Serious Money:  The Dow Jones Industrial Average recently eclipsed the record high set at the height of the technology bubble more than six years ago - the longest wait for a new high since 1982.

Defying the historical odds and contrary to most investors' expectations, stock prices posted healthy gains in both September and October for the first time since 1998.

Following on the heels of modest gains in July and August, the stock market advanced in all four months for the first time in more than 40 years.

Meanwhile, daily price volatility is running at the lowest level in more than a decade. Are happy days here again?

There is no doubt that America's corporate sector is in excellent shape. Indeed, the current reporting season, which is well under way, will see earnings grow at a double-digit rate for the 18th consecutive quarter.

Profit margins are at a 40-year high while the after-tax profit share of GDP is at a post-second World War high. It doesn't get much better than this.

However, earnings in the current quarter received a significant boost from the insurance, basic materials and energy sectors. The insurance sector posted impressive gains due to a mild hurricane season compared with last year's depressed results following Hurricane Katrina. Basic materials and energy continued to benefit from favourable year-on-year commodity price comparisons.

Excluding these factors, the rate of earnings growth slips into single digits.

Looking forward, investors should expect no more than pedestrian growth in 2007 due to sluggish economic growth combined with difficult year-on-year comparisons, notably for basic materials and energy.

The healthy economic outlook implied by the stock market's strength is at odds with the message emanating from the bond market.

The yield curve, which graphs the relationship between interest rates and the term to maturity of identical fixed income securities, suggests that there is a better than 50 per cent chance of economic recession within the next 12 to 18 months.

The yield curve is currently downward sloping with the yield on 10- year bonds currently more than half a percentage point below the yield available on 90-day government paper.

A downward sloping curve has preceded every economic downturn and the accompanying decline in corporate profits during the past 40 years. Indeed, the only false signal in the past 50 years occurred in late-1965.

The private economy slipped into recession and a bear market ensued although an outright recession was avoided due to the military build-up following the Gulf of Tonkin incident in Vietnam.

It is widely believed that the US interest rate tightening cycle is over. However, expectations of an interest rate cut early in 2007 have been pushed back to the summer following upward revisions to previous months' employment data combined with strong gains in unit labour costs.

Conventional wisdom holds that stock prices struggle during a bout of monetary tightening and resume their upward march when the sequence of interest rate hikes come to an end.

This is simply not true. The stock market typically moves higher on the back of solid earnings gains as policy is tightened and struggles once the peak in rates has been reached until policy is eased. Stock prices typically decline during this phase of the cycle and the drop is usually accompanied by a marked increase in volatility.

Furthermore, appearances can be deceptive. Although the Dow advanced to record highs in recent sessions, only 10 of its 30 constituent stocks have registered all-time highs this year. All the remaining stocks peaked more than five years ago and are on average more than 30 per cent below their all-time highs.

The broader S&P 500 is still more than 10 per cent below its March 2000 peak while the technology-laden Nasdaq composite is more than 50 per cent below its all-time high.

Consequently, it's no wonder that the Dow's recent highs have been greeted with limited fanfare.

The recent strength in stocks defied the historical odds and the typical seasonal pattern calls for further gains in the immediate future. However, belief that the Federal Reserve will deliver a soft economic landing while corporate America continues to deliver double-digit earnings gains is almost universal.

This view will be severely tested as earnings momentum slows while the timing of interest cuts remains unclear.

Current valuations offer little protection. Indeed, stocks are trading at more than 20 times trend earnings. Investors should brace themselves for trickier times in the months ahead.