eventual pricking of the alleged housing bubble," Levkovich said his proprietary sentiment model is in "panic territory" for the first time since the summer of 2004, which prompted the strategist to turn more optimistic in September. In retrospect, that was a prescient call, as was his more bearish call in early 2004.

Whether this week's optimism will be similarly rewarded remains, of course, to be seen. Still, optimism was clearly not the prevailing emotion early this week, regardless of the VIX's level or any other sentiment gauge. How quickly traders are able to forget Tuesday's wipeout will go a long way in determining whether it will prove to be a big misunderstanding -- as South Korea's central bank suggested Wednesday -- or a harbinger of the dollar and market's shared fate.

P.S. I'll be back on John Batchelor's nationally syndicated ABC Radio Network show starting at 9 p.m. EST to discuss these and related issues Friday night. Check Wabcradio.com for streaming Web casting.

Editor's note: Aaron Pressman is on vacation.
Aaron L. Task is the co-executive editor of TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to atask@thestreet.com.

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