The Dow Industrials fell 81 points yesterday, but we view the relatively light damage as a sign of strength, considering the news. Profit warnings were issued by several retailers, and Helicopter Ben was on the tape with yet more “worries” about “inflation.” For a guy supposedly steeped in the lessons of the Great Depression, it’s amazing that the ongoing collapse of the housing market has yet to shift his attention to the real economic threat of debt deflation.

There was a related, negative development in the bond markets, as yields on the 10-Year Treasury Note crept toward the 5% level. Since mortgage rates take their cue from this instrument, it portends even greater pressure on the already imploding real estate sector in the coming months. Higher rates will be weighing not only on home sales, but on the many millions of homeowners with adjustable-rate mortgages.

Of course, all of these pathological woes have been metastasizing for some time without dampening investors’ ardor for stocks one bit. This shouldn’t surprise anyone, given that the stock market is in the midst of a full-blown mania – one as impervious to danger signs as a crack-addict to the warning label on a pack of cigarettes.  

We surmised long ago that the stock market had lost its ability to discount trouble in the accustomed way -- i.e., by falling. Private equity deals alone have removed hundreds of billions of dollars worth of shares from the market in just the last year or so, shrinking supply and making it possible for even relatively tepid demand to drive the broad averages higher. In the absence of any more shards of disturbing news this morning, we should expect tepid demand to rule the markets once again.  It may take investors a little while to get used to 5% yields on the 10-Year Note, but once the pill has been swallowed the attitude will doubtless revert to its devil-may-care self once again -- until the spectre of 6% yields looms on the horizon.

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