The market continues inching up despite fears about rising inflation and a declining dollar. The market rally may still have legs in the short term, these experts say, but inflation will hit eventually.

Who s Talking: Jeffrey Saut, managing director, Raymond James

The Gist: Investors fear the runaway rally may be over-extended, but there s still plenty of cash on the sidelines that could pile into the market to keep it creeping up.

Fear of the music stopping (in other words, that the recent rise in stock prices will soon come to a halt) is worrying most investors, says Saut. The idea that the market is rising even as the dollar declines in value is especially vexing to some, he says. Investors have even speculated that the market may experience another October 1987. (That s the date of so-called Black Monday, when stock markets around the world crashed.)

But Saut says there are several reasons to believe the stock market will continue to head upwards. For one thing, the dollar will remain stable in the short term. As the economy recovers, so too should the dollar, says Saut. After all, the dollar index is at the same levels it was in November 2007, he says. However, longer term, inflation will win out, says Saut. The country is currently experiencing both inflation and deflation at once, says Saut. High-end wage-earners are experiencing deflation because their housing values have collapsed, their retirement accounts have dropped off in value, and their bonuses have been whacked. But prices on health care, food and insurance are all rising, says Saut, all indicators of inflation.

Naturally, investors are wondering how these factors will affect the stock market. Saut says the March 2009 lows were lower than the norms and that the rally merely took the market back to normalized valuations, and since the decline was so deep, Saut says there is no reason why stocks can t rally to above those norms. What s more, stocks don t need strong economic growth to rally, he says. They just need some growth. According to market research firm GaveKal, says Saut, slow growth will actually be more beneficial to equity markets than stellar growth, since slower growth typically allows for low interest rates and strong levels of liquidity. A prolonged period of cautiousness among consumers and banks is an ideal environment for corporate profit growth, according to GaveKal.

There is also a lot of cash yet to be invested in equities, says Saut, enough to buy out the entire S&P 500. In such an environment, Saut s advice is to buy large, dividend-paying stocks or stocks with lower volatility. A few of his suggested stock picks: Home Depot, Chevron, Pfizer and Altria.

Who s Talking: The Wells Fargo Securities Economics Group

The Gist: Investors worry the signs of economic recovery are still too good to be true. Economies of Western nations will reach positive, if slower, growth rates by next year, but inflation remains a threat.

The go-go days of 2004-07, when the world averaged about 5% economic growth per year, appears to be a thing of the past, the research team says. But the team says the medicine doled out by governments around the world during the economic crisis slashing interest rates and pouring out fiscal stimulus -- is working. Asian economies are leading the way since their financial systems weren t as indebted as Western economies, which allowed their banks to crank up their lending again. Canada, the U.S. and most Western European economies are also showing signs of stabilization, the group says.

Eleven out of the 12 Fed regions reported that economic conditions stabilized or improved in July and August. The trade deficit also widened more than expected as imports rose more than any month since March 1993, a sign of some firming in domestic demand, the group says. Meanwhile, consumer sentiment has risen, though consumer spending won t likely see a major shift any time soon since employment conditions haven t improved, the group says.

The big question, according to the Wells team, is what effect inflation will have on investors. Core inflation, inflation excluding changes in food and energy prices is still below the 2%, which gives the Fed free reign to keep liquidity high in order to help the economy recover and allow banks to improve their balance sheets. But with 10-year Treasury bonds around 3.4%, it won t take Jimmy Carter-type inflation numbers to wipe out any real returns, the group says. And if the Obama administration increases federal spending to boost the economic recovery and win the midterm elections in 2010, global investors will turn increasingly skittish about both Treasurys and the dollar. In such a situation, higher interest rates, a depreciating dollar and higher inflation all seem fairly likely, if not the best case, the group says.