John Maynard Keynes once said that playing the stock market was "analogous to entering a newspaper beauty-judging contest in which one must select the six prettiest faces out of a hundred photographs, with the prize going to the person whose selections most nearly conform to those of the group as a whole."

Along the same line of thinking, a portfolio manager trying to keep up with current market trends should pay heed to the stock market moving higher Wednesday despite hawkish testimony from Federal Reserve Chairman Alan Greenspan and disappointing outlooks from Intel ( INTC) and Yahoo! ( YHOO). Fueled largely by strong biotech earnings, the Nasdaq Composite closed at a four-year high and in positive territory for 2005, while the S&P 500 again closed at a four-year high.

The Dow Jones gained 42.59 points, or 0.4% to 10,689.15, its highest close since March, after earlier touching a low of 10,581. The S&P 500 rose 5.85 points, or 0.5%, to 1235.20, while the Nasdaq gained 15.39 points, or 0.7%, to 2188.57.

The gains came even as Greenspan signaled that the Fed is going to continue raising rates -- seemingly past current expectations.

In what will likely be his last testimony to Congress, Greenspan repeated his mantra that even if inflation pressures remain contained at the moment, the economy remains strong enough for the Fed to continue removing its accommodative monetary stance.

Bond pits first reacted to Greenspan's comments by sending the 10-year Treasury bond sharply lower in price and its yield up to as high as 4.23%. But the benchmark note bounced back and ended up 5/32 on the day with its yield down to 4.16%.

Equities players, busy sifting through the second-quarter earnings season, largely ignored Greenspan's comments. Early pressure on major averages was mostly due to an earnings miss from GM ( GM) and the disappointing outlooks at Intel and Yahoo!, which fell 4.4% and 11.5% respectively.

Afternoon gains were powered by Amgen's ( AMGN) earnings and hopes for positive tech surprises, as delivered after the close by eBay ( EBAY), whose shares were recently up 12.7% in after-hours trading. Tech aficionados now turn their attention (and hopes) to results after the bell Thursday from Google ( GOOG) and Microsoft ( MSFT).

Never Assume

There may have been some relief that Greenspan didn't sound even more hawkish than he did. After all, he didn't stray too far from his previous stance. But judging by all the recent commentaries, many market players had still nourished secret hopes that the Fed would soon stop raising interest rates, or at least pause, sometimes soon.

Those expectations, leftovers from the slowdown in economic activity -- the so-called soft-patch -- seen during the spring, still have not gone away completely.

"The market is still assuming that the Fed is going to be more gentle and is going to cease raising rates sooner than is likely," says Tom McManus, market strategist at Bank of America.

Those misplaced expectations have kept the strategist more cautious on equities this year. He reduced the equities weighting in his model portfolio to 55% from 60% back in June, then saying that investors were anticipating strong stock performance on the belief that the Fed was close to wrapping up its rate-hikes campaign. He kept traditional bonds out of his portfolio, preferring Treasury Inflation Protected Securities (TIPS).

But the market has continued to power ahead since June 6, the date McManus lowered his recommended equity allocation. Since that date, the Nasdaq has gained 5.4%, the S&P has gained 3%, and the Dow has added 2.1%.

Bond prices continued to rise throughout June, although they have started to come down since the last Fed meeting on June 30.

After Greenspan's speech, the market also began to price in for the first time some chances that the central bank's fed funds rate will stand at 4.25% early next year. Market expectations so far pin the key rate at 4% by year-end, implying one pause at one of the Fed's next four meetings.

"The market has started to move a little bit in my direction, but that's really not consequential," McManus says. The market has yet to come to terms with the implications of higher short-term rates, which are "quite important, given the symbiotic nature of stock market wealth, house wealth and retail sales."

Remaining stubbornly skeptical given the Fed's aggressive stance, the strategist says "you can't put a high price-to-earnings multiple, which implies that a trend is sustainable, on profits derived from the sales of highly discretionary items."

Jim Paulsen, market strategist at Wells Capital Management, for his part, maintains a much more sanguine view of current market trends, even if he does expect the Fed to continue raising rates past current market expectations and into next year.

"I think if you're a stock bull, you should be hoping that rates go up, because in the current environment it means the economy remains stronger," he says.

Paulsen's approach is to be underweight bonds and overweight equities -- such as small-caps and tech stocks -- as he believes the stock market can continue rising as long as the Fed remains in a tightening mode. Only when the Fed stops, he says, will it mean the economy and profits have peaked.

"The same thing that will takes the S&P 500 to 1300 will take bond yields to 5%," Paulsen says. "Eventually, higher rates and inflation would be a problem, but you don't go from here to there without stocks going higher."

On Wednesday at least, the stock market's gains in the face of Greenspan's comments seemed to validate that view.

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; click here to send him an email.

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