A heretical idea is making the rounds of Wall Street these days - that credit-tightening by the Federal Reserve and rising interest rates might actually be good for the stock market.
To experienced investors, that's a bit like declaring that the law of gravity has been repealed.The suggestion is not only hard to swallow. If it is true, it throws a lot of other basic financial calculations out of whack.
There is an abiding logic to the idea that rising interest rates serve as a brake on future economic activity and that they simultaneously tend to attract money out of stocks into less risky interest-bearing investments like Treasury bills.
But the experience of the past few months in the financial markets hasn't followed the standard script at all.
As short-term rates in particular have climbed steadily, stocks have staged a spirited rally, climbing back above where they stood on the eve of Black Monday Oct. 19, 1987, when the Dow Jones industrial average fell 508 points.
Among the many explanations that have been offered for this paradoxical performance, the most commonly advanced one says old relationships have been distorted by the increasing internationalization of the markets.
That has introduced a new variable of increasing importance: fluctuations in the dollar against other leading currencies.
"There is a silver lining to high short-term interest rates," said John Connolly at Dean Witter Reynolds Inc. "They kept the dollar firm, even bullish, in the face of a surprisingly poor trade report" issued by the Commerce Department on Jan. 18.
"That enabled both stocks and bonds to rally."
Adds the Merrill Lynch Market Letter in its current issue: "It's interesting to note that the dollar and the Dow Jones industrial average have been following virtually parallel paths since mid-November."
"Interesting" might not be the first word chosen by practitioners of the art known as tactical asset allocation, the dominant approach to decision-making in the late 1980s among institutional money managers and the brokerage firms that cater to them.
Asset allocation is a system of shifting money under management among stocks, bonds and short-term interest-bearing securities, often based on a computer "model" that automatically weighs a variety of influences.
The typical asset allocation model puts a heavy emphasis on interest rates.
"As short rates go higher and higher, the models allocate less and less to equities," observed Michael Sherman at Shearson Lehman Hutton Inc.
"This has worked more often than not, but we submit that the decade of the 1980s is at variance with postwar experience.
"Many investors have wondered why bond yields don't rise when the Fed raises short rates.
"The reason is that long-term investors are encouraged by a tough Fed monetary policy because it assures them that inflation won't erode their historically high rate of return.
"In the same way, holders of U.S. currency are encouraged by the prospect of high short-term interest rates."
All this raises a corollary question. If stock-market investors have learned a way to become comfortable with high and rising interest rates, how might stocks react when the Fed loosens credit and short-term rates decline?
Many analysts argue that such a setting would be ideal for a powerful rally in the stock market. Others say the optimists can't have it both ways, benefiting from both rising and falling rates.
As this debate persists, some suggest, the answer may well be provided by currency traders and how they treat the dollar if and when interest rates do start to fall.