Deflation emerges as a Wall Street concern

''Deflation'' - a strange word to ears that have grown accustomed to its opposite, inflation, or to the 1980s variant, ''disinflation.'' Deflation is all the rage today. Falling prices are one aspect of deflation.

Economic commentators and financial-market analysts alike are invoking the word to describe what is happening to the commodity markets. What's happening to commodity markets is a virtual rout. In inflation-adjusted terms and otherwise, prices have been falling in copper, steel, aluminum - and most significantly - oil.

Some citizens of the financial universe, no longer greatly worried about an explosion of inflation, are beginning to worry about an implosion of deflation. It is too early to tell if this is anything more than doomsayers looking for new forms of bad news. Their primary argument, however, is sobering: If commodity prices continue to drop, debtor nations will not have the money to pay back loans; defaults will follow; American banks will be in trouble.

That, however, is a worst-case scenario.

Somewhere short of the worst case is what many would consider an optimum economic and investment environment for America. At present, you can combine the lower commodity prices with the continued moderation of inflation, with a Federal Reserve signal that credit may not tighten, and with prospects of strong corporate earnings. That leads to the conclusion that the economic environment 14 weeks before the presidential election is - and may continue to be - rosy.

As a result, the bond market has been growing stronger, no longer concerned that interest rates are heading inexorably upward. In fact, in recent weeks bonds have dropped a full percentage point in yield. If bonds hold up in early August during the Treasury's credit-draining ''refunding'' session, the durability of the bond rally may have been proved.

Moreover, given the link between bond and stock markets, an upward-tending stock market is likely to occur at the same time. That may have begun last week. After reaching an 18-month low of 1,086.57 on the Dow Jones industrial average, the stock market turned around last Wednesday. Gains of 10.38, 10.60, and 7.07 points were posted the last three days of the week.

A particularly deflationary rumor - that the Organization of Petroleum Exporting Countries was on the verge of collapse - contributed to the latter rise. And the money supply report for last week showed a drop of $100 million, bolstering Fed chairman Paul Volcker's assertion that the supply was not in need of tightening. That spurred on the market. The Dow closed Friday at 1,114.62, up 13.25 points since July 20.

Is this the start of the much-advertised summer rally? Some market-watchers think so.

Two relatively optimistic analysts are to be found at two brokerage firms that weathered the awful market conditions during the second quarter. Suresh Bhirud, technical analyst at First Boston Corporation, and Eric Miller, chief investment officer of Donaldson, Lufkin & Jenrette (DLJ), represent firms that posted gains while most other brokerages sustained big losses.

Mr. Bhirud holds that interest rates will probably not rise in the next three months. He expects a technical rally on the stock market - but one that does not reach beyond 1,180 to 1,200 on the DJIA. Under current economic conditions, he says, ''there is no question that the economic recovery is healthy and will go at least through the end of this year and the first half of next year.''

Anticipating a strong Christmas retail season, Mr. Bhirud favors the stocks of retail stores and expects a recovery in cyclicals and growth stocks.

DLJ's Mr. Miller has been counseling portfolio managers for many months now to try to break out of ''crowd'' thinking. He notes that the 1984 financial markets have been as troublesome for technical analysts - who track market statistics and patterns - as for fundamental analysts - who examine individual stocks.

''We believe that there are basic flaws in strictly top-down and bottom-up methodologies and urge a multidirectional approach - or for want of a better term, a poking-around or circle-the-wagons methodology.''

Miller is cautious about the market today. It has been a rough seven months on Wall Street, and three up days do not a big rally make. But he is encouraged that bonds weathered what would usually be bad news: a hot GNP and a social security payment boost.

''There was no negative impact on the bond market,'' Miller says. ''That's constructive and suggests that a rally in bonds is occurring. We can probably look for continued decline in bond rates - a precondition for a better stock market.''

Nonetheless, he remains skeptical about the stock market. Declining bond rates may make stocks more competitive with bonds, but they have to drop further to make stocks really attractive. Moreover, with the expansion looking strong for a minimum of six to nine months, liquidity might begin to run down.

''There are a few rays of sunshine,'' Miller says. ''But not too many just yet.''

Interest rates Percent Prime rate 13.00 Discount rate 9.00 Federal funds 11.50 3-Mo. Treasury bills 10.26 6-Mo. Treasury bills 10.54 7-Yr. Treasury notes 12.92 30-Yr. Treasury bonds 12.80 Source: Bank of Boston