Last week was a quiet one for equities with all three major averages sagging slightly. For the week, the Dow Jones Industrial Average lost 0.1% to close at 10,785, the S&P 500 Index fell 0.3% to 1,202, and the Nasdaq Composite declined 0.9% to 2,059. Market volatility has continued to dampen. In the past, we frequently commented about how often the Dow experienced triple-digit point changes in a single week, and it is noteworthy that this has not happened in some time. In fact, last week saw two days in which the Dow made only single-digit moves.

Outside America, economic weakness in Japan continues, although corporate takeover activity in Japan has been heating up to some degree. While U.S. averages are down fractionally year to date, Japanese equities are down nearly 2%. The strength at this point in major markets is in European stocks, which are up nearly 2% for the year, highlighted by the U.K. market, which is up nearly 3.5%, and the French market, which is up 2%.

The major action last week was in the bond market, where yields climbed following Fed Chairman Alan Greenspan’s comments that the pattern of long-term rates coming down while short-term rates are going up has been a “conundrum.” We are gratified that we are not the only ones mystified by the recent action in the bond market. Chairman Greenspan offered some reasons for this conundrum, and they are the commonly cited ones. He discussed the impact of foreign central bank purchases of U.S. bonds, hedge funds buying bonds to offset other short positions, low business demand for credit, the globalization of markets and the relative attractiveness of U.S. securities. In the wake of all of this, the fed funds futures curve continues to forecast that the Federal Open Market Committee (FOMC) will continue to boost rates by 25 basis points per meeting through June, taking the fed funds rate to 3.25%. There is concern that Chairman Greenspan’s comments mean that the FOMC might raise rates faster and to a higher degree than the economy would like. In our opinion, however, once the target short-term interest rate reaches the 3% to 3.5% level, that will likely represent a normalizing of rates, and the FOMC will likely pause at that point to see what effect rates have had on the economy and on inflation.

Nevertheless, the longer bond yields stay low, the longer we can expect reasonably good growth in the United States and reasonably good news for other asset classes. Excess savings around the world is seemingly entering the United States, which acts to boost spending. The process will only end if the Fed becomes too restrictive or if U.S. bond yields begin to rise. For equities, the profit outlook remains murky enough to keep investors from moving prices up aggressively, particularly if the fed funds rate continues to rise above the 3% to 3.5% level and/or if the economy does eventually slow. Clearly, we are past the period of maximum bullishness, as the Fed is in the process of reducing liquidity and it seems likely that profit margins will begin to drop somewhat. While we are unlikely to be in a full-out bearish environment in 2005, we may be in a rebound or correction period similar to what we saw in the mid 1990s and in the early to mid 1980s.

Mr. Doll is president and chief investment officer of Merrill Lynch Investment Managers.