stock marketBig-name investors were bracing for inflation just months ago. But as the economic recovery shows signs of slowing, deflation has become the main bet for a growing number of financial market luminaries.

As deflation displaces inflation as a talking point, though, investors should note the real fixture of Wall Street remains extrapolation. And the most rewarding bets might be to go against the grain since reality tends to veer toward the messy middle.

A severe financial collapse two years ago, for example, led to predictions of a return to the Stone Age. When a recovery emerged sooner and stronger than most had anticipated, Wall Street projected a "Goldilocks scenario" of booming earnings yet benign inflation.

Unwieldy debt loads in minor Southern European economies like Greece created fears of an outright breakup of the eurozone, which proved grossly exaggerated. And now, signs that the economic recovery is slowing are leading to calls for a deflationary spiral or double-dip recession.

Shunning Stocks Despite Increasing Strength?

The prospect of deflation has led investors to pile into safe assets like bonds, bringing yields on U.S. Treasurys to rock bottom. In a scenario where prices are falling, a steady income stream (however small) from a safe asset is tough to trump, according to this line of thinking.

But that has created a situation where investors are shunning stocks despite what's increasingly shaping up to be a very impressive second-quarter earnings season. Guidance, too, has been solid, and the risk that companies would use the cover of a slowing economy to ratchet down next year's earnings expectation is waning.

Some companies reported lackluster revenue growth at the start of the earnings season. But strong results in economically sensitive sectors like media paint a more bullish picture.

Media giant Time Warner (TWX) raised full-year guidance after impressive results. And earnings at CBS (CBS) leaped tenfold compared to last year, thanks to a rebound in sectors like local advertising that offer a good proxy for business activity.

Ahead of a Big Wave of Capital

Even the biggest bears like Gluskin Scheff economist David Rosenberg estimate that the S&P 500 companies will earn $77 a share next year. While a sharp dive from the record highs of $96 that Wall Street analysts are expecting, that's still enough to put a valuation on the S&P 500 of 1,155 with a reasonable 15 multiple.

If the tide turns, investors might find themselves followed by the massive pile of capital that's currently content with lower returns in safe assets. And the time to sell would be when a rise in stocks is exaggeratedly lauded as the return to a new gilded era, if prior machinations are any guide.

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deflation is better than inflation.
that said, vote out all career politicians and keep voting out incumbents til they start being fiscally responsible!

August 06 2010 at 8:11 AM Report abuse +2 rate up rate down Reply

Capital accumulates capital; it does not disburse capital. We have deflation because the consumers are not buying. They are not buying because Wall Street and the financial sector have transferred wealth out of circulation and into the markets that do not create jobs but export jobs. There is not enough money going to consumers to keep the economy afloat and the capitalists wonder when things are going to go back to normal. Here is a little bit of news capitalists. Workers (consumers) are not just an entry on the debit side of the balance sheet they are the consumers who buy the goods and services that business offer.

August 06 2010 at 6:18 AM Report abuse rate up rate down Reply

I'm 100% invested... No margin! As we "turn the corner," I don't want to hear any Republicrats either taking credit or blame, for something we ought to thank God for. Just fade into the background, or visit Politics Daily! :-)

August 05 2010 at 11:02 PM Report abuse +1 rate up rate down Reply

If Bush tax cuts are not extended, you will see the market totally crash and tank and the wealthy with the most investments in WallStreet will pull out and sell off hurting once again the Little Man who works hard for a living-I have little faith in our markets and WallStreet with all the crooked paws in it as it as already exists

August 05 2010 at 10:15 PM Report abuse rate up rate down Reply

Extrapolation , extrapolate . extrapolating a good buy is like pulling teeth in this market when we face more deflation. Everyone is too busy paying debt to do the economy any good .Especially the small people with no jobs. Reality is they dont need us any more to make a profit they just wait to get bailed out.

August 05 2010 at 7:14 PM Report abuse +1 rate up rate down Reply
1 reply to ajgorm's comment

"they don't need us"..... sounds like another out of work blue collar welfare recipient who doesn't want to see educated people make any money... if you blog about it, it will come true... now tap your red ruby steel toed boots together and say "There's no place like a Union hall, there's no place like a Union hall"

August 05 2010 at 7:19 PM Report abuse -1 rate up rate down Reply

Are you really going to go and be a buyer in the face of deflation??
That would not be a good idea look up the word deflation in the dictionary
and think again. Its a shock to me that anybody would suggest that you should consider buying during a deflationary period. But don't listen to me I never lost a dime in the market can you say the same??

August 05 2010 at 5:54 PM Report abuse rate up rate down Reply
1 reply to BUFFALO's comment

ok, I won't listen to you... Mr. Never made a dime in the market

August 05 2010 at 6:00 PM Report abuse -1 rate up rate down Reply

on a more serious note.... the gains do seem to be holding their ground this time... could be a DOW 11,000 moving average on the menu

August 05 2010 at 4:52 PM Report abuse rate up rate down Reply
2 replies to socialeconomist's comment

I like CAT to $90 too... maybe $100 on a good day

August 05 2010 at 4:53 PM Report abuse rate up rate down Reply

here's another free bone to the desperate:.....GIGA....... $2.73/share earnings after retooling the books, 7 straight quarters of profit (usually around a nickle), only 5 million outstanding shares, and the stock only costs $2.35..... just don't look at the volume and expect to hang on for a few years

August 05 2010 at 5:41 PM Report abuse rate up rate down Reply

I bought some more Bank of Ireland (IRE) today.... I should have bought yesterday but I was hoping for more of a pullback that never came... sold at $4.80 on the stress tests and bought on a $4.60 pullback isn't bad to add more shares on a long term ride... I didn't fall in love with this stock... it's just a summer fling till it hits $10-$12.. :)

August 05 2010 at 4:50 PM Report abuse rate up rate down Reply
1 reply to socialeconomist's comment

my theory is:.... Republicans get elected to all those Senate seats this Nov... everyone experienced anticipates this and momentum will build between now and then... getting in now is getting in early.... getting in during Sept is still good.... getting in during Oct is cutting it close.... Then the Small business lending and tax cuts will come and the economy will recover just in time to vote out Obama

August 05 2010 at 5:14 PM Report abuse +1 rate up rate down Reply

Mr. Kumar---please tell us what you have bought lately---

August 05 2010 at 2:18 PM Report abuse rate up rate down Reply
Tom & Brenda

Are you nuts? Bying opportuinity?? The market is down 28 pts.
People are REALLY alarmed. Give me a break!!!

August 05 2010 at 2:05 PM Report abuse rate up rate down Reply