We've become equal-opportunity worriers.

A few months ago, investors were fixated on deflation, afraid the economy would plunge Depression-style and take the stock market with it. Now, with the stock market up more than 30 percent from its lows, oil prices doubling and U.S. Treasury bond yields sharply higher, investors have become worried about the opposite issue - inflation.

Gold and oil have moved sharply up on the fear that the trillions of dollars in government bailout spending eventually will end badly, with inflation eating away at the buying power of money.

While the flow of money into the system ultimately could ignite inflation, the concern seems disconnected from today's realities. The government reported Tuesday that wholesale prices were down 5 percent in May from a year earlier, the largest drop in nearly 60 years. The consumer price index, due Wednesday, has fallen year over year for the past two months for the first time since 1955.

"Some investors fear that the rise in gold prices [and] interest rates and the rapid expansion of money supply around the world indicate that inflation is a looming threat," said Pequot Capital Management strategist Byron Wien. "But that seems unlikely anytime soon."

Wien notes that exports from leading manufacturers China and Germany still are declining. "And with excess capacity almost everywhere, and high levels of unemployment, there seems limited risk of any near-term rise in inflation," he said.

In addition, Tuesday's report on May industrial production was dismal.

"A third of industrial capacity now sits idle," said Citigroup economist Steven Wieting. May production fell 1.1 percent, a continuation of a trend for 16 of the past 17 months.

"To get inflation, you need plenty of money and plenty of demand," said Mairs and Power Balanced Fund manager William Frels. "There is plenty of money but not plenty of demand."

Clearly, the weak job market and the restraint in spending are not the types of conditions that lead to higher pay or higher prices, ingredients for inflation.

Chicago Federal Reserve Bank President Charles Evans said this week that he remains more concerned about the possibility of deflation than inflation, but he acknowledged that inflation is difficult to access until it has taken hold of the economy.

To avert inflation, Evans said, the Fed would need to pull back some of the supply of money in the system. That's a feat worrying some investors. But, he said, the Fed was creative with its rescue maneuvers and can be equally creative when unwinding them.

Because the economy remains weak, but inflation and rising interest rates could be a threat in the future, some financial advisers are going over portfolios to make sure they are set for any type of economic environment.

Trying to anticipate interest rates is generally a loser's game for the best of bond fund managers, so they are avoiding large bets on any type of investment and retaining diversified portfolios of stocks and bonds.

Martha Pomerantz, portfolio manager for wealth-management firm Lowry Hill, said that for the first time she is considering investments in hard assets such as commodities and gold, but has not taken the plunge.

Frels said that because inflation eventually could appear; he is avoiding bonds that will mature in more than five years. The last thing investors want during a period of inflation and rising interest rates is to be locked into bonds that don't mature for years. Given the weakness in the economy, he also remains reluctant to invest in non-investment grade, or junk, bonds. He generally invests in dividend-paying stocks, which can be a defense against inflation.

Sam Stovall, a strategist for Standard & Poor's, said dividend-paying sectors such as utilities and energy stocks tend to do best in inflation. On the other hand, if inflation rises above 4 percent, stocks tend to perform poorly.

Currently, investors are more focused on stocks doing poorly because of a weak economic environment, rather than inflation.

"The real question now is: Do you see the economy gradually improving?" said Ned Notzon, chairman of T. Rowe Price's asset-allocation committee.

He thinks so, and the committee recently added stocks to the firm's balanced fund in preparation, moving to 65 percent from 60 percent. Yet, Notzon added, "We are still concerned about the recovery."

Given the prevailing weaknesses, "significant inflation seems far off," he said.

Gail MarksJarvis: gmarksjarvis@tribune.com

(c) 2009, Chicago Tribune.

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